Corporate bond issues storm ahead
European bond investors are still keeping a wary eye on news emanating from the US. Bonds have held firm in the face of continuing volatility in equity markets, a reflection of a certain levelling out and a more positive view on Europe. Analysts believe the mark-down on European bonds has been overdone. They believe that, while growth rates remain high, it is not runaway growth and there is value in the bond markets.
The European Central Bank’s latest monthly report makes it clear that it does not expect much change in European inflation in the short term. The benign picture is supported by the turnaround in the euro, with the exchange rate recovering to 1.06 against the dollar and moving towards 1.08. While the US isn’t concerned at this stage about dollar weakness, that would change if it continues to spiral downwards against the yen, raising another reason for year-end uncertainty.
Roger Nightingale at BBV Securities, suggests dollar/ yen is the key dynamic in the short term. Nightingale’s concern stems from an excess of debt in the US. He suggests Federal Reserve Board chairman Alan Greenspan will raise rates, not necessarily to curb inflation but “to burn the fingers of the operators who have been behaving imprudently”.
He is suggesting a defensive stance on stocks; for investors to move into short-dated bonds and within that choosing the currency that’s going to be strongest, which at this stage seems to be the yen.
Murray Johnstone’s Rod Davidson expects capital flows to move towards the yen in the short term and thence towards the euro: “If we see euro/dollar move to 1.08 then we would expect the BOJ to intervene.” Yen strength is underpinned by a lot of buying from foreign investors who are rebalancing portfolios.
Davidson has not ruled out further increases in US rates, although he recognises the dangers that this may tip the wider US economy over the edge: “The US market continues to price in a soft landing, but we feel that there is a spike in the offing before that happens.”
Paul Thursby at Barings feels that the euro/dollar damage has been done: “From this point I think we will see strong support for the market and a decline in yields. We feel there is good value to be had based on vastly improved sentiment and low inflation. We don’t believe in the low pricing the market has given European bonds. Investors have been given more believable growth and the euro looks reasonably underpinned here. Barings has a duration strategy at sight over 5.5 years, but no more because, as Thursby says, “people are cautious and there’s no major liquidity because of year end. But there is value on the table. Without the year-end we would be longer.”
European corporate bond issuance is storming ahead, according to Standard & Poor’s, particularly in the euro-denominated market, thanks to growing investor appetite and a shift away from bank funding. Cross-border corporate bond issuance in Europe was $108bn (e101bn) in the first half of 1999, more than double the same period in 1998. A significant portion of this is a result of merger and acquisition activity, with a stream of record-breaking debt offerings coming to the market.
European pension funds have been the major buyers of this paper, as their investment restrictions have been liberalised to allow them to invest in corporate debt, coinciding with their need for extra yield as they decline in the sovereign and municipal markets.
Although the size of issues has grown enormously, with a number of billion-plus euro issues such as Olivetti’s, the increase in the actual number of issues has been more muted. Although there has been a marked shift in companies’ attitudes to raising finance, the revolution has not happened quite yet, says S&P.
The glut of euro bond issues has certainly played on the market. A lot of debt has been issued, particularly on 10-year paper. And of course there are many issuers lining up to come back this month. Davidson says, “you’re always going to get that where you have a new capital market appear. It will be different next year.”
Peter Rains, head of global bonds with CGU, remains sanguine about the outlook for bonds: “There is little evidence of a resurgence in inflation in the US and there are still strong disinflationary pressures in the rest of the world.
“In the nearer term we see the US offering better value than Europe or Japan. However, longer term, Europe continues to look attractive, with bond markets supported by very low inflation, a growth trend well below that of the US and continuing low interest rates. We remain overweight in corporate bonds, which should gain from the global economic recovery.”
Ashburton’s Peter Lucas adds, “It is our belief that we are now seeing the last selling crescendo as the die-hard euro bulls offload their positions. Not surprisingly, this move is being accompanied by a great deal of confusion and volatility, some of which is spilling over into the bond market. Economic recovery may not sound like the best recipe for a bond market rally, but if it means that the euro stabilises and recovers, much of the recent panic sell-off in the bond market should also be reversed.”
The view of Invesco’s CIO for Europe, Riccardo Ricciardi, is that even if interest rates are no longer falling in the major economies, the global environment remains reasonably benign for bonds. “Real yields in bonds exceed real economic growth rates throughout the developed world. US Treasuries and UK gilts offer especially good value. Bonds issued by Emu countries that are generally yielding 3% or less do not appear attractive either in absolute terms or in relation to gilts.”