Tone downbeat in wake of hawkish Fed, but selective opportunities for issuance remain

Going into the final quarter of 2023, the outlook is uncertain after the Fed at its last meeting hammered home its “higher for longer” message. But although the credit market remains subject to the whims of the rates market, lower than expected supply and divergent dynamics have proven supportive of euro bank issuance. Neil Day reports, with insights from Crédit Agricole CIB trading and syndicate, and analysts.

The avoidance of a US government shutdown on Saturday and a positive move by credit indices into Friday offered some solace to the euro primary market for financial institutions at the end of a subdued week, but the outlook remains subject to the evolution of yields in the face of the Fed’s unexpected hawkish stance and ample US Treasury supply.

Euro benchmark unsecured issuance was sparse last week as yields climbed and spreads backed up, and the outlook is uncertain amid the wider macroeconomic developments. A German public holiday on Tuesday will further restrict issuance opportunities.

“Ever since the Fed, we’d had a risk-off tone,” said William Rabicano, director, credit trading at Crédit Agricole CIB. “Before [Friday’s] bounce, we’d pretty much had seven or eight consecutive moves wider with very little resistance — albeit from what were basically year-to-date tights.

“We’ve now had some buying taking us tighter, but if we come in the next day and Treasuries are down another 20 or 30 cents, then that’s going to spill over into the credit market again. We are very much being dictated to by macro forces at present.”

Although a “hawkish pause” had been expected from the Federal Open Market Committee (FOMC) on 20 September and a well-telegraphed rate hike before year-end is still anticipated, the degree of hawkishness from the Federal Reserve was greater than expected, noted Crédit Agricole CIB US economist Nicholas Van Ness. This was mainly due to upward revisions to the dot plot, whereby the 2024 median was revised up 50bp to 5.125%, compared to expectations for an upward revision of 25bp.

“This really hammered home the ‘higher for longer’ message,” said Van Ness, “indicating that, whether or not the Fed raises rates again, cuts will not arrive any time soon, and will likely be gradual when they do.”

The yield on the 10 year Treasury rose from 4.33% the end of the previous week to 4.46% at the end of the FOMC week, before peaking around 4.63% in the middle of this past week — levels not seen since 2007.

The revisions to the dot plot were spurred by much more optimistic economic projections, spurring a revision of market expectations.

“We have been moving from hard landing to soft landing, and now no landing,” said Vincent Hoarau, head of FI syndicate at Crédit Agricole CIB. “The neutral rate was pushed higher and this is what investors dislike. The benchmark yield inversion of 2s and 10s normalised to around minus 45bp, the tightest since May.

“The bear steepening move has been drastic lately.”

The Fed’s move doused positive sentiment in the euro FIG market spurred by the perceived “dovish hike” of the European Central Bank on 14 September.

“That was taken very positively,” said Rabicano. “Most viewed that as a last and final rate hike, and we actually rallied quite hard on the back of that for the next few sessions.”

The central bank did not rule out further rate rises, citing its data-dependent approach, but said that the hike is likely to be the last in the current cycle: “The Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.”

A slowdown in German inflation, from 6.4% to 4.3%, according to the latest consumer price figures released on Thursday, supported this narrative, although other data suggest a mixed picture and on Wednesday ECB board member Frank Elderson reiterated that policy rates have not necessarily peaked.

Supply eases, deposit pressures rise

Sentiment in the euro market had already in September been supported by post-summer financial institutions issuance coming in far below expectations, particularly from top tier names. Euro senior unsecured and subordinated volumes in the first month of the new issuance season was down 20% versus 2023, and down 30% when including secured funding, i.e. covered bonds.

“We saw a decent move tighter at the start of September when it pretty quickly became evident that supply was going to underwhelm,” said Rabicano. “Expectations for September were that it was going to be on the large side, but it never really materialised.

“We then got an additional kicker from the likes of Barclays, ING and UBS deciding to hit dollars over euros as well, with the US currency providing much better economics in relative terms than what had been available there earlier in the year.”

European national champions who might have had to pay up some 50bp in March to diversify from euros into dollars found that post-summer the cost was only 10bp-15bp.

“Coming after a very dense and active first half to the year where many issuers have been front-loading significantly, we have ended up with a post-summer period in the euro market that has been less heavy than expected when it comes to core names,” said Hoarau.

“So what we have mostly seen for the past two or three weeks is second tier names either progressing with regards to MREL targets or further refinancing the very last TLTRO tranche,” he added, “or issuers raising pure liquidity because the situation when it comes to deposit outflows is becoming more tense. The fear of a deposit war is growing everywhere.”

The latter was exemplified by a 3.30% one year Belgian government retail bond that the Federal Debt Agency said on 4 September had raised €21.9bn from more than 200,000 investors. The amount was equivalent to almost 5% of total Belgian bank deposits and was reported to have caused substantial outflows from local banks.

“This is certainly an interesting juncture in the post-quantitative easing world,” said Hoarau, “with a sovereign issuing a retail bond having a direct impact on how bank treasury officials are envisaging their funding plans. It has certainly triggered some to raise a little bit more senior preferred than they had initially planned.”

Belgian banks have taken liquidity measures in response to the state initiative, while elsewhere in the Benelux banks have embarked upon uncommon funding exercises.

ING Bank hit the market on Monday with its first OpCo issuance since April 2019, a €1.75bn three year deal split into fixed and floating rate tranches according to demand that allowed it to maximise investor interest and granularity. A €1bn fixed rate tranche was priced at mid-swaps plus 58bp and a 4.125% coupon, following initial price thoughts of the 85bp area and on the back of books above €2.2bn, pre-reconciliation, while a €750m floating rate tranche was priced at an equivalent spread of three month Euribor plus 66bp on the back of books above €1.4bn, with the new issue premium put at around 5bp.

Compatriot Rabobank also sold OpCo paper the following day, raising $1bn (€945m) through fixed and floating rate three year tranches.

Euro bank opportunities remain

While ING’s rarity and status stood it in good stead, issuers outside the top tier have been able to succeed with convincing offerings, including two peripheral issuers buoyed by positive rating trajectories.

Portugal’s Banco Comercial Português (Millennium bcp) on Monday attracted some €1.45bn of demand to a €500m three year non-call two senior preferred deal and was able to tighten pricing 30bp to 190bp over, after having been recently upgraded by Moody’s, S&P and Fitch to investment grade. And on Tuesday

National Bank of Greece issued a €500m 8% 10.25 non-call 5.25 Tier 2 on the back of some €1.25bn of orders, having tightened pricing from initial price thoughts of the 8.375% area, against the backdrop of upgrades across the Greek sovereign and banking sector.

The market also accommodated senior preferred supply from a varied roster from Spain’s Abanca to Slovakia’s Slovenska sporitelna, and Denmark’s Spar Nord Bank to Hungary’s OTP, while BayernLB got away a sub-benchmark green Tier 2.

“Although conditions have been deteriorating, second tier names have been able to execute deals successfully,” said Hoarau, “and in every case the pricing and sizing approach was very consensual.”

He further attributes the constructive outcomes — as well as the relative resilience of the euro credit market — to the more benign rates outlook in Europe.

“In the US, it looks like labour market resilience implies higher wages and more inflation, and bonds are repricing to this new reality. But although the overriding narrative is ‘higher for longer’, the situation in Europe is drastically different, with the prospect of a rate cut soon more realistic given how quickly the economic situation has deteriorated and the disinflation trend has been confirmed. The degree of concern around rates is therefore less pronounced in euros, while investors see the juicy coupons on offer as too good to miss.

“And while spreads may blow out at some point, the carry is sufficient protection against phases of high volatility and credit spread widening — we all remember how the Credit Suisse and US regional bank events were overcome by markets earlier this year. This explains why the capacity of the primary market to absorb deals remains intact — it is the level of investor discipline on pricing and sizing that has increased.”

For similar reasons, senior preferred and senior non-preferred (SNP) offerings typically enjoy stronger demand than subordinated debt, according to Hoarau.

“If you look at appetite across the bank capital structure, there is much stronger demand in senior versus Tier 1 or AT1. Why? Because yields on senior offerings are very high and many investors aren’t bothered with the extra basis points for the subordination and implied volatility.”

The market is indeed expected to remain volatile and subject to macros headwinds.

“Most investors want to see some stability in the rates market,” said Rabicano, “which should flow through into equities, and then credit should find some kind of floor.

“Given where valuations have backed up to, and given that we keep seeing cash being parked in front-end paper, I would expect cash to then be put to work further out the curve.”

In the wake of the last ECB meeting, the bid for duration — as had been anticipated — increased before the Fed soured the tone, he added, but latent demand for longer dated bonds persists, according to Hoarau.

“The average maturity of FI issuance has been very low,” he said, “partly due to the profile of issuers, outside the top tier, but there is appetite for longer tenors from core banks. It is just that they have not been willing to pay up the requisite higher spreads, with the steepness of the credit curve as the yield curve is inverted, albeit less now than at the beginning of September.”

As the fourth quarter opens, thoughts are already turning to 2024. While investors could welcome a clean slate and liquidity is expected to remain high, the primary market may seem like an unfamiliar place in one critical respect.

“On 2 January, everyone will start the year knowing that unlike the past decade there is no quantitative easing,” said Hoarau, “no safety net — and potentially active QT ahead. What stance will investors take in this context? — particularly given that they are already sitting on an enormous stock of very juicy on the run coupon bonds.

“The level of cautiousness and prudence will depend on where the year starts in terms of absolute spread levels. The list of risk factors and signs of cracks in the system being intact, expect Q4 to be marked by intense pre-funding as RWAs grow.”