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Capital Markets Weekly: Increased trade conflict sparks further bond-market rally

09 August 2019 Brian Lawson

The expansion of US trade tariffs against China triggered a further rally in high-grade sovereign debt, taking Germany's 10-year yield to a new record of -0.59% by 9 August: media reports suggest that between 2 and 5 August, an extra USD1 trillion of outstanding debt moved to offer negative yields.

Bond-market rally with increased caution towards riskier assets and equities

Capital markets are experiencing volatile conditions and raised uncertainties after the US announced plans to impose a 10% levy on a further USD300 billion of Chinese exports to the USA. On 5 August, this led to the renminbi trading through the psychological barrier of CNY7/USD, with the currency reaching a ten-year low of 7.0297/USD.

European markets rallied sharply on 2 August in response and have continued to strengthen. On 2 August, the 10-year German Bund closed at -0.5%, with its 30-year bond offering a negative return (-0.006%) for the first time, making Germany's full curve negative. Slovakia's 10-year bond reached -0.14% during 2 August trading. Having turned negative only in late June, the Netherlands' 10-year bond reached -0.38%: Denmark's, which went negative roughly a month earlier, reached -0.46%.

According to Bloomberg and other estimates, negative-yielding debt reached a record USD15 trillion by 5 August, rising by over USD1 trillion in just two days.

Conversely, Emerging Market spreads have increased with the EMBI+ global emerging market spread index wider by nearly 9% in August overall (to 6 August): individual countries, particularly those with lower absolute spreads, show greater percentage changes in their margins, in several cases well into double digits. Against a background of electoral uncertainties, Argentina's spread had widened over a full percentage point since end-July.

Late in the week, Italy stood out for sharp movement in the opposite direction. Against the background of growing government division and increasing likelihood of the collapse of its governing coalition, its 10-year yield surged from its close of 1.42% on 7 August, a 2019 low, to 1.78% as of early trading on Friday 9 August. In response, Germany's 10-year yield reached -0.59%, another new record low.

Emerging market debt

One Latin American issue has been completed despite the widespread market volatility. The concession for Line 2 of Lima Metro sold USD563 million of 17-year debt at 4.35%, saving 1.5 percentage points versus prior obligations callable due to technical slippage in the project. However, the deal had been in the market for some while, and thus is unlikely to reflect its latest movements.

On 3 August, the Philippines confirmed the sale of JPY92 billion (USD855 million) in Japan's domestic samurai market. The issue was in four tranches, spanning maturities of three, five, seven and ten years, priced at 0.18%, 0.28%, 0.43% and 0.59% respectively. The three-year tranche was largest, at JPY 30.4 billion, followed by that for ten-years (JPY22.7 billion). Philippine News Agency reported that the deal was upsized.

Late last week, China Petroleum Corp (Sinopec) raised USD2 billion through a package of five, 10 and 30-year debt. While it issued less than in prior funding rounds, the deal was well received with no signs of market pushback.

Other debt

This week's main deal was for Occidental Petroleum which raised a USD13 billion ten-tranche package to help finance its recent USD38 billion acquisition of Anadarko Petroleum. Peak demand reportedly reached USD78 billion despite the company's recent downgrade by Moody's and a pending potential adjustment by S+P. The 30-year (longest) tranche of the deal reportedly was priced at 225 basis points over Treasuries versus initial guidance of 2.7 percentage points, with a 10-year tranche priced at 195 basis points, versus initial price talk of a 220 basis-point spread.

Supply grew as the week progressed. Among those issuing was Global Payments, a financial technology firm, which sold a USD3 billion three-tranche deal. Public Service Company of Colorado sold USD550 million for 30 years at 3.269%, one of the lowest-cost long-dated utility issues to date. Other issuers included Hertford Financial Services, which sold USD800 million of 30-year debt at 3.662% and USD600 million for ten years at 2.837%. CVS Health raised USD3.5 billion of term debt alongside a tender offer to repurchase 2020 and 2021 liabilities.

German state Schleswig Holstein raised EUR500 million of 2039 debt, pricing this at 4 basis points over mid-swaps, equating to 0.269%. The deal is noteworthy for extending the borrower's maturity schedule by a decade, with a reduced stock of German sub-sovereign debt now available at positive yields.

Equity

The Renaissance IPO index fell 5.2% in the week to 2 July, reflecting the wider equity market sell-off after increased US tariffs were announced against China. The S+P500 index lost 3.1% in the same period. Despite this, four corporate IPOs were completed last week. By far the largest was for Dynatrace, a cloud software firm, which raised USD570 million well above its initial range, and ended the week 63% above its issue price. Five small deals are slated this week: this week's largest deal-related news is Snap's announcement it plans a USD1 billion convertible issue imminently.

Overview

The deteriorating trade environment threatens to increase downside risks to real economic development, and already has substantially exacerbated the growing lack of positive returns on international sovereign debt instruments.

Recent developments appear adverse for new share-raising and should encourage greater caution towards riskier debt assets, with these potentially damaged by a slower economic trajectory. This may be counter-balanced by ever-greater search for yield, pushing investors to take higher risk to avoid poor returns and fund withdrawals.

Against a background of greater economic and political uncertainty, central banks will face increased pressure to cut rates further: US markets, for example, now appear to be discounting multiple further rate cuts despite Federal Reserve caution.

From a more immediate deal-flow perspective, Occidental's deal was a clear success, with investors shrugging-off rating agency concerns over the firm's growing debt burdens. The EM calendar does appear lighter this week, but this may well also be influenced by vacation-related seasonal factors.

Posted 09 August 2019 by Brian Lawson, Senior Economic and Financial Consultant, Country Risk, IHS Markit

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