Tim Winstone, credit portfolio manager, explains how technical factors are likely to buoy demand for euro investment grade bonds.
- The European Central Bank has restarted its purchases of corporate debt but much of the impact was already in the price.
- Even so, having a price-insensitive buyer acts as an ongoing positive technical for the market
- Spreads are still not at their recent tights and with 84% of the market offering positive yields we believe the euro corporate bond market should continue to attract investors
After a hiatus of almost a year, the European Central Bank (ECB) restarted its corporate bond purchases in November 2019. Some €4.6 billion of bonds were purchased in the first three weeks, taking total purchases since the Corporate Sector Purchasing Programme (CSPP) began in June 2016 to €182 billion (as at 22 November 2019).
Figure 1: European Central Bank CSPP purchases
Source: HSBC, ECB, as at 22 November 2019.
It is hard to deduce the impact on spreads (defined as the difference in the yield of a corporate bond over an equivalent government bond), partly because the ECB announced the restart of the programme in September 2019 and consensus had been forming even earlier that the ECB was set to act. It could be argued that the price impact was already felt in the months ahead of the restart. The spread on euro investment grade bonds as measured by the ICE BofAML Euro Corporate Index fell from 155 basis points (bp) at the start of 2019 and reached a low for the year of 98bp on 7 November 2019, but has since climbed to 105bp by 22 November1. There are myriad factors that explain spread movements, but in terms of lowering spreads it does no harm to have a price-insensitive buyer scooping up bonds in the market.
The universe of euro investment grade corporate bonds as measured by the ICE BofAML Euro Corporate Index is approximately €2,600 billion1. The ECB’s CSPP-eligible universe of bonds is smaller at around €600 billion2 as there are a number of restrictions on the type of bond that can be purchased. For example, the bonds must be issued by non-bank corporations and be from corporations established in the euro area. The debt instruments need to be issued in the eurozone and denominated in euros, they must have a credit quality of BBB- (or equivalent) or better, a minimum maturity of six months and a maximum maturity of 31 years.
What is notable about the most recent purchases is that the ECB extended the possibility of buying assets with yields below the deposit facility rate (ie below -0.5%), so negative-yielding bonds are also eligible.
European companies have not been lax in taking advantage of this backdrop. In the last few years there has been an increase in net supply of euro investment grade issuance as companies have sought not only to refinance at lower rates but also to issue debt while borrowing costs are relatively low and there is a ready buyer in the market. It is not just European companies that have been issuing. There has been a notable pick-up in Reverse Yankees – bonds issued by US-based companies in euro markets, as US companies seek lower funding rates or to match funding costs with local revenue streams.
Taken together, the market is in a reasonably balanced state. Supply has picked up but there is plenty of demand for the flow which is keeping spreads in check. With negative yields prevalent on many eurozone sovereign bonds investors are looking to euro investment grade corporate bonds to offer some positive yield, without taking on excessive amounts of risk. As the chart below shows, the vast majority of investment grade corporate bonds offer positive yields, with only 16% of the euro investment grade market negative yielding3.
Figure 2: Breakdown of positive and negative yielding debt by sector
Source: Citi Research, Markit iBoxx Euro Corporate Index, as at 31 October 2019
With euro investment grade bonds trading with an average spread of 105bps, which is wide of their tights of the last five years (74bps in February 2018), but slightly below the five-year average of 114bp, we believe the market is neither expensive nor cheap1. In our view, investor interest in euro investment grade corporate bonds is likely to remain strong given caution around the economic outlook, with ECB purchases offering something of a backstop to the market.
1Source: Bloomberg, ICE BofAML Euro Corporate Index, Full Market Value, Govt OAS (option-adjusted spreads), as at 22 November 2019.
2Source: Bloomberg Intelligence, 30 October 2019
3Source: ICE BofAML Euro Corporate Index,, as at 13 November 2019