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Capital Markets Weekly: Supply lightens after recent yield reversal without indicating major market dislocation

25 February 2021 Brian Lawson

Overview

This week's activity is considerably below that recorded earlier in 2021, in part reflecting seasonal factors - corporate reporting blackouts and the slowdown around the Chinese New Year holiday - but also reflecting greater market caution after the recent reversal in bond prices. US and UK 10 year yields have risen 50 and 60 basis points respectively versus recent lows, with a broader measure of bond prices indicating nearly a 2 percent average fall in prices during 2021. Saudi Arabia's first negative yielding sale (in Euros) was the market highlight, with a medium to longer-dated sale by Peru pending.

Emerging markets

Saudi Arabia has arranged a two-part bond sale denominated in Euros with maturities of three and nine years. Books opened on 24 February with price guidance of mid-swaps plus 60 and 90 basis points respectively. The Kingdom went on to price EUR1.5 billion, with EUR1 billion in the shorter tranche at a 40-basis point margin: the nine-year tranche priced at a 70-basis point spread.

This implied reoffer yields of -0.057% for the three-year bond and 0.646% for the nine-year debt: the short-dated offering is the Kingdom's first negative yielding sale.

The operation was described by Global Capital as opportunistic. Demand was a modest EUR3.75 billion with market sources reported by Reuters claiming that the borrower had sought to raise EUR2 billion, but favoured tighter pricing over a larger size. Saudi Arabia had debuted in the Euro sector in 2019 with a two-part eight and 20-year sale that raised EUR3 billion, with the tranches priced at 0.78% and 2.04%.

Peru is reported to be undertaking marketing ahead of an international debt sale. The report in Latin Finance claims it will seek euro and dollar denominated debt of intermediate to long maturity, with launch likely shortly.

Tunisia

Following our recent update on Tunisia's borrowing plans, Bélchir Trabelsi, Director General of Reserves and Markets at the Banque Central du Tunisie contacted IHS Markit to deny that the country was undertaking discussions to reschedule its liabilities with selected creditors, as suggested in 2020 by Fitch Ratings. Instead, he suggested that confusion may have arisen over Tunisia starting new discussions with the US administration, seeking a USAID guarantee for a new international bond sale.

The same source highlighted a recent presentation to investors, flagging several indicators:

  • Unfavourably, the fiscal deficit was 11.6% in 2020, versus 3.9% in 2019, and the country's debt stock rose to 86.8% in 2020, versus 72% in 2019: however, this was "due to the Covid-19 crisis", and matches sharp borrowing increases in many other countries.
  • Tunisia also confirmed that it faces funding relatively sizeable needs of USD5 billion in 2021, based on external net debt amortization of USD2.3 billion and a projected current account deficit of USD3 billion.
  • More positively, it claims "comfortable FX reserves" of USD9 billion in December 2020, equivalent to over five months of import cover. It projects that even without new funding, this should remain above 3 months cover at end-2021.

In respect of funding, it claims that multinational organisations have committed USD1.5 billion of new funds for 2021, and that it is "well engaged" on talks with USAID and Japanese authorities for new guarantees for international bond sales.

Despite this, on 24 February, Moody's downgraded Tunisia by one notch to B3, with negative outlook. Moody's cited risk of further delays in obtaining an IMF programme, "increasing uncertainty" over the country's access to official funding sources. It also warned that "reform resistance" could prove higher than previously expected, hindering the government's ability to "stabilize Tunisia's fiscal accounts and debt dynamics".

Other debt

In a quieter calendar, processing and payments firm Fidelity National Information Services launched a USD5.5 billion six-part issue. The deal is linked to a USD8 billion tender offer for 11 outstanding bonds denominated in dollars, euros, and sterling.

UK budget airline easyJet sold EUR1.2 billion of seven-year bonds on 24 February. The deal - which just qualifies for investment grade ratings - was priced at a 1.875% coupon. According to the company statement "over 300 pan European investors" were involved in the deal which enjoyed "c. 5x oversubscription", according to Kenton Jarvis, CFO.

Implications and outlook

A slowdown in bond issuance is not unusual at this time of year, reflecting the Chinese New Year holiday period, and the completion of the traditional rush of supply in January, a month in which both borrowers and investors in many countries start their calendar-year investment programmes.

As an important additional factor, however, bond markets do appear to have undergone material correction, based among other factors on the expansionary nature of US fiscal plans and the expectation that vaccination programmes will permit faster economic revival from the impacts of the COVID-19 pandemic. Rising oil prices also have raised the concern of faster inflation, a potential constraint to monetary easing going forward. Overall, bond yields suggest that greater probability is now being assigned by investors to economic recovery and/or higher inflation within 2021:

  • The 10-year US Treasury yield has moved from 0.91% at end-2020 to trade at over 1.4%.
  • Germany's 10-year Bund yield increased from -0.6% to -0.28%.
  • 10-year UK gilt yields have risen from 0.17% in early January to 0.77% at present.
  • Having auctioned 10-year debt at a marginally negative yield in early 2021, Spain's 10-year bond yield has deteriorated to 0.4%.
  • The Bloomberg Barclays Multiverse Index, a broad measure of bond performance, shows (as of 24 February) an average decline of 1.9 percent in price during 2021. This is the worst first-quarter outcome so far for six years.

It is probably premature to describe a 50-basis point reversal in reference rates as a major dislocation, especially in the context of supply over the last month:

  • Several borrowers including Italy achieved record lows in pricing during February, with Italy funding EUR10 billion of ten-year funds at 0.604%, initially attracting a record book of EUR110 billion.
  • As described above, Saudi Arabia has achieved its first borrowing at negative yield with its three-year Euro-denominated sale this week.
  • National Bank of Kuwait, with an AT1 issue priced at 3.625% to initial call, and PetroPerú with 4.65% 2047 dollar-denominated debt, cited "the lowest pricing in our history" and "best ever pricing".
  • Egypt raised an expanded USD3.75 billion of funding including a five-year tranche at 3.875%, and 40-year money at 7.5%, with over 100 new investors participating in the package.
  • Ivory Coast tapped its 2042 Euro-denominated deal at 4.3%, having sold the initial deal at a 5% last yield last November.

Overall, the current slowdown in activity and reversal in yields needs close monitoring, but the above list suggests that there are ample indicators of borrowers recently enjoying attractive funding despite the rise in underlying reference rates. Greater caution would apply if supply remains at lower volumes, or a series of deals meet investor resistance and are withdrawn: this week, the only such indicator relates to Swedish property company AB Balder. It withdrew the domestic currency component of a package of hybrid debt denominated in Euros and Swedish Krona, citing relative pricing grounds rather than a more basic lack of demand.

Although Saudi Arabia no longer enjoys the scarcity factor it enjoyed a few years ago, both it and Peru are highly regarded credits, facilitating their market access despite the indications of recent bond market caution. The sale by Peru is expected very shortly.

Tunisia's planned market re-entry has been clarified by its recent investor communications. If it seeks to borrow with US and Japanese state support, this will reduce the degree of investor sensitivity to its underlying credit condition, and permit it access to very fine borrowing terms (prior to the cost of guarantees). There are past precedents for USAID support even without an IMF deal being in place (notably in Egypt). Successful arrangement of the planned US and Japanese guarantees would clearly be risk positive, as would progress with an IMF facility, while failure to implement the planned path of official support would be likely to increase the difficulty of subsequent stand-alone issuance.

Posted 25 February 2021 by Brian Lawson, Senior Economic and Financial Consultant, Country Risk, IHS Markit

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