Pause for thought after blistering FIG start as volatility rises on persistent inflation prints

With market conditions having cooled in the past fortnight on the back of surprisingly strong data out of the US but also Europe, issuers can expect to encounter more modest demand and pay higher new issue premiums than during a record-breaking start to the year for financial institutions issuance. Neil Day reports, with insights from Crédit Agricole CIB syndicate, trading and strategists.

Jerome Powell Fed Feb 2023

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European financial institutions issuance hit a low for the year in the past week as, with the exception of a few brave souls, banks avoided risking muted demand and elevated pricing in the face of increased volatility, which has given investors pause for thought after a resurgent start to the year for buy and sell-side alike.

The slowdown came after growing concerns about the strength of the US economy, on the back of surging non-farm payroll figures on 3 February, escalated into outright fears of higher than expected terminal rates as CPI and PPI prints surprised to the upside on February 14 and 15, respectively.

“In the US, we are gradually shifting from a soft/not-so-hard landing to a no landing/continued overheating narrative,” said Valentin Giust, global macro strategist at Crédit Agricole CIB, “as consumer spending reaccelerates, demand for labour remains outstandingly solid, growth forecasts are edging higher, and inflation pressures are not receding.

“In the Eurozone,” he added, “domestic consumption is much weaker than in the US and the slowdown is well underway. However, we are increasingly confident that there will be a soft landing in H123, instead of a harsher and more protracted recession.”

The implication, said Giust, is “a one-way ticket to higher-for-longer rates”.

Having rallied from a yield of 2.57% at the start of the year to touch 2% in mid-January, the 10 year Bund gave up almost all its gains in February to trade at around 2.53% on Friday (24 February), with rates volatility increasing in parallel and credit spreads softening as equity markets fell.

“In hindsight, the rally in January was probably a bit too strong, a bit too fast,” said André Bonnal, FI syndicate at Crédit Agricole CIB. “People clearly got carried away about the macro backdrop, and as a result, investors are now being a bit more diligent and so a bit more on the backfoot in terms of engagement in primary, wanting to be compensated a little more for the risk and the volatility in rates we have been seeing.”

This has been reflected in a rise in both absolute spreads and the new issue premiums (NIPs) being paid by financial institutions, contributing to a slowdown from the record pace of issuance in January.

On 3 February, a €1bn three year non-call two senior non-preferred trade for Nordea marked an absolute tight for unsecured bank issuance, coming at mid-swaps plus 48bp following initial price thoughts (IPTs) of the 75bp area, and achieved a new issue premium of around 3bp thanks to an order book of some €3bn. And even after the first rate rumblings began, conditions remained ripe for issuance. When UniCredit issued a €1bn six non-call five senior non-preferred (SNP) bond on 9 February, it could tighten pricing from IPTs of the 185bp area to 160bp and achieve a NIP of 5bp on the back of some €1.4bn of demand, while Banco Sabadell the same day priced a €500m 10 non-call five Tier 2 issue inside fair value, at 315bp, after tightening of 45bp from IPTs and on the back of a €1.9bn book.

However, the supply came just as the market was turning, and the following day the Italian and Spanish trades widened around 15bp and 25bp, respectively. Issuers approaching the market in the past two weeks have had to navigate changed dynamics as investors have repositioned themselves vis-à-vis the primary market.

Mizuho, for example, found capacity constrained when it launched a dual-tranche, five and 10 year HoldCo trade on 15 February. The Japanese issuer was able to tighten from IPTs and print near the tights for the year to achieve very competitive funding, but it paid new issue premiums of 17.5bp and 20bp for the shorter and longer tranches, respectively, while the shorter dated tranche was sized at €600m on the back of some €800m of orders, compared to a €750m size for the longer.

Intesa Sanpaolo two days earlier had shown that rarer offerings could still achieve attractive execution, selling a €1bn 11 non-call six Tier 2, rated Ba1/BB+/BB+, at plus 325bp, a NIP of around 10bp and a re-offer level inside some investment grade Tier 2s on the back of some €2.25bn of demand (Crédit Agricole CIB joint books). ING was also able to price a £750m (€850m) 10.25 non-call 5.25 debut sterling Tier 2 flat to fair value that day as part of a dual-tranche/dual-currency trade, but its more regular euro Tier 2, a 12 non-call seven, was priced with a NIP of some 15bp and even then suffered heavy drops from the book, leading to a size of €500m — although cannibalisation across the tranches was cited as a potential idiosyncratic factor in the latter’s outcome.

Amid mounting evidence of the market having come off the boil, some banks who were eyeing new issuance in the past week held off, while those who did brave the market paid yet higher NIPs: a €1bn seven non-call six SNP for BPCE on Tuesday paid some 30bp, while NatWest Group paid around 25bp on a £700m 11 non-call six Tier 2. The French bank’s spread of 160bp for the seven non-call six was also 5bp wider than what it paid for a €1.25bn 10 year bullet SNP on the opening day of the year, 2 January.

However, syndicate bankers note that while conditions have deteriorated, the primary market has been anything but closed.

“The market has turned around and the mood is weaker, so issuers are tending to hold off,” said Vincent Hoarau, head of FI syndicate at Crédit Agricole CIB. “But the market is reacting fairly decently to the spread widening.

“Why? Because you have juicy carry and this offers investors a significant buffer against potential further widening. Some asset managers are also happy to reload because they are buying at lower cash prices as we are now back where we were in very early January after the back-up in rates. And nobody wants to be in the situation where they end up chasing the market if ultimately rates start to decrease sooner rather than later — the majority of real money accounts want to remain invested.”

This is borne out by a lack of selling pressure during the widening phase, according to William Rabicano, director, credit trading at Crédit Agricole CIB.

“We’ve actually gone wider on very little selling,” he said. “It’s purely sentiment-driven — we are sort of at the mercy of both equities and, even more so, rates.

“Flows are very thin in both directions,” added Rabicano, “so it really doesn’t take a lot to move the market one way or the other. And when we do move one way or the other, we overshoot in both directions.”

Getting liquidity through the door

As well as the attractive carry available, the market proved resilient in the January deluge thanks to an anticipated tightening of swap spreads — the opposite of which had proven painful for investors in 2022 — and the anticipated pivot from central banks after tightening last year, according to Hoarau — something that also encouraged investors to scoop up relatively high coupons ahead of expected lower rates.

“So we were in a kind of win-win situation for both issuers and investors.”

While the exuberance of January may now appear overdone, the record-breaking issuance last month is seen as supportive of today’s spreads, given its implications for supply going forward. Banks have issued some €145bn year-to-date, €77bn of it unsecured/subordinated and €68bn of covered bonds. The €77bn compares with €42.5bn in the same period last year, when spreads soon buckled under the weight of what might now look like modest supply.

“Issuers have been keen to make sure they do not face a repeat of 2022,” said Hoarau, “i.e. at some point being stuck in a market that is not well functioning and hence getting behind in terms of progress in the funding plan. That’s why everyone had one priority on the first day of 2023, which was front-loading.”

Although slightly down on 2022, US dollar supply has added over $100bn, while debuts in new markets and issuance in more exotic currencies — Australian and Singapore dollars, for example — has been en vogue, as issuers have sought to diversify away from their traditional investor bases in home currencies, often taking advantage of positive arbitrage and raising significant volumes. In the past week, BNP Paribas and Crédit Agricole tapped Singapore dollars, for example, the former issuing a SGD600m (€420m) AT1 and the latter selling a SGD500m Tier 2 at levels comfortably inside what could have been achieved in euros. ABN Amro meanwhile joined compatriot ING with a sterling first and also debuted in Swiss francs, with green trades of £500m and CHF350m (€353m).

At the start of the year, higher beta issuance such as AT1 took precedence for many European banks keen to get their riskier trades out the way, but the boom in volumes has largely reflected a focus on liquidity funding, in the form of covered bonds and senior preferred. The latter constituted €34bn, the largest part of the €77bn of unsecured/sub supply, after having played second fiddle to senior non-preferred issuance in each of the last three years.

Among the factors cited as driving this are the lower remaining MREL build-up needs of banks and the winding down of TLTRO funding. While French banks have been among the busiest across asset classes — with one understood to have already completed as much as 60% of its 2023 funding programme in January — they have been particularly prominent in liquidity funding: BNP Paribas, for example, in January issued its first benchmark covered bond since 2017 and on 16 February sold its first senior preferred benchmark after a similar-lengthed hiatus.

The €68bn of covered bond supply has been smoothly absorbed, contrary to fears that the withdrawal of CBPP3 support from the primary market would make life difficult.

“And the covered bond market has been immune from the resurgence of volatility,” said Hoarau. “With rates well established in the context of 3%, we have buyers returning to the asset class — many credit investors are happy to put cash to work in the three to five year part of the curve, getting juicy coupons for a very low level of volatility on a triple-A instrument.

“The presence of the Eurosystem in the secondary market remains a strong technical support, and even if it were to diminish, the impact on spreads would be fairly limited — whereas if spreads widen in senior non-preferred, for instance, we’re talking 20bp to 50bp, or sky high if the geopolitical context gets tougher.”

Indeed, a further factor in banks’ thirst for liquidity funding — particularly given the end of TLTROs — has been concern that the good times may not last.

“The message we get from some funding officials is, can you please provide liquidity,” said Hoarau. “They are worried about the geopolitical situation and would rather be conservative and overdo it than risk being stuck in a liquidity crunch.

“The war in Ukraine and its duration is the sword of Damocles for the markets. At some point, everything related to that and the energy crisis will come back on the table — unless for some unanticipated reason the war ends.”

Nearer term, the next US CPI release is on 14 March with the Fed meeting outcome on 22 March, and in the interim, ECB governing council decisions on 16 March.

The latest evidence — an increase in the US personal consumption expenditures (PCE) index on Friday to 0.6% month-on-month — pointed to continued hawkishness, potentially undermining signs of market stability that had been emerging later in the week.

“The acceleration shown by the PCE index adds to a string of inflation and sales data that bolster the case for the Fed to hold rates above 5% for some time,” said Hoarau. “Signs of disinflation have been observed, but how sticky inflation really is remains to be seen. 475bp of hikes is all well and good, but there is a lag effect in terms of its impact on the ground, and getting closer to 6% terminal rates because of persistent inflation is not out of the question.

“On top of the geopolitical situation, a prolonged period of higher rates could trigger the return of volatility for global markets. We therefore expect activity in primary to remain dense when the market is actionable.”

You can download a pdf of this article, alongside a Nordic banks focus, by clicking here.