Jeremy Wharton, Church House joint CIO delivers an informative assessment on the current state of global credit markets
Our august Parliament finds itself with a ‘flextension’ until Halloween, five days before Guy Fawkes Night. It’s hard to see what will change and stop the Conservative party leaning on their self-destruct button, while our international friends look on in awe and wonder, mixed with not a little bemusement. Citi waded into the fray stating that a Corbyn government would be worse than a ‘No Deal’ Brexit. They have a point as some of the plans mooted would decimate Government finances and lead to a dramatic rise in borrowing. However, UK plc plods on regardless. The latest GDP and employment numbers were better than expected and reflect a resilience in our economy (although stockpiling would have had some effect). The Bank, forcibly, remains on hold throughout this time but as unit labour costs rise, must be getting a little twitchy. Assuming a resolution one day, it appears they would move fairly swiftly. Back in the Eurozone, things look a little shaky economically and the ECB remains mired in its own self-made quandary. Ten-year Bund yields have just turned negative for the first time since 2016; maybe this fragility helps explain some the unity of ‘the 27’.
There was some questionable behaviour by Santander surrounding the non-call of their €1.5bn Additional Tier 1 Contingent Convertible Notes (bail-in bonds). They preceded the non-call by a new AT1 USD issue of $1.2bn marketed to European investors which served to reinforce expectations of a call. So there was plenty of dissatisfaction when the expected didn’t happen. Caveat emptor applies as ever, particularly to AT1 and its characteristics as an asset class (we do not invest in AT1), but any perceived whiff of arrogance towards your capital market lenders does not sit well with the market.
In a feeding frenzy by Investment Banks, eerily reminiscent of the stock market flotation of a certain commodities trader in 2011, a new entrant to capital markets made its debut. Saudi Aramco came to the market with an inaugural multi-tranche bond offering. The final size of the transaction was $15bn and attracted a book of over $100bn. They resisted the temptation to upscale the whole offering, but all tranches priced considerably tighter (more expensively) than initial indications and there was much scaling back of allocations.
All tranches of these new Aramco bonds are now trading wider than their re-offer prices, so the enthusiasm was misplaced. For example, the 2029’s are trading at +115bp over US Treasuries having priced at +105bp, not a great result for the investor as that translates into a 100bp capital loss.
Another constitutional experiment across the water also provided amusement, as the US President attempted to parachute his chosen members into the Federal Reserve Board. Once this failed, he resumed his attack on current members and policy. The Fed has signalled a pause, and is pausing, but data coming through remains strong and speculation that the next move is down maybe premature. What does look to be certain is that the scale of balance sheet readjustment might finish at around $3.8tn, rather higher than the $0.9tn seen before the crisis, and once they are there the Fed is keen to roll the proceeds of maturing Mortgage Backed Securities into Treasuries. This has always appeared to have been an elastic process anyway, due to the scale of what has been implemented by QE; weaning risk assets off such a high level of support was never going to be easy. US initial jobless claims are now at fifty-year lows while US risk assets continued their strong Q1 rebound and stock indices have nearly regained their early October highs.
In sterling, we continue to see credit spreads grind tighter and corporate credit remains well supported. The Q1 rally in spreads has been impressive and latterly, at times, felt slightly irrational. After retracing a lot of Q4/2018’s widening there has been a recent reversal of momentum. The primary market remains active; high demand and confidence enabled some issues to price tightly some way from initial indications. Apart from Aramco, we have seen a few other whoppers offered to willing hands, one multi-tranche issue from Power Solutions (to fund Brookfield’s Leveraged Buy-Out) was in such demand, and banks so keen to participate, that they downscaled the Senior Secured notes and upscaled the term loan element instead, i.e. the High Yield, Covenant Lite, leveraged loan element took over as the larger part of the funding for the buy-out.
We can be pleased that the UK is leading the charge in establishing a risk-free rate as an alternative to GBP LIBOR. Over £14bn has been issued into SONIA (Sterling Overnight Index Average) referenced floating rate paper so far this year, on a proportional basis way ahead of other currencies. The figure of $400tn of liabilities outstanding referenced to LIBOR in all currency’s is often cited, so there is a long way to go to reduce systemic risk. We no longer have any post 2021 LIBOR referenced liability.