Corporate Treasury Weekly: economic recovery & inflation are delicately balanced in favour of credit

15 April 2021

Giles GaleHead of European Rates Strategy

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

The big picture

With corporate earnings season soon upon us, economic optimism & inflation remain the top market themes but bond yields are likely to stay in check in the US & Europe, with the new fiscal year bringing pension funds and foreign investors into the former and the European Central Bank (ECB) boosting its asset purchasing in the latter. We think corporate earnings will likely validate the market’s optimism – and help shift perceptions around Europe, where vaccinations are accelerating – so we continue to expect higher rates in the future, but for now, the supportive environment for credit should persist.

This week in headlines

  • The recovery – and inflation pressure – are top themes this week, with attention shifting to the US: We are starting to see evidence that inflation pressure is building. US producer prices were up 1% in a single month and Chinese producer prices 1.6%, the highest monthly rise in 10 years. A slew of US business surveys, retail sales & inflation data expected later this week should help paint a clearer picture of the economic recovery and inflation (stay tuned for an update on this next week!).
  • End-of-quarter investor activity means we’re less bullish on US bond yields near-term: Investor activity can be a little different around quarter-end and the start of a fiscal year. Foreign investors & pension funds often use this as an opportunity to rebalance their portfolios (selling equities to buy bonds, for instance), and US fixed income looks very attractive at the moment, which suggests continued strong demand for the asset class (and keeping yields in check). Longer term, we still think more economic growth and higher inflation translate to higher yields, but for now, perhaps it’s best to think of us as hibernating bond bears: rates will rise, but not until more growth & inflation data materialises.
  • The recovery story in Europe is gathering pace – but ECB bond buying will still keep yields in check (at least until H2): Pandemic pessimism has hung over Europe for longer than most places, but we expect the region’s reopening to follow a similar timeframe to the US & UK. Vaccine progress is accelerating (in some countries, overtaking the UK) and with better weather it looks likelier the region can return to something close to normal this summer. Again, upward pressure on rates near-term will likely be countered by the ECB, which accelerated its asset purchases to June – but that won’t stop investors from trying to anticipate whether it will continue opposing higher yields thereafter.
  • A strong economy with well-behaved bond markets are positive for issuers – but risks remain: Earning season starts this week, which should at least help validate our optimism around the economic recovery, but risks – mostly political in nature – remain: French elections in June, German elections and the Merkel transition, and perhaps most importantly right now, a German Constitutional Court (GCC) decision on whether to allow the passage of a law facilitating the EU recovery fund.
  • High-growth regions – and their currencies – should outperform as emerging market pessimism peaks: There are signs already that negative emerging market (EM) sentiment has peaked, so notwithstanding idiosyncratic cases (i.e. Turkey) we are more positive on EM in the short-term. We see high growth regions’ currencies outperforming and lower-growth ‘safe havens’ doing worse. And among G3 currencies, assuming a positive GCC outcome on the EU Recovery Fund, we see ourselves becoming more bullish on the Euro, while Sterling should gain from the latest round of lockdown easing.

Trending treasurer trades & talking points

Lower bond supply amidst corporate blackouts is supportive for credit & issuers

Following a busy Q1 that saw around €110 billion in corporate bond issues, lower supply last week has set the pace for what we expect throughout April – especially given large pre-funding volumes over the past four to five months, and corporate blackouts amidst earnings season (we expect €15-20 billion in investment-grade corporate bond issuance this month). This should create an interesting window for bond issuers – and lead to solid spread performance in the secondary markets.

Pandemic-affected companies have drawn significant (positive) attention from investors

Following a successful holding company transaction at the end of March, NWM led Gatwick’s follow-on transaction for the operating company last week – where investor demand was significant. The trade very much speaks to what we’ve been hearing from investors in recent weeks: that they like the “road to recovery” story – companies affected by the pandemic but likely to benefit from continued economic reopening & normalisation.

Going green has helped low-beta issuers at the bottom line

With investors keenly aware that higher rates are on the cards in the medium & long-term, bond issuers (typically highly-rated) whose asset performance is less exposed to near-term volatilities & market gyrations (low-beta issuers) may start having to pay new issue premiums when selling fresh bonds. Selling in green or sustainable formats, or bringing an otherwise strong focus on environmental, social and governance (ESG) risk can help. Both of last week’s low-beta / highly-rated trades had a solid reception, although Deutsche Bahn’s recent €1 billion conventional bond did require a roughly 10 basis point concession, compared to the greater price tension for Enexis on its €500 million green bond (NWM participated), which paid around 2 basis points versus fair value on their yield curve.

Chart of the week

Speaking of sustainability, we’ve seen much greater focus on ESG risk from corporate & institutional decision-makers since the pandemic began. Besides making businesses & the wider economy more resilient, it’s turning out to be a good thing for corporates looking to raise funding: as the chart below shows, issuers of bonds in green or sustainability-linked formats can indeed benefit from better pricing when compared with conventional formats.

It pays to go green: new issue premiums (NIP) on GSS vs. conventional bonds in the Euro market

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