30th March 2016

Zero coupon bonds, why bother!

MARKET CLOSE:
FTSE 100
6,106, -1
DAX
9,888, +37
S&P 500
2,055, +18
iTraxx Main
76bp, unch
iTraxx X-Over Index
322bp, +2bp
10 Yr Bund
0.14%, -4bp
iBoxx Corp IG
B+155bp, +0.5bp 
iBoxx Corp HY Index
B+542bp, +4bp
10 Yr US T-Bond
1.80%, -8bp

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Rare, but brace for more “genuine” zero coupon deals…

We reopened after the long Easter break to be greeted with a multi-tranche issue by A1/AA rated Sanofi which saw demand of €7bn for its combined €1.8bn deal. The story though was around the 3-year offering which was priced at midswaps+17bp, offering a yield of 0.05% and a coupon of 0%. The zersanofio percent coupon itself was the point of interest in that it has been a while since we last saw a zero coupon bond. “Back in the day” (pre crisis) a zero coupon bond would have been of a medium to longer-term maturity and sold at a deep discount to offer a “sensible” yield, and they were quite rare.

Anyway, the last time was saw one was back in March 2015, but in the form of a 2-year from French utility Engie (formerly GDF Suez, midswaps+2.5bp) priced at €99.741 to give a yield of 0.13% (rated A1/A). In March 2015, yields and spreads were at their historic lows/tights.  This time, Sanofi’s discount was also very minimal given the 0.05% yield of this issue. Sanofi might have been beaten to the zero coupon by Engie, but its deal is a 3-year offering (versus Engie’s 2-year) and market spreads and yields are higher now versus where they were in March 2015. The surprising €1.8bn of demand smacks of a desperate investor base, and the whole situation might be – likely is – a harbinger of things to come. That is, tighter spreads, lower corporate bond yields and lower coupons! You have been warned. That said, the 5-year swap rate is still positive at 0.015%, so we might have bit of a wait before we can look forward to the first 5-year zero percent coupon deal – with a small discount at re-offer, of course.

Tantalisingly close to record

The session passed by with little altercation, but we’re choosing to get excited by the potential for a primary bond market record to be broken. With €2.1bn printed from two borrowers yesterday (Sanofi and a tap from BASF), we are now just €4bn away from this month being the heaviest for issuance ever for the European IG non-financial corporate bond market. Two days, €4bn needed with the current January 2009 record standing at just under €49bn. The assault on that level would not have been seen as being possible as we closed out February, but a push from ABInBev’s funding of its SABMiller acquisition sabmilleras well as a nudge from the ECB’s forthcoming corporate QE buying programme have made it possible. Otherwise, in thin post-holiday trade, we saw out a light session amid low flows and volumes, with investors now looking on cleaning up positions ahead of quarter-end.

As suggested previously, there is going to be a focus on the ECB in Q2 and the specific ingredients they might need to add to their shopping list. With that in mind – and we’re choosing to look at the bright side of it from a spread impact perspective – we think taking the highest beta position one’s portfolio can reasonably undertake is going to be the way to play it. There is room for disappointment nevertheless – if they have their calculations wrong. We, for example, think a realistic number of bonds they could add will only be €2bn a month – which is not overly aggressive. Still, €2bn a month with room for more will be enough for spreads to quite possibly crunch tighter – everywhere. That’s because there will be a ‘crowding out’ effect as money continues to come into the credit funds looking for a home.

Some good news around eurozone macro

The eurozone lending survey was good. Bank lending to corporates was up 0.9% in February after increasing by 0.6% in January, leaving us watching for March’s figure to buttress the ECB’s recent liquidity injection. Consumer lending was also up. Still, we’re not sure what to make of it in the sense that bund yields declined with the 10-year back down at 0.14% (it was over 0.30% two weeks ago)! That yield drop might have been a response to the general view that the risk asset rally was previously overdone, or that some quarter-end positioning was motivating the bid for bunds.

Government bond yields fell everywhere but it was the periphery that outperformed. 10-year BTP yields dropped 6bp to 1.23% and are just 9bp off the lows seen a year ago, while Spanish 10-year yields fell 8bp to 1.44% but with some 30bp to go to achieve their historic low (also 1.14%). Equities moved in mixed fashion in the session, eventually mostly ending slightly higher. Oil was lower, down over 2% with the price per barrel now under $40 for both grades (Brent/WTI).

Fortune favours the brave

That drop in government bond yields comes at an opportune time for total return corporate bond asset managers as it will make their performance for the first quarter look very very good. For IG credit, the quarterly performance to date stands at +2.2%, while March alone has returned +1.4% (Markit iBoxx index). Small wonder – and it makes sense – that money continues to flow into the asset class while existing investment in corporate bonds has been resilient.

In the session, corporate bond spreads closed unchanged amid little activity – if not it Yellenbeing month-end, then simply because it is frustratingly difficult to get hold of bonds. This technical dynamic will persist. The synthetic indices closed unchanged. A dovish Yellen testimony overnight gave a boost to US stocks (specifically cautious on the inflation and growth outlooks) and will likely have the same impact here today, likely serving to keep the risk asset rally intact into the second quarter. US Treasuries also got a good bid behind them, with yields dropping 8-10bp almost across the curve, leaving say the 10-year yield at 1.80%.

Have a good day, back tomorrow.

Suki Mann

A 25-year veteran of the European corporate bond markets and in his role as Credit Strategist, Dr Mann has been ranked number one in the Euromoney Investor Survey eight times in ten years. Previously with Societe Generale and UBS, he now shares views of events in the corporate bond market exclusively here on Credit Market Daily.