Corporate Treasury Weekly: investor sentiment improves as the economic recovery proceeds undismayed

April 08 2021

Giles GaleHead of European Rates Strategy

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The big picture

Low rates, low volatility and an undismayed economic recovery are all positive for credit. Bond yield volatility continues to subside as the UK continues to reopen and the economic recovery accelerates in both the US – unsurprising given the huge fiscal boost & rapid vaccination progress – and Europe, where we think the European Central Bank’s (ECB) bond buying should help rates resist a rise until markets become more convinced of the region’s improvement (to be fair, France just entered its third national lockdown). Once they do, we see greater prospects for the Euro.

This week in headlines

  • The UK reopening is slow but sure – boosting Sterling’s prospects: the next step towards reopening was confirmed for April 12 (next Monday) and UK reinfection rates remain very low – with some sources suggesting herd immunity may not be far away. We see Sterling positioned to perform well as the government’s reopening plan progresses and gains market credibility.
  • Economic growth in Europe is picking up despite coronavirus-related pessimism: new restrictions in a number of regions – most notably France – have fuelled concerns that the Euro Area is struggling to ensure a lasting economic reopening by summer. But we are more optimistic. Vaccine deliveries are expected to accelerate substantially from this month – European Commission (EC) forecasts 360 million doses in Q1 compared to 100 million in Q1 – and improving weather should help reduce reinfection rates, while vaccination progress should ease hospital pressures. Lately, surveys reflecting broad business sentiment across the region have also come in higher than expected.
  • Better growth & longer-term US investment is positive for investor risk sentiment: fuelled by vaccination progress and fiscal stimulus, US economic data has been exceptionally strong. March payroll data showed over 1 million jobs were added last month, and the ISM survey, which reflects service sector activity, rose from 60.8 to 64.7, the highest level in more than 37 years. New long-term investment in the form of a $2 trillion support package, which we think might pass by September, should also be seen as a positive for investor sentiment.
  • Greater economic growth points to higher bond yields – but ECB bond buying & lower corporate supply should protect European rates: better economic growth should start pushing bond yields higher globally, but in Europe – where the ECB has boosted its asset purchases and corporates look set to scale back issuance – bond supply might feel considerably tighter over the next quarter (perhaps €50 billion/month less compared to Q1). That combination of lower supply & higher demand should keep bond yields in check.
  • Strong growth & stable rates are the ideal environment for credit & borrowers – but defaults could pose a risk: credit spreads are, unsurprisingly, very close to long-term lows now, and we see no reason why they should not continue to perform well. Rising defaults could be one risk. Non-performing loans are likely to pick up once moratoria & pandemic support measures are unwound. But we expect only reasonable increases, which shouldn’t upset credit markets.

Trending treasurer trades & talking points

Swap pricing factors come into focus as hedging edges up the corporate agenda

We’ve seen more clients looking to hedge their activity in Euro markets this week, primarily to lock in attractive fixed rates. With the increasing focus on the full range of costs and charges related to hedging activity (imposed by banks and regulators), swap pricing has become ever more transparent – but not necessarily easy to predict. In a dynamic (and tightly priced) market, less discussed factors such as the currency of underlying collateral agreements, timing, and the dynamics of the underlying derivatives book of respective banks involved with these transactions all have a material impact on competitiveness & pricing.

SOFR-linked hedging gains traction as IBOR reform continues apace

We are seeing more activity in the Sterling Overnight Financing Rate (SOFR) swaps market, with clients asking for SOFR-based quotes on new hedges and amending existing US dollar LIBOR-linked trades. That said, IBOR reform continues to be front of mind with corporate clients, many of whom are examining alignment across different markets.

Charts of the week

The UK recovery continued to accelerate in March. UK PMI, a broad measure of business sentiment & activity across different sectors, remained positive despite small downward revisions to the UK services sector (which weighed slightly on the composite measure).

UK PMIs remain consistent with the view that a recovery is imminent

Sources: Markit, NatWest Markets. A score above 50 implies economic expansion, a score below 50 implies economic contraction.

Notable in the UK Services PMI breakdown was the jump in both input prices (64.0 from 58.6 – the highest level since June 2018) and prices charged by services providers (55.2 from 51.9 – the highest level since November 2017). This could offer some evidence of nascent price pressures, and consistent with our view that a rise in inflation in the second half of this year and first half of next will likely be most pronounced in consumer leisure services.

UK PMI inflation indices hint at emerging price pressures

Sources: Markit, NatWest Markets. A score above 50 implies rising prices, a score below 50 implies falling prices.

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