Public sector issuers upbeat for 2014 but risks abound
LONDON, Dec 30 (IFR) - European public sector borrowers are cautiously optimistic about conditions in bond markets next year, even though there are plenty of hurdles ahead that could seriously narrow issuance windows.
After years in a tight spot some of the continent's most fragile economies are showing tentative signs of recovery while the European Central Bank is ready to nurture this fledging growth with further loosening of monetary policy.
Meanwhile, issuers have got the numbers on their side with overall volumes expected to tick down a fraction in 2014 to EUR847bn which should create a positive supply/demand dynamic.
According to Barclays, this is largely due to a EUR34bn decline in gross government bond supply while supranational, sub-sovereign and agency supply is expected to be unchanged at EUR360bn.
"We think the market is in good shape, and is acknowledging progress in the governance of the euro area," said Christophe Frankel, deputy managing director and CFO of the European Stability Mechanism and the European Financial Stability Facility.
For the zone's third and fourth-largest economies - Italy and Spain - this should provide a helping hand in getting away the EUR240bn and EUR130bn of gross issuance the countries need to do in 2014, of which more that EUR110bn will be net issuance, according to Barclays.
As well as progress made in the eurozone, the hunt for yield that has characterised the latter part of 2013 is expected to continue as investors seek to build a buffer against a back-up in rates.
"It's been beneficial for peripheral names," said Rodrigo Robledo, head of capital markets at Spanish government-backed agency Instituto de Credito Oficial.
FED SETTLES NERVES
Hopes are that this strong bid will continue, especially now that the US Federal Reserve has taken a big unknown off the table by announcing at the end of December that it would begin trimming its USD85bn per month stimulus programme by USD10bn from January.
Meanwhile, a more dramatic taper next year would not come as a shock to many.
"It wasn't anything earth-shattering," said Eila Kreivi, head of capital markets at the European Investment Bank.
"If the Fed increases the tapering amount at some stage then there could be increased volatility in the US dollar market next year, which could possibly spill over into the euro market."
The ECB will want to calm any contagion risks with either non-standard measures like a third Long-term Refinancing Operation, or simply through further rates cut.
"They will first try to do it on a vocal basis, but if needed I'm sure there will be some measures taken to ensure the fragile economic growth returning to the eurozone is not damaged by rising rates," said Anne Leclercq, director of treasury and capital markets at the Belgian debt agency.
But while the bid for higher-yielding peripheral debt should help countries like Spain and Italy, they are facing pressure domestically as their most loyal supporters - domestic banks - are likely to accelerate the pace at which they are trimming holdings of their country's bonds ahead of wide-ranging bank health checks in 2014.
Italian banks have already sold a net EUR11bn of Italian sovereign bonds between July and October 2013, coinciding with increased repayments of ECB loans. A more dramatic sell-off is not out of the question, however, especially with Europe looking like an increasingly anachronistic outlier on the issue of risk-weighting for sovereign bonds.
This means they will have to rely more heavily on international investors to sell their bonds at a time where there is expected to be more competition in the euro market from other issuers.
A narrowing in cross-currency swap rates has lessened the arbitrage benefits European borrowers get from issuing in the US dollar market, making them more reliant on their domestic currency.
In the five-year sector, for example, the euro/US dollar basis swap that was negative by as much as 69bp at the start of 2012, was bid at around minus 14bp at the end of December, its tightest levels since 2008.
Increasing bank charges for issuers that only have one-way collateral swap agreements, like the EIB, are also making cross-currency swaps increasingly punitive for many of the sector's most prolific supranational and agency borrowers.
Meanwhile, the narrowing swap rates have also caught the attention of international issuers, looking to return to euros after long absences, or launch inaugural trades.
In November, the World Bank issued its first euro-denominated deal since 2009, and now its private sector arm, the International Finance Corporation, is considering a debut in the single currency.
"If the EUR/USD basis swap continues to tighten we may have the opportunity to fund in euros which we have never done before, in benchmark form at least," said Ben Powell, senior financial officer at the IFC.
While this should be seen as a strong vote of confidence for the euro market, some of the richest European issuers are already preparing to have to pay higher returns in order to hold investor attention in 2014.
"There should be a correction in these extremely tight levels we have seen coming into year-end," said Horst Seissinger, head of capital markets at German development bank KfW. (Reporting by John Geddie, Editing by Helene Durand, Luzette Strauss)
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