Corporate Treasury Weekly: European credit gains, US & UK rates risk rising & sustainability grows among high-yield borrowers

18 March 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

The European Central Bank (ECB) went against the grain last week in signalling it would speed up asset purchases to tame rising bond yields, a significant move that will likely lead to lower rates in the short term – a positive development for European credit & risk assets in general and high-yield bond issuers specifically. This week, the Federal Reserve and the Bank of England met and as expected, both declined to change their stance on rising rates.

This week in headlines

  • The ECB’s pushback on higher rates brings near-term positives for European credit (and issuers): The ECB’s intention to “significantly” accelerate asset purchases and push back on rising yields should meaningfully change investors’ perceptions of risk-reward, lead to lower volatility and attract new buyers into the market – which is positive for euro-denominated issuers. While we still think rates will be allowed to lift higher as we move through the year, we now see rates stabilising or even falling a little in Europe near-term.
  • But don’t expect the same in the US and UK: The Federal Reserve and the Bank of England met this week and their stance towards higher rates was a key focus. In contrast to the ECB, both declined to change recent guidance that a rise in rates is justified by the economic outlook (which appears to be improving in both countries). This may lead to higher volatility and upward pressure on yields in the near-term.
  • US rates stabilise but risks remain as markets and the Fed diverge on inflation risks: A large & well-supported US treasury auction last week has boosted investor confidence and helped US rates stabilise. But risks remain, as the way the markets & the Fed see inflation risks has diverged – and more evidence in the form of economic data is needed to close the gap and unlock that fundamental tension. Against this backdrop, US credit investor sentiment may be waning – investment-grade (IG) credit spreads have recovered somewhat but total returns on the year have been poor (down ~6% year to date on the Iboxx USD Liquid Investment Grade Index, an index of investment-grade US dollar corporate credit).
  • Monetary, fiscal policy, vaccine differentiation and more risk appetite are the key themes in FX this week: we see the euro continuing to fall against Sterling and the Scandinavian currencies, while more positive risk sentiment around the US (and more broadly) seems to be pushing the US dollar higher against safer havens like the Japanese yen and the Swiss franc. An improving commodity outlook also seems to be favouring commodity-linked currencies like the Aussie & Canadian dollar, the Colombian peso and the rouble.

Trending treasurer trades & talking points

ECB support is positive for high-yield issuers as IG investors broaden their horizons

The ECB’s acceleration of QE over the coming quarter is helpful, but not a game changer, for IG credit, whose spreads are already at or near to record tights. But greater impact is likely to be felt in crossover and high yield markets (particularly BB-rated paper). Although the ECB does not buy bonds directly unless they have at least one IG rating, the impact cascades as IG investors broaden their demand in order to pick up yield in lower-rated names. This helped drive the outperformance we saw in the BB market on the back of the ECB meeting last week.

Sustainability-linked bonds (SLBs) are gaining traction with non-IG borrowers

The European high-yield bond market saw the first sustainability-linked bond (SLB) issuance last week, a sign that the format is starting to gain traction down the credit curve. Public Power Corporation sold a €650 million SLB at 3.875%, with the total size of the bond upsized due to strong demand. Investors were particularly attracted by potentially higher coupon payments: the notes included a 50 basis point step-up, paid to investors in the event the company doesn’t achieve its sustainability KPIs, in contrast to the IG market where a 25 basis point step-up is more common.

ESG disclosure obligations are ramping up

The new Sustainable Finance Disclosure Regulation (SFDR) brought in its first wave of disclosure obligations from 10 March 2021, with the aim to provide more transparency on sustainability within financial markets in a standardised way. The disclosure rules are primarily aimed at institutional investors & portfolio managers, but it will undoubtedly impact corporate treasuries – which will have to evidence key ESG risks & impacts for investors – and is driving more client conversations as a result.

Libor reform remains a top focus for clients

Companies continued to opt into the International Swaps and Derivatives Association (ISDA) fallback protocol but are mindful of the mismatch between ISDA and Loan Market Association methodologies. Issuers are generally not including risk-free rate (RFR) language in their euro medium-term note (EMTN) bond documentation, but they are proactively addressing loan docs and amending existing Sterling-denominated floating-rate notes (FRN) as the Libor endgame nears.

Chart of the week

Bond rates have shifted higher on a fiscally driven recovery and expectations of higher inflation. But there are signs markets have found a level they are comfortable with for now. The ECB’s decision to lean into the sell-off may have helped in Europe. But it is a high-risks week – markets may yet be upset by the way the Fed and BoE describe their view of the move.

10-year benchmark bond yields (%) for US, UK and German government

Sources: Bloomberg, NatWest Markets

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