Article / 28 September 2016 at 10:30 GMT

Weekly Bond Update: Uncertainty reigns

Fixed Income trader / Saxo Bank
  • Primary bond markets have been 'red hot' in the wake of ECB purchase plan
  • 'Plenty of downside potential in the short-term for European credit'
  • Norddeutsche Landesbank, Lufthansa step away from planned bond issues

German flag carrier Lufthansa has cancelled a planned seven-year bond issue, 
citing unsatisfying demand. Photo: iStock 

By Michael Boye 

Underpinned by an unprecedented commitment from the European Central Bank, which earlier this year launched an ongoing corporate bond purchase programme, the primary bond markets in which corporations sell new bonds to the public have been glowing red-hot.

Companies have been looking to take advantage of favourable loaning conditions and investors have been standing on top of each other frothing for high-yielding (or maybe not even that!) assets.

This has raised concerns over market discipline and moral hazard as the yields on some loan deals have reached near-absurd levels; here we are thinking of items like the zero-coupon Unilever bonds or Deutsche Bahn even selling negative-yielding bonds.

However, this week saw some bond issuers tighten the screws a bit too far. On Monday, German airliner Lufthansa dramatically withdrew a planned seven-year bond issuance following unsatisfying demand at indicated price levels. Lufthansa was trying to jump in ahead of a potential downgrade below the crucial Investment Grade threshold, having already seen Moody's take its credit rating down to Ba1 and high-yield territory...

Apparently, investors were not fooled this time. 

It is an encouraging development, certainly, if it is in fact evidence of market discipline. But coinciding with this story, market confidence in Deutsche Bank – Germany's biggest lender – has once again been challenged...

Subordinated CDS spreads for Deutsche Bank debt close to all-time highs yet again:

Source: Bloomberg

This would seemingly have a greater explanatory force in the case of Norddeutsche Landesbank, which on Tuesday became the second bond issuer to withdraw a planned bond issuance this week, confirming widespread concerns over the German banking sector. 

The Investment Grade-rated regional lender stepped away from an intended seven-year bond issuance as it struggled to find sufficient demand.

For credit investors and financial markets in general, this presents a much more dire scenario, as a credit crunch would have the potential to quickly pull the rug out from under asset valuations. 

Given the elevated levels of credit spreads in a historical context of late, this leaves plenty of downside potential for European credit in the short-term if the uncertainty surrounding Deutsche Bank persists.

Compared to previous stress hikes this year, 
plenty of downside potentially remains for European credit:

Source: Bloomberg

— Edited by Michael McKenna

Michael Boye is a fixed income trader at Saxo Bank


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