Corporate Treasury Weekly: credit regains confidence – and beckons more supply

03 June 2021

Imogen Bachra, CFAEuropean Rates Desk Strategist

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Breaking down trending trades & themes to help corporate treasurers get ahead of the latest issues shaping markets

Markets are performing well this week – including credit and riskier assets – as investors start regaining confidence and central banks start using more hawkish language around inflation. Lower bond yields and stronger investor confidence was duly met with more supply and pricing that favoured borrowers.

  • Markets were up this week – with credit and riskier assets performing particularly well: Credit markets took comfort in better government bond performance in Europe, while other risk assets performed well, and bond yields stayed low. Stronger economic data, particularly in the Euro Area and UK, helped fuel investor confidence.
  • The Bank of England (BOE) and the Fed are striking a more hawkish tone on inflation: BOE Governor Vlieghe, who usually strikes a more dovish tone, suggested a recent move to higher bond yields appears justified by a stronger economic backdrop – and has revised up future interest rate projections to 0.75% by 2024 (25 basis points higher than the start of the year). Meanwhile, the Fed’s Governor Quarles added to the debate over its more hawkish direction by stating that wage pressures and huge fiscal spending suggest medium-term inflation risks are rising.
  • The European Central Bank (ECB) is still dragging its feet on reducing quantitative easing: Many ECB speakers this week emphasized the transitory nature of inflation, the still uncertain economic outlook and the rise in European bond yields as reasons for the Bank to remain cautious. This suggests it is in no rush to pull back on tapering quantitative easing in June.
  • US employment data could show yet more signs of labour supply issues: Friday will bring US non-farm payroll, which will garner even more attention than usual given the record miss against expectations in April (266K vs. 1 million). We expect a 550K rise in jobs, a little below consensus (650K). Higher bond yields are a risk if a larger-than-expected job growth is followed by stronger inflation data, but another miss vs. expectations could be yet more signs of labour supply issues.
  • An uneven path to monetary policy tightening creates new opportunities in FX: Sterling saw its largest moves this week on the back of Governor Vlieghe’s comments, and we continue to see strength so long as the latest coronavirus variant doesn’t dramatically alter the course of the recovery. Meanwhile, the Euro has held up well thanks to strong data – and despite the ECB’s more dovish tone on inflation.

Credit is regaining confidence – and with that comes more supply

Credit markets have been more constructive this week, recovering from last week’s yield widening and supported by better sovereign bond performance.

This week saw more than €10 billion in European supply, with a strong sustainability flavour: University College London printed its inaugural £300 million 40-year sustainability bond, and EDF sold the first social hybrid corporate bond – which saw very strong investor demand and marked a turning point for primary market performance.

Corporates are re-assessing their net investment hedging strategies as spread between UK and US short-term rates shrinks

Net investment hedging – where corporates swap the currency of their debt to better match assets, reducing the volatility of their balance sheet to FX fluctuations – was popular amongst US corporates in 2020, where short-term (up to 3-year) US rates were as much as 20 basis points higher than UK rates at similar maturities. Over the past month, this differential has collapsed, forcing many to re-evaluate hedging strategies.

UK corporates are exploring US  dollar net investment hedging for the first time (swapping Sterling-denominated debt to US dollars) as there is no longer a higher rate penalisation for doing so. Meanwhile, US corporates, which used to benefit from swapping their debt out of higher US rates into lower UK rates, are having to extend their hedges (towards 5-years and beyond) in order to capture the beneficial interest rate differential.

Better LIBOR transition solutions for those with loan-linked derivatives

For many corporates, LIBOR transition is a significant challenge, particularly those with loan-linked derivatives due to the mismatch in convention between the loan market and derivative market. This leaves some with a difficult predicament: either accept a mismatch between their loan and derivative if they rely on the International Swaps and Derivatives Association (ISDA) fallback protocol, or alternatively, undertake an extensive and manual exercise to proactively transition their loan-linked derivatives pre-cessation to ensure alignment with the underlying loan.

We think a better solution lies in one that enables loan-linked derivatives to fallback to Sterling Overnight Interbank Average Rate (SONIA) post cessation on the same basis as the loan.

The disruption caused by the pandemic makes it quite difficult to use past data as a reliable lens for viewing a future capex trend. Business investment actually fell some 11.9% during the first quarter of this year, much more than rates seen during previous lockdowns – and it remains unclear why (we do think it’s likely the data will be revised). Still, the latest investment intentions survey data show a sharp rebound despite remaining some way below pre-pandemic levels (see below).

Good intentions: UK corporate capex intentions (standard deviation from the mean)

Sources: Bank of England (BOE), BCC Group, Confederation of British Industry (CBI), NatWest Markets.

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