Before things can better, first they must get worse..
Some folk were caught by surprise by the dovish Fed FOMC minutes – Yellen’s concern about the effect of the strong dollar on US corporates was enough to boost bonds. “Lower for longer” was how the bond optimists read the impact on US interest rates. We still think upside growth surprises and pressure on wages, employment and the deflationary sideshow means we’re on course for tightening sooner rather than later. Watch that space.
And later today we get the first edition of the “Collective Wit and Wisdom of the ECB” (no jokes about the world’s shortest book please!) when the ECB publishes its account of the January 22 ECB meeting. Unfortunately, “the fair and balanced reflection of policy deliberations” will be on an unattributed basis, which is a shame as we know the decision to mount QE wasn’t a smooth discussion. Understanding how the ECB thinks about European growth is going to be… interesting.
Meanwhile, back in the bond markets, corporate spreads remains as tight as tight can be. I’m seeing TDC announce a 1,000-year bond (get over the shock, it’s just a perp), but I’m really struggling to get my head around the concept of Total launching a 2.375% hybrid sub perp deal. When rates normalise what incentive will Total have to actually call it? Remember the market has no memory. Really???
And it was a new issue orgy yesterday. European fixed-income new issue market saw yet another staggering day of too much cash chasing too few assets. Deals that were originally indicated at +30 basis points got launched at +17bps. Deals were typically five times oversubscribed.
And that oversubscription got me thinking. Firstly, is oversubscription real? Most accounts inflate orders because they know allocations will be scaled back. But, how does the global financial system leave so much unallocated money sitting on the sidelines of the new issue market looking for something to buy… when the global economy is still in such obvious trouble?
I am struck by the disconnect even as the global bond market is awash with cash; yesterday the European commissioner for financial services (Lord Hill - who he you ask?) was announcing the launch of the European Capital Markets Union – a move designed to enact common market standards and encourage non-bank lending, especially to the SME sector.
Something pretty fundamental must be wrong with the fixed-income markets when conventional new issue bonds are being bid up and launched at frankly stupid levels – yet a significant portion of sound unrated SMEs are finding it difficult to raise capital to expand their business. As SMEs are set to drive the bulk of job creation as Europe recovers, the EC is quite correct to be looking at.
However, it strikes me there are a number of reasons the new issue market is as it is.
There really hasn’t been any innovation in fixed-income capital markets since the global financial crisis. Instead, what we’ve seen is: i) backward-looking regulation (designed to avoid a repeat of the last crisis rather than the next one; ii) new capitalisation rules that punish market making and risk; and iii) a Luddite approach to any of the “complex” (therefore evil) financial transactions such as derivatives or securitisation.
The secondary effect has been retrenchment by banks. If they aren’t allowed to sell complex deals, they don’t need their armies of experienced and expensive bankers, traders and salesmen to shift complex product, so they dumbed-down fixed-income to very basic bonds and lower paid graduates – which is today’s new issue market. About the only complex new security we’ve seen in the last eight years is the CoCo – a muddled and ill-thought response to messy capital rules. The fact that retail investors have been banned from owning them sums it up. By the way, my financial traders reckon the bank sub market is about to puke.. so there you go..
Investors have been slow to respond to the rules that ended market making and squashed liquidity. They have been forced into the new issue market as the only place where there is the illusion of activity, and the possibility to acquire assets. Rather than investors being able to pick and choose from liquid secondary markets to refine portfolios, they are forced to design portfolios from what’s in the new issue pipeline – the tail wagging the dog.
The cumulative effect hits issuers – if you fit the market’s model it’s easy to get the investment banks to launch bonds into bullish and well defined investment grade, high-yield, or EM spaces. But heaven help issuers that don’t fit the bank models of what they think they can easily sell.
This is going to become very apparent when the bond market spins around – when rates start to rise and defaults start to rise. At that point an increasing number of issuers will find themselves excluded.
There is an alternative. The differences between issues in public bonds or private placements are negligible – except a private placement is a much more difficult sale (which banks can no longer do). However, the private placement is a negotiated market between lender and borrower and is a far less crowded investment space – meaning pricing may be slightly higher for issuers, but investors get rewarded for doing the additional work. More to the point, borrower and lender are aligned.
Developing alternative asset markets outside the narrow view of what the new issue bond market does is where I’m now spending the bulk of my time – and it’s fascinating. I might not ever get rich, but it's better than digging a ditch as a bored new issue originator. It’s also a space where I can use the banned financial magic of securitisation and derivatives.. hubble bubble toil and trouble..
No Porridge tomorrow I’m afraid, but full service on Monday.
Before things can better, first they must get worse..
Some folk were caught by surprise by the dovish Fed FOMC minutes – Yellen’s concern about the effect of the strong dollar on US corporates was enough to boost bonds. “Lower for longer” was how the bond optimists read the impact on US interest rates. We still think upside growth surprises and pressure on wages, employment and the deflationary sideshow means we’re on course for tightening sooner rather than later. Watch that space.
Before things can better
Mint – Blain’s Morning Porridge
Before things can better, first they must get worse..
Some folk were caught by surprise by the dovish Fed FOMC minutes – Yellen’s concern about the effect of the strong dollar on US corporates was enough to boost bonds. “Lower for longer” was how the bond optimists read the impact on US interest rates. We still think upside growth surprises and pressure on wages, employment and the deflationary sideshow means we’re on course for tightening sooner rather than later. Watch that space.
Meanwhile, back in the bond markets, corporate spreads remains as tight as tight can be. I’m seeing TDC announce a 1,000-year bond (get over the shock, it’s just a perp), but I’m really struggling to get my head around the concept of Total launching a 2.375% hybrid sub perp deal. When rates normalise what incentive will Total have to actually call it? Remember the market has no memory. Really???
And it was a new issue orgy yesterday. European fixed-income new issue market saw yet another staggering day of too much cash chasing too few assets. Deals that were originally indicated at +30 basis points got launched at +17bps. Deals were typically five times oversubscribed.
And that oversubscription got me thinking. Firstly, is oversubscription real? Most accounts inflate orders because they know allocations will be scaled back. But, how does the global financial system leave so much unallocated money sitting on the sidelines of the new issue market looking for something to buy… when the global economy is still in such obvious trouble?
I am struck by the disconnect even as the global bond market is awash with cash; yesterday the European commissioner for financial services (Lord Hill - who he you ask?) was announcing the launch of the European Capital Markets Union – a move designed to enact common market standards and encourage non-bank lending, especially to the SME sector.
Something pretty fundamental must be wrong with the fixed-income markets when conventional new issue bonds are being bid up and launched at frankly stupid levels – yet a significant portion of sound unrated SMEs are finding it difficult to raise capital to expand their business. As SMEs are set to drive the bulk of job creation as Europe recovers, the EC is quite correct to be looking at.
However, it strikes me there are a number of reasons the new issue market is as it is.
There really hasn’t been any innovation in fixed-income capital markets since the global financial crisis. Instead, what we’ve seen is: i) backward-looking regulation (designed to avoid a repeat of the last crisis rather than the next one; ii) new capitalisation rules that punish market making and risk; and iii) a Luddite approach to any of the “complex” (therefore evil) financial transactions such as derivatives or securitisation.
The secondary effect has been retrenchment by banks. If they aren’t allowed to sell complex deals, they don’t need their armies of experienced and expensive bankers, traders and salesmen to shift complex product, so they dumbed-down fixed-income to very basic bonds and lower paid graduates – which is today’s new issue market. About the only complex new security we’ve seen in the last eight years is the CoCo – a muddled and ill-thought response to messy capital rules. The fact that retail investors have been banned from owning them sums it up. By the way, my financial traders reckon the bank sub market is about to puke.. so there you go..
Investors have been slow to respond to the rules that ended market making and squashed liquidity. They have been forced into the new issue market as the only place where there is the illusion of activity, and the possibility to acquire assets. Rather than investors being able to pick and choose from liquid secondary markets to refine portfolios, they are forced to design portfolios from what’s in the new issue pipeline – the tail wagging the dog.
The cumulative effect hits issuers – if you fit the market’s model it’s easy to get the investment banks to launch bonds into bullish and well defined investment grade, high-yield, or EM spaces. But heaven help issuers that don’t fit the bank models of what they think they can easily sell.
This is going to become very apparent when the bond market spins around – when rates start to rise and defaults start to rise. At that point an increasing number of issuers will find themselves excluded.
There is an alternative. The differences between issues in public bonds or private placements are negligible – except a private placement is a much more difficult sale (which banks can no longer do). However, the private placement is a negotiated market between lender and borrower and is a far less crowded investment space – meaning pricing may be slightly higher for issuers, but investors get rewarded for doing the additional work. More to the point, borrower and lender are aligned.
Developing alternative asset markets outside the narrow view of what the new issue bond market does is where I’m now spending the bulk of my time – and it’s fascinating. I might not ever get rich, but it's better than digging a ditch as a bored new issue originator. It’s also a space where I can use the banned financial magic of securitisation and derivatives.. hubble bubble toil and trouble..
No Porridge tomorrow I’m afraid, but full service on Monday.
Bill Blain
44 207 786 3877
44 7770 881033
[email protected]
[email protected]
Posted at 09:32 AM in News & Comment | Permalink