Rates Spark: As Libor Falls Slow

Fed facilities have been hugely successful so far. That is partly why we doubt that corporate facilities will be put to use with too much vigor. Libor has already fallen impressively. A steady state here is tolerable. Heavy debt issuance is the dominant threat to rates. Steeper curve are still the most likely outcome, but with macro angst containing rises.

Fed facilities less needed - key observations

The Fed is standing ready to execute its primary and secondary corporate credit facilities. Given the 100bp penal cost attached to primary issuance help, we doubt there will be significant take-up here. In any case, most issuers have access to an open primary market. Hopes for big secondary market purchases should also be shelved, at least for now. Many of the other facilities have been pared back in recent weeks, as the Fed has spent less on support for money market funds and primary dealer credit; it would look incongruous for the Fed to go big in corporates against this backdrop.

What is likely is for the Fed to dip their toes in through ETF buying. Here they would not have to go big, they can buy high yield direct, and they avoid the need to get too name-specific too soon. That said the latter is not that complicated, and can be done if needed. But if it is done it would likely need to be done in more size. In any case, it is tough to see the Fed's corporate scheme being anywhere near as aggressive as the ECB's version. Note that the Fed's version of corporate buying is also technically not QE. In addition, ECB involvement in primary issuance contrasts with the explicit penalty that obtains if the Fed were to get involved.

So far the Fed's emergency facilities have been a huge success. The best measure of this has been the fall in Libor from 1.45% a month ago to sub-45bp now. Corporates have found themselves in a position to finance themselves without help, including from a fully functioning commercial paper market. Often they have used the cash proceeds to pay down bank revolvers, in turn taking some pressure off the banks. We can see all of this evident in the fall in Libor, which has been very impressive. We see fair value in the 30bp area. Expect the fall from here to there to be much slower though. An elevated Libor reading continues to make sense; if it stayed in the 40bp area for a while it would not surprise us.

Still counting cases

It is fair to say that one of the most closely watched developments is the outcome of the live de-confinement experiment happening in a number of economies, not least in Europe and in the US. We suspect the bar to re-entering a full lockdown if cases rise is higher than previously, given the extent of the economic damage done by those measures. Nevertheless, it is fair to say that growing infection rates would further delay expectation of a ‘return to normal’, whatever this may mean.

Ironically, downbeat news could help debt markets absorb the extra issuance the pandemic has already caused via two channels. Firstly, dim economic news would further depress growth expectations, and thus push investors in the safest categories of assets. Secondly, it may boost already high expectations of further policy action. Syndicated bond sales data show 2020 year-to-date issuance is running well ahead of the past three years’ average. Our expectations remain skewed towards slightly higher rates and steeper curves in the near-term as supply takes its toll. A deterioration of fragile sentiment could easily end this trend early.

EUR syndication volumes running ahead of previous years after March surge

 

 

Source: Bond Radar, ING

This being said, we think investors should stay alert to a further increase in borrowing needs. We noted previously an alarming tendency for economic expectations to be downgraded, this will come with wider deficits. In the UK, The Telegraph reports this year's deficit will reach £337bn. Whether this is paid for by austerity as the newspaper reckons, and thus lower growth, or whether it is financed by BOE balance sheet expansion, rates will remain pinned down.

Events today: all eyes on Powell

In addition to a heavy supply slate including 30Y Germany, 3Y/7Y/15Y/20Y Italy, 5Y/10Y Portugal and 30Y US, the focus will be on Powell’s interview. The tone of Fed’s speakers so far this week has set the stage for a dim assessment of economic prospects this year, and for a further dismissal of negative rates as a credible policy option for the Fed. Mester's comments overnight were the latest example to date of Fed officials opposing further cuts, despite renewed pressure from Trump.