Corporate Treasury Weekly: the Bank of England is the latest to taper – will tapering become negative for credit?

07 May 2021

Giles GaleHead of European Rates Strategy

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4 minutes

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

With economic growth gaining and coronavirus trends encouraging in developed economies, we expect the interplay between inflation and central bank asset purchase tapering – most recently with the Bank of England – to remain a dominant theme in markets. Though we believe this will eventually lead to higher borrowing rates, we don’t think this will prove particularly dangerous for credit (or borrowers).

  • Bank of England is the latest to slow the pace of bond buying as the economic recovery proceeds apace: as we anticipated, the Bank of England (BOE) this week announced it would slow the pace of its bond-buying scheme from ~£18 billion per month to ~15 billion (slightly higher than our ~14.5 billion estimate) while keeping the size of the overall programme (£895 billion) unchanged. It also raised the UK economic growth forecast for the year (7.5% vs. 5% previously) as the recovery proceeds apace and the pandemic remains in check. Ultimately, we think the move will put upward pressure on bond yields – but won’t cause many headaches for credit imminently (see more below) and we still think rate hikes are far away.
  • Economic growth remains strong and coronavirus trends encouraging elsewhere: US economic sentiment data was less spectacular than expected – but readings were still strong in historical terms; as we noted previously, March was a bumper month for US data. Meanwhile, pandemic trends remain encouraging, particularly in Europe, where daily vaccination rates have accelerated sharply and countries that struggled to contain new outbreaks – France in particular – are showing improvement.
  • Global bond yields will edge higher – even in Europe: led by the US & UK, we continue to see no way but up for bond yields – even in Europe, where in March the European Central Bank (ECB) stepped in to tame the rise by boosting asset purchasing to June; Euro rates have increased over the past month, signalling even stronger willingness by bond holders to sell (or at least not to buy) at these levels, a trend we expect to extend into H2 2021.
  • The question on everyone’s mind is: will central bank tapering become negative for credit, and when? Previous tapering cycles have been negative for credit, but we don’t think the next round will hark back to the now infamous 2013 Taper Tantrum – when markets shifted rather abruptly to view the Federal Reserve ending quantitative easing as a pre-condition for hiking real interest rates (which led to much volatility in the process). For a deeper dive into why we think things will be different this time, check out our latest episode of the On Point podcast.

Embedding sustainability KPIs across a broad range of time horizons

More companies are looking to embed environmental, social or governance (ESG) KPIs into the treasury function, and the range of products that can be linked to them is also growing. However, whilst a sustainability-linked bond can be structured using a longer-term ESG target (like when the bond matures), other products, like ESG-linked FX products or revolving credit facilities, require near-term (often annual) targets to be met.

So, the challenge becomes how to break down longer-term ESG targets into nearer-term KPIs – especially when the trajectory of sustainability achievements is not linear: when initial investment is high, but the majority of measurable progress is produced in later years, for example; or when some kind of event (say, a global pandemic) reduces confidence in a company’s ability to meet near-term targets despite reasonable confidence in achieving longer-term goals.

Growing diversity among treasuries in how to take advantage of rising bond yields

We see higher bond yields in the months ahead – but there is a growing divergence in thinking of how to take advantage among those planning funding and others more focused on asset-liability management (ALM). Those looking at funding activity in the near term are more concerned with fixing borrowing rates at these levels, while ALM planners tend to view a steep yield curve as an opportunity to increase the proportion of low floating rates in the funding mix.

Economic confidence continues to grow in the UK as it emerges from the pandemic’s grip. The composite purchasing manager’s index (PMI), a broad reflection of business sentiment across sectors, rose to 60.7 from 60.0 last month, the highest level since late 2013 (see chart below).

The UK economic recovery proceeds undismayed

Sources: Markit, UK Office for National Statistics. Scores above 50 typically imply economic expansion, and scores below 50 a contraction.

While PMI’s predictive power on actual economic output is distorted by the pandemic and base effects, these readings suggest momentum continued to build in April – as we would expect given the wider re-opening of the economy - and that the UK remains on course for superficially stellar economic growth in Q2 and Q3.

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