Corporate Treasury Weekly: post-pandemic credit performance hits new heights but summer poses volatility risks

17 June 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.

Credit markets are going from strength to strength as we head into the summer – bond yields are low and investor demand high. Summer promises to see continued speculation over whether inflation is here to stay – which could lead to greater volatility as warmer months bring thinner trading. Meanwhile, corporate treasurers we speak with are focused firmly on timing fundraising just right, and emerging currency arbitrage opportunities.

  • Credit markets are going from strength to strength as investors broaden their appetite: Investment-grade bond spreads have tightened to record levels, even after a week that saw among the heaviest corporate supply in Europe this year. Investor demand appears broad and deep, despite concerns about rising inflation.
  • Three key reasons why bond yields are shrugging off higher inflation: Speaking of concerns about rising inflation, we think there are three important reasons why bond yields have stayed low: (1) central banks have downplayed higher inflation as ‘transitory’, a view we think is defensible; (2) if it isn’t transitory, central banks will be among the last to admit it; and (3) summer trading is thinner much earlier than usual because the pandemic has meant days of leave are piled up.
  • Lower levels of trading – as is typically the case in summer – could lead to higher volatility: lower liquidity (fewer bonds trading hands) often exaggerates volatility, which could rise as uncertainty over inflation and the pandemic remain high – note the UK government’s recent decision to delay a full easing of lockdown measures in England.
  • The US will likely continue setting the tone for global bond yields: bond supply favours this view. In the US, net supply is formidable (in the government bond market alone, around $200-250 billion per month), while it is far lower in Europe or the UK.
  • We expect the Euro to continue performing well: relative growth, fiscal policy and pandemic trends have been keen drivers of the Euro’s performance against the US dollar – and they’re mostly swinging back in favour of Europe as the economic outlook brightens. We think EURUSD could move to 1.25 during the summer, with risks skewed higher rather than lower.

Strong bond market conditions has issuers talking about timing and tactics

Investors are coming back to primary bond markets with enthusiasm, and corporate clients that would have expected to come to market after the summer are now considering taking advantage of a favourable window.

Scarcity in Sterling markets has corporates (and banks) looking at arbitrage opportunities

Relative scarcity of Sterling in the interbank market has favoured borrower who would typically fundraise in other currencies, as are tight credit spreads in the UK. More corporates and banks to are looking at tapping Sterling bond markets only to swap into other currencies, particularly Euros.

Treasurers are mulling ESG-linked swaps

Environmental, social and governance (ESG) risks are being increasingly embedded into a range of financial instruments to help corporates achieve their sustainability objectives and ESG-linked swaps are starting to creep into discussions. One discussion involved a proposed ESG swap which included KPIs (two, with annual tests) directly linked to a loan being hedged.

Euro Area economic growth is beating expectations, with recent surveys contributing to the brightening outlook. Industrial production grew 0.8% in April from a month earlier, beating expectations of 0.4%, and industrial output for March was revised upwards from 0.1% to 0.4%, which point to stronger growth ahead.

Euro Area industrial production (IP) continues to move higher

Sources: Eurostat, National Statistical Institutes, NatWest Markets

Record high consumer demand isn’t without its risks, however. Supply constraints, if left unresolved, could dampen the outlook.

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