Corporate Treasury Weekly: QE tapering is upon us, but the sun still shines on credit – take advantage or wait?

29 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.

With the Bank of Canada trimming its quantitative easing programme, we think it may have fired the starting shot for other large central banks to begin unwinding record levels of pandemic-driven market support. This includes the Bank of England, which meets next week. In the meantime, a key consideration for corporates is whether it’s worth taking advantage of today’s strong funding conditions before investors start applying upward pressure on borrowing costs.

  • Canada has markets talking about tapering quantitative easing: the Bank of Canada cut its asset purchasing programme by 25% last week, kicking off what we think will be the next big theme driving markets – the ‘taper cycle’. We expect the Bank of England to start tapering when it meets next week. And we think the US Federal Reserve could start discussing its own asset buying reductions in late 2021 – and begin reducing purchases in early 2022.
  • Expect higher rates in the US & UK, but not immediately in Europe: as markets look forward, strong economic growth and a gradual reduction in support from central banks are fundamentally negative stories for rates – leading to rising bond yields as investors look to get ahead of QE tapering, particularly in the US & UK. But rates may not rise as quickly in Europe. The European Central bank (ECB) upsized its bond buying for the second quarter, putting downward pressure on bond yields, and even though we expect ECB support to slow in June, discussions around tapering may still be deferred until data & pandemic developments allow.
  • Higher yields are not necessarily bad news for credit: though bond yields may rise as a consequence of higher growth & more optimism, we don’t see real interest rates rising – as a consequence of central bank hikes – any time soon. Higher real interest rates are a drag for risk, true, but not an immediate concern.
  • We’re positive on risk currencies – but cautious on Sterling ahead of Scotland’s elections next week: we expect investor demand will support currencies in countries where the recovery story is strong, particularly in commodities – so places like Brazil, Russia, Australia & Canada. But we’re also less positive on the US dollar because a strong recovery there likely means more consumption & imports from abroad. In the UK, the upcoming Scottish elections – and potential outperformance of a nationalist movement – leaves us cautious on Sterling, even though we think Scottish independence is ultimately a tail risk when compared with more urgent & influential themes (pandemic recovery & Brexit pessimism chief among them).

Future central bank tapering & strong credit conditions are getting bond issuers focused on timing

Strong demand for paper continues and some bond issuers, who expected to come to the market after summer, are now inquiring about coming earlier to take advantage of a strong funding environment and in advance of rising bond yields & potential central bank QE tapering.

Fixed versus floating-rate debt is back on the list of priorities

That said, the prospect of higher rates & steeper yield curves has corporates talking once more about floating versus fixed-rate funding. We think firms should remain cautious about the risk that rates rise further still.

IBOR transition work hots up

IBOR transition remains an ongoing theme, with corporates focusing on transitioning their derivatives books from IBOR to go-forward risk-free benchmarks, and renegotiating loans terms. In the UK, the Sterling Risk-Free Rates (RFR) Working Group just published two papers to help with the transition: one on the pros & cons of “active transition” (compared with using fallback contract language), and another on the operational considerations of using fallbacks. Read our take on the pros & cons of both approaches and those operational considerations here.

With UK economic growth surprising positively, a sizeable revision to government borrowing (see chart below) and the Bank of Canada firing the starting shot on tapering, we think the Bank of England (BOE) will start pulling back on quantitative easing – with more guidance possibly coming as early as next week. What does this mean for corporate borrowers? Rising bond yields – as markets look to get ahead of any central bank move.

UK government borrowing & BOE quantitative easing (£ billions)

Sources: UK Office for Budget Responsibility, Bank of England, NatWest Markets

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