September’s bond pipeline may be bulging but bankers expect issuance to decline markedly during the fourth quarter as investor demand wanes and Chinese issuance tapers off after October’s National People’s Congress.
As FinanceAsia has been reporting in a three-part autumn preview, it has not only been a record-breaking year in the dollar-denominated market, but also yet another one when US Treasury yields continue to defy economists’ expectations.
While global economic growth has picked up, inflation has not and its absence has once again wrong-footed many commentators. US Treasury yields have not spiked up towards the 3% mark as expected. Instead, they currently remain around 2.44%, above the 2.13% level they started the year at.
The performance of the US Treasury market has provided a firm underpinning for bond issuance. And over the near term, JP Morgan’s Asian fixed income analysts expect secondary market spreads to remain fairly steady too, based on the performance of JP Morgan's Asian Credit Index (JACI).
“Credit spreads have been ranging from 220bp to 235bp for the most part of this year,” they noted. “We don’t see any catalyst in the near term to move spreads either way out of this range for now even as we maintain our view that valuations remain on the rich side.”
However, the desk does note that, “onshore demand is waning from China somewhat".
This potentially puts September’s new issuance pipeline in a weaker position, particularly since bankers expect supply to remain strong right up to the beginning of October.
“So far, there hasn’t been a material slowdown in issuance in any month this year,” said Jake Gearhart, Deutsche Bank’s head of debt origination and syndication, APAC. “But I’m anticipating a slower fourth quarter, more like 2015 volumes of circa $30 billion rather than the nearly $50 billion we saw last year.
“I think investors will be keen to protect their gains,” he added. “We’re also expecting less issuance from China after the NPC meets.”
James Arnold, Citi’s head of debt capitals markets syndicate, APAC, also believes there will be a shift in the type of issuers over the coming four months.
“The first half of the year has been more skewed towards high yield than in 2016,” he commented. “I do think we’ll see better balance during the last four months particularly on the corporate side.”
New income stream
High yield is where Asian bankers have historically made their money. But both Citi and Deutsche have recently been involved in transactions, which point to a second lucrative income stream.
In mid-June, Deutsche and Standard Chartered were joint global co-ordinators of Asia’s first bond, which deployed proceeds purely for a dividend re-capitalization - Blackstone and Government of Singapore Investment Corporation taking money out of Indian outsourcing company MphasiS.
Gearhart stated: “Asia’s leveraged finance market is really starting to mature, which is good news given how much private equity investment there is in the region these days.
“The bond market is proving its worth as an avenue to re-finance acquisitions,” he continued. “Investors are now willing to accept these players as company' owners, enabling the most responsible to take some equity out of their business through dividend re-caps."
One month after MphasiS, PT Paiton Energy executed a $2 billion structured bond alongside a six-year amortising loan via Barclays, Citi, Deutsche and HSBC.
The quasi-project transaction demonstrated how the bond and loan markets are able to complement each other. A chunk of the proceeds were also partially used to fund shareholder distributions for a group including Mitsui and Qatar Electricity & Water Co.
Risk-off factors
Yet there are plenty of factors, which could suddenly spell the end of the bull market for Asian bonds. And after such a long run, investors are constantly on the look out for potential triggers.
At the beginning of the year, economists were very focused on the potential inflationary impact of President Donald Trump’s promised fiscal expansion and the Federal Reserve’s response to it. Since then, the focus has switched to the president’s frequent missteps, ranging from his difficulties executing policy to simply retaining staff.
Or as Gearhart put it: “I’m less worried about black swans and more about an orange one. Congress appears to have zero appetite for conflict over the debt ceiling, but it’s not clear the White House feels the same.”
AllianceBernstein has even gone as far as describing the US as a potential “rogue state” thanks to Trump’s bellicose rhetoric towards North Korea. Citi’s Arnold highlights global uncertainties as a top downside risk.
“We see geopolitical issues as the biggest potential market risks; in particular the ongoing North Korean missile crisis, German elections and China’s National People’s Congress,” he outlined.
Arnold also flags uncertain central bond policy.
“Our house view is for the next rate rise to come in December,” he said. “But a potentially bigger focal point for markets is the adjustments to central bank balance sheets.”
Gearhart agrees that December is likely to see the next rate rise, before adding that the market’s biggest challenge remains a disconnect between what the Fed is saying and what the markets are pricing in.
“Conventional wisdom dictates it is never a good idea to bet again the Fed, but that is exactly what the market has been doing and seems to be winning,” he explained.
“US interest rates really should be higher,” he argued. “Current levels don’t really feel very sustainable in a world where even the IMF is talking about sustained global growth.”
The most recent US Commerce Department figure showed core inflation running at 1.4% on an annualised rate in July, below the Fed’s 2% target and despite a pick-up in consumer spending.
Yet Gearhart concludes there is still time for inflation to rear its head before the year is out.
“My two macro concerns surround inflation and oil,” he said. “Both could surprise on the upside and spiral into the rates market. Where oil is concerned supply could be a lot tighter than people imagine because of instability in Venezuela and Nigeria.”
Rajeev de Mello, Schroders' head of Asian fixed income, is more relaxed. He suggests central banks will unwind their balance sheets very gradually and have been very careful about their choice of words.
“There’s plenty of communication and we think emerging market investors are well set up,” he said. “Those that are invested should remain confident that we will not see a big drop off in values – at most, a small correction.”
Whether the Asian bond market’s favourable supply/demand dynamics will extend through into 2018 remains to be seen.
“We’ve learned to expect that some years will be bigger than others,” Citi’s Arnold concluded. “I think we’ll need to see a few more years like this before we can confidently say there’s been a step change.”
