Corporate Treasury Weekly – 4 March 2021

March 04 2021

Imogen Bachra, CFAEuropean Rates Desk Strategist

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The big picture

Bond markets were hit hard by selloffs and rising yields last week as investors started to unwind their bets on future interest rate hikes and rising inflation, but new credit demand seems to have held up well against a rise in volatility. Our conviction in the reflation story is still strong and to that end, we – and the rest of the market – will be closely watching the forthcoming ECB meeting for signs of any pushback on higher bond yields. In the UK, meanwhile, all eyes were on the 2021 Budget – which featured larger-than-expected fiscal stimulus and plans for more longer-dated borrowing.

This week in headlines

  • Rising long-term bond yields could lead central banks to push back: bond selloffs last week – first in the US then in Europe & elsewhere – has led to more questions about whether and how central banks respond. While other G3 central banks (the Bank of England and the Fed) have been more relaxed, we see the ECB – which has stepped up its rhetoric around taming rising yields and meets on 11 March – as the likeliest of the three to push back.
  • Markets are equivocating on inflation expectations: with markets hitting ‘pause’ on the selloff in core rates markets, we see two potential scenarios playing out: the virtuous circle of lower rates fuelling risk-taking breaks, and bonds and stocks continue to fall, possibly as markets worry about higher inflation over the longer term; or, bonds rally back, and inflation expectations return to crisis levels. We think the latter is more likely of the two.
  • Corporate credit spreads remain resilient despite the volatility: credit spreads only widened moderately after a fairly aggressive selloff in core rates markets, with demand in primary bond markets holding up fairly well for corporates: new issues from existing borrowers priced flat to their secondary yield curves and with no new issue premiums (a pricing concession most new bond issuers pay). That said, secondary markets showed some signs of investor trepidation as spreads drifted wider during last week’s rout.
  • The UK Budget saw a lot more stimulus and QE will likely be required to keep rates in check: the UK government announced a larger-than-expected fiscal stimulus package (£59 billion) and revealed a shift in the composition of gilt issuance to favour longer-term bonds and linkers. We think more QE will be called for to counter upward pressure on bond yields in the medium-term.
  • Coronavirus progress continues with new vaccine approvals on the horizon: vaccine distribution and still low case numbers underpin our assumptions around a sustained recovery in the second half of the year, even if they took a back seat to reflation concerns last week. The news that the US has approved the single dose Johnson & Johnson vaccine is positive, and we expect the UK and the EU to follow suit in the coming weeks. As ever, vaccine progress is the name of the game – and with the UK still a clear leader, we expect Sterling to continue its strong performance.

Trending treasurer trades 

With volatility back on the cards, treasurers who think bond yields have peaked in the near-term are considering a move from fixed into floating-rate debt

The return of volatility and the rise of bond yields may incentivise corporates who think yields may be peaking near-term to swap fixed-rate debt to float, to take advantage of improved funding costs and lock in lower spreads than could be achieved at the time of issuance. 
But locking in today’s rates could mean missing future rate rises, which is why some of those eager to make the switch have taken to selling “swaptions” – which would allow a company to identify a rate, above current fixed rate levels, at which they would happily switch to float, and means the company would get “knocked-in” to the rate lock if rates rise (while getting paid a premium to wait).

Chart of the Week

Long-term UK yields are on the rise

With expectation of better UK economic prospects (given the pace of UK's vaccination) yields are rising across the UK government bond curve, with the 30-year segment of the curve gaining the most since global financial crisis. We think yields still have room to rise further.

Monthly yield change (bps) on 30-year UK government bonds

Sources: NatWest Markets, Bloomberg.

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