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Booze and Fags

1 July 2016 by Chris Bowie

Before and after the EU Referendum much has been speculated about what would happen to the sterling credit markets in terms of bond issuance. Some commentators had suggested that issuance would dry up as corporates tapped the euro or dollar markets instead, or that investors would stay away from the pound, or were too nervous to commit capital to potentially loss making investments. Well yesterday we had our answer: things have got so bad, the markets have returned to the old vices of booze and fags.

Brown Forman (makers of Jack Daniels) and British American Tobacco (makers of Lucky Strike, Rothmans amongst others), both issued sterling IG bonds, and both deals went very well. We couldn’t resist, and took a draw of the fag behind the bike sheds, but declined a sip of the whiskey (not the usual Scottish spelling I know). The BAT deal was a 5yr issue; initial spread talk was 5yr Gilts +150bp, later tightened to +130bp, with a deal size of £500m but a total book size of £2.3Bn. Very healthy for such an unhealthy habit. The Jack Daniels deal was done at +150bp, for a 12Yr deal in £300m size with a book size of £1.4Bn.

The 5yr part of the curve is more attractive to us right now for two reasons; firstly we think any rate cut expectations following Brexit will be more likely to lead to yield falls in that part of the curve, and secondly the duration profile of the 5yr gives a good trade-off between the yield you will receive and the low potential for capital losses. By contrast, and as enjoyable as a Jack Daniels is, for a 12yr bond we’d need to see a lot more spread to improve its breakeven potential to protect that investment from potential losses. A splash of coke with the Jack Daniels if you will.

These deals are fantastic news for the sterling market. They prove that the UK bond market is still open for business, we still have strong client demand for good quality bonds (even at low sovereign yields), and that for consumer staples at least, investors are willing to take a view through the likely volatility we might see over the coming months until we have more clarity on the EU negotiations.

Whilst the obvious metaphor here is to say it will all end with a massive hangover, in this case I’ll reject that and end with a truism from my old gran, “from time to time, a little bit of what you fancy does you good”.

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