Sovereign and Corporate Debt Deluge with Fed's Tightening Policy on Pause
Issuers of U.S. dollar-denominated government and corporate bonds based in certain emerging market countries have been generally taking advantage of the ultra-low interest rate landscape to sell new deals.
To date in February, the governments of Uzbekistan, Turkey, Indonesia and Egypt, for example, have each contributed to the recent rise in the volume of primary market sales, while the Federal Reserve appears to have shifted gears to a more dovish stance on monetary policy.
The Federal Open Market Committee (FOMC), the Fed’s policy-making body, had decided at its January 30th meeting to leave the target range for the federal funds rate at 2.25-2.50%, and noted it will be “patient” as it determines what future adjustments may be necessary.
Many in the financial markets had interpreted the FOMC’s statement as a sign that the central bank will refrain from further rate hikes and other “quantitative tightening” measures throughout 2019.
Ward McCarthy, chief financial economist at Jefferies, noted that the Fed is most likely “going to slow the rate normalization process and be more data dependent going forward as policymakers probe their way toward a neutral fed funds rate estimate of 3%.”
He added that due to “the combination of the effect of the trade war on commodities markets in general since mid-2018, and the related weakness in energy prices, inflation is very likely to hold below the Fed’s 2% target at least into Q2 this year. Consequently, it is likely to be several months before the FOMC resumes the rate normalization process with the next rate hike.”
Against this landscape, issuers of U.S. dollar debt have continued to roll out blockbuster deals, with buyers continuing to line up for the yield offered in the primary market.
Among the long list of deals to date in 2019, Anheuser-Busch InBev SA/NV (NYSE: BUD) priced US$15.5bn worth of new debt in six parts to decent demand, and Altria Group (NYSE: MO) fetched more than US$50bn in orders for its US$11.5bn, seven-part sale.
Prices of Anheuser-Busch InBev’s 4.15% notes due 2025, and Altria’s 5.8% 2039s, were each up well-over 1.1% intraday Wednesday, according to the IBKR Trader Workstation.
Meanwhile, the yield on the 10-year U.S. Treasury note – at 2.652% intraday Wednesday – continues to trade below its 20-day moving average at 2.686%, with the 50-DMA at 2.732%, according to analysts at Fibocall.
Tallied in the trillions
Indeed, with the Federal Reserve keeping rates low, most bond issuers continue to reap benefits from the low-cost borrowing.
According to SIFMA researchers and recent data sourced by Thomson Reuters, in the ten-year period from 2008-2018, investment-grade and high yield corporate debt issuance has soared more than 61% and 139%, respectively, over the ten years from 1997-2007. On a combined basis, the past ten years have seen nearly US$14trn in new deals come to market, an increase of over 71.5% from the prior decade.
Moreover, the issuance continues to see healthy demand, in large part as improvements in the U.S. economy have been helping lure investors to the yield offered in the primary market – especially those buyers who have been priced out of their local markets or have a dearth of available paper.
The yields on Japanese and German government bonds were last in the area of -0.046% and 0.092%, respectively.
For the week ended February 13, Thomson Reuters/Lipper U.S. Fund Flows reported a net inflow of roughly US$1.89bn into investment-grade corporate bond funds, while high yield funds reported net inflows of US$728m. Risk appetite also appears to have increased, as emerging market equity funds saw US$411m of inflows, and international and global debt funds posted net inflows of US$232m.
Ron Quigley, head of fixed income syndicate at Mischler Financial, characterized Tuesday’s US$10bn worth of new investment-grade corporate bond sales as deals that got done by syndicate managers for issuers, and “investors bought the paper. That’s it.”
He also pointed out that more than 45% of this week’s expected volume priced on the first day back from the long holiday weekend.
Risk appetite returns
In the meantime, some emerging market countries have decided to exploit the favorable rate environment, and relative calm in the financial markets, to sell new debt.
To date in 2019, The Arab Republic of Egypt priced US$4bn worth of sovereign bonds in a three-part private placement, the Turkish government sold US$2bn of three-year sukuk at a price to yield 5.8%, Indonesia priced a total US$2bn of five- and 10-year sukuk, and The Republic of Uzbekistan debuted US$1bn of evenly split five- and 10-year notes at 4.75% and 5.375%, respectively.
The offerings fell squarely in the higher risk category.
Mood’s Investors Service, for example, placed a first-time, long-term issuer rating on the Government of Uzbekistan at a junk status ‘B1’.
Uzbekistan is largely beset by low income levels, with a government that remains heavily involved in the economy, notably in the banking sector, as well as in mining and energy.
Moody’s analysts Martin Petch and Marie Diron noted that under Uzbekistan’s President Shavkat Mirziyoyev, “the country has embarked on a number of economic, trade, and foreign policy reforms, with the aim of liberalizing prices and introducing competition in a number of sectors.
“However, Uzbekistan lacks a full range of monetary and fiscal policy tools to preserve macroeconomic stability and offset potential shocks to the economy during the reform process. The transmission mechanism for monetary policy is weak as a significant share of bank lending remains directed by the government and credit risk is not priced.
“Fiscal policy has no track record of adjusting expenditure and planning revenue measures in response to the economic cycle and in adherence to long-term fiscal and social objectives.”
Up in price
With the markets apparently enjoying a period of calm, and amid a general uptick in risk appetite, some of the emerging market sovereign notes have risen in value since their issuance.
The yield on Turkey’s 5.8% sovereign notes due February 2022, for instance, was bid at a premium of US$100.093 intraday Wednesday, and Indonesia’s 4.45% bonds maturing February 2029 were at US$100.149, according to Bloomberg.
Briefing.com’s chief market analyst Patrick O’Hare noted that the Federal Reserve “hacked into the market in early January to write a new line of code that told the market to settle down with its volatile behavior and to start rallying.
“It was a pretty simple line, too, that said the central bank will be patient with its approach to policy and won't hesitate to alter the balance sheet normalization process, if necessary.
“Nothing was more effective in re-booting the system than that new line of code.”
Investors will have an opportunity Wednesday to glean more details into the FOMC’s decision and policymaking path, when it releases its minutes for the January meeting at 2:00PM ET.
Participants in the bond market will likely expect to see more U.S. dollar-denominated deals as rates remain low, including from Turk Telekomunikasyon A.S., which is set to unveil at least US$500m worth of new ‘BB’-rated debt for refinancing purposes.
Note: This material was originally published on IBKR Traders' Insight on February 20, 2019.
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