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Supply stays healthy

12 July 2017 by Gordon Shannon

We wrote last week about the continued sell-off in government bonds across Europe and the US. Investors in government bonds appear to remain worried about central bank policy shifting to a more hawkish stance, and so far we have not witnessed any relief rally in risk free yields across these markets.  However, while seeing a clear red light for risk on core European government bonds, we felt contagion into the credit was less of an issue.

One signal of the credit market’s relative immunity is how open it has been to new issuance in recent days and weeks. Therefore as we rapidly approach the traditional summer close to the primary market, we believe now is a good time to review year to date supply levels.

The last fortnight has seen £3.7bn of non-financial supply into the sterling market via a flurry of issues from the likes of Annington, BMW, Volkswagen and Go-Ahead.  This is compared to only £0.8bn over the same period last year. Non-financials in euros have been similarly strong with €21bn issued, versus €9bn during these weeks in 2016.  A wide-open for business primary market is not what we would expect from nervous credit investors.

Given sterling is often lambasted as being an illiquid market which struggles to digest much supply without an aggressive repricing of secondary spreads, recent activity shows the depth of money still ready to be deployed into credit. Not only were secondary spreads stable, but order books for these deals were multiples of the sizes available; in the case of Annington £7.8bn of orders for £2.5bn of issuance.  This is against a backdrop of 10 year gilts losing 2.4% over the period.

There is an argument that higher absolute yields on offer as a result of the rates move might have attracted in yield buyers. However, given that most portfolio managers appear to remain underweight duration, showing their nervousness about further government bond losses, it looks likely there are those who are simply keen on adding spread.

Looking back on monthly issuance through 2017, we can see that euro denominated issuance is holding pace with previous years. Primary is well supported by the ECB’s Corporate Sector Purchase Programme (CSPP), which makes euro issuance attractive by having forced spreads to historically tight levels and also because the ECB can purchase directly in the primary market. So although we are not seeing any contagion from a shift in policy around the support of European government bonds, there is plenty of scope for spread widening in European investment grade paper when the tapering moves onto the CSPP.

Source: Bloomberg

Sterling primary issuance in 2017 has clearly outpaced previous years, already ahead of 2015 and 2016 totals and shows no signs of slowing down despite the BoE ending its own corporate bond buying programme at the end of April.

Source: Bloomberg

The sterling market’s continued ability to absorb paper shows its underlying technical strength, with many investors still holding large cash balances and deploying them when opportunities arise. This gives us additional confidence buying those sterling bonds where we think an unjustifiably high Brexit premium offers an attractive discount.

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