Hunting For Free Money In Europe’s ‘Cosmopolitan’ Bond Market

Over the summer, the Saudis tapped the euro bond market as part of a broader push to shore up the kingdom’s finances amid lower oil prices and diversify Riyadh’s funding sources.

The move came on the heels of January’s $7.5 billion international offering (which served as a test of the market in the wake of Jamal Khashoggi murder) and April’s blockbuster Aramco deal, demand for which was so voracious that the company was able to borrow for less than the sovereign. The euro bond sale came with an extra incentive – it represented an opportunity to tap what might as well be free money.

The ECB has, of course, driven rates into the floor and the central bank’s bond buying programs (plural) have helped push even corporate yields below zero. That, in turn, makes the euro market extremely attractive to foreign issuers.

“While the [dollar] remains the top choice of emerging market governments, euro-denominated securities now account for 30% of their borrowing abroad… up from 21% in 2013”, Bloomberg wrote earlier this month, in a piece highlighting the euro’s growing popularity as a borrowing currency for emerging markets.

Given the ECB’s renewed commitment to accommodation, one imagines the conditions will be favorable in 2020 as well.

Consider the effect of the same dynamic on the euro corporate bond market, where around €500 billion in bonds are negative-yielding.

“It’s not just European bellwether names that are enjoying this topsy-turvy world, foreign issuers contribute plenty to the backdrop”, BofA’s Barnaby Martin wrote Monday, adding that “just under 20% of all negative-yielding Euro bonds are from US issuers, and just under 10% are from UK names”.

(BofA)

Building on the theme discussed in “Twilight Zone Markets: Liabilities Are Assets“, this means that corporates will continue to see an opportunity to effectively mint “assets” in euro bonds, a perverse dynamic that will naturally lead to more supply. For Martin, that means 2019’s record €525 billion of expected issuance “now feels like the norm for the euro high grade market, rather than the exception”.

These dynamics are illustrated side-by-side in the following set of visuals. The chart on the right shows, to quote BofA, “the Euro credit market becoming more cosmopolitan than ever” thanks to “the allure of negative-yielding bond issuance”.

(BofA)

Non-eurozone domiciled issuers now outnumber Eurozone-domiciled issuers, and it’s not even close.

This raises the same set of familiar questions, some of which were posed by Howard Marks last month.

What happens when negative rates effectively convert liabilities into assets? Or, to quote Marks: “If having negative-yield debt outstanding becomes a source of income, will levered companies be considered more creditworthy?”

He continued: “How will the market now value businesses that hold a lot of cash and thus have to pay banks to keep it on deposit?”

That cash is a liability one way or another in a negative rates regime where large deposits aren’t spared — either the cash “earns” a negative yield on deposit, or you pay to store it somewhere, which is, in effect, the same thing (the cost of storage is essentially a tax).

As for the sovereign side of things, Bloomberg summed it up nicely in the linked post above. “Sovereign sales of euro-denominated bonds, which had stalled in July-August, were revived in the fall as sovereign issuers from Kazakhstan to Ivory Coast came to the market”, Srinivasan Sivabalan writes.

Serbia raised some 500 million euros earlier this month and Morocco is pondering tapping the market for 12- or 20-year funding too.

Read more: Howard Marks On Negative Rates