On June 14 Mario Draghi announced that quantitative easing in Europe would continue until December this year, with monthly purchases reduced to €15 billion a month from €30 billion in the interim. The ECB president indicated, however, that interest rates in the eurozone will remain at their present levels at least until mid 2019. He then inevitably capped it all off by stating that: “The Governing Council stands ready to adjust all of its instruments as appropriate to ensure that inflation continues to move…” towards its target.
As ever, the move is opaque – on the one hand indicating the end of QE and on the other not indicating the start of monetary tightening. Some commentators saw this dovish taper as a massive curveball, however, noting that it is highly unusual for the ECB to give the level of certainty. What is important is that the move comes as the effects of the withdrawal of QE are finally starting to bite in Europe.
Investment-grade debt markets are taking the brunt. In a QE world, nobody cared about events. Now they do. The iBoxx began the year at 45 basis points, and many now reckon it could be at 100bp by the end of it. Spreads in Europe are expected to move wider by 25bp from current levels.
Hurting
This is a market that is already hurting: corporate supply in Europe is down 26% on the year, but spreads are nevertheless still widening. Issuance in euros is down 11% thanks to a heavy drop-off in US corporates issuing in euros. And although it is up 3% in dollars, this is largely due to two large issues – $15 billion for Bayer and $11 billion for Vodafone.
Deals are being pulled. Bertelsmann recently postponed a €500 million seven-year deal in euros through Credit Suisse, JPMorgan and Morgan Stanley, and Whirlpool also pulled a $500 million 10-year via BNP Paribas, JPMorgan and Mizuho – both citing deteriorating market conditions. Others cited insufficient new issue premiums (NIPs).
In financial institutions, Allied Irish Banks’ €500 million seven-year deal through Deutsche Bank, HSBC, Nomura and UBS only limped over the line at the end of June despite a NIP of 30bp.
It is little better in high yield. Spreads have widened 78bp so far this year, the market is getting much more sensitive on levels and returns are down. Five deals have been pulled so far, including polymers manufacturer Synthomer’s €300 million trade at the end of June.
The markets are finally facing up to a reality where fundamentals actually matter and are no longer being swept away by ‘QE infinity’
In 2016, US high yield was returning 18% and European high yield 10%: today the equivalents are 1% and minus 1%. Unsurprisingly, outflows are meaningful globally, and new issue premiums in Europe have doubled from 25bp to 50bp. Leveraged loan issuance is down from €79.1 billion year to date in 2017 to €69.1 billion this year, and investors have been pushing back aggressively on deal documentation – the terms of over half of leveraged loan deals have been renegotiated in the market this year.
In equities, overall issuance is down 27%. Follow-ons are down 39% from $107 billion equivalent to $65 billion and convertibles are down from $14 billion to $10 billion. The bright spot is IPOs, which are up 39% from $20 billion to $27 billion. Nevertheless, scientific publisher Springer Nature pulled its €1.2 billion IPO in early May, saying that it will evaluate market conditions.
This is hitting investment banks where it hurts: the overall wallet was down 5% year on year by June. Despite heavy caveats from Draghi, the only direction of travel on asset purchases is down for the foreseeable future. The markets are finally facing up to a reality where fundamentals actually matter and are no longer being swept away by ‘QE infinity’.
Liquidity
But let’s not get carried away. Springer Nature was a late-cycle transaction and Bertelsmann was up against two other triple-B issuers on the same day. Pre-QE investment-grade yields were up to 3.5%. Average yields in the two years of the ECB’s corporate sector purchase programme were between 1% and 1.1% (the low was 0.6%) – today in investment grade they are 1.2%. So, there is still a lot of opportunity on a yield basis. There is still plenty of liquidity; the euro deposit rate is minus 40bp so it is very expensive to be in cash. But as one banker observes: “Issuers are having to recalibrate to a new reality”. In other words – pay more.
The pressure to do just that will grow as backlogs build. Access windows have shrunk and those borrowers that have baulked at issuing now will probably try to return to the market after the summer. That will mean even more pressure on timing in the third and fourth quarters.
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