Fixed income bankers surveying the geopolitical turmoil from Russia’s invasion of Ukraine on February 24 are pinning their hopes on a flight to quality supporting the best borrowers and a repeat of the prudential approach to fundraising that was seen in the early days of the coronavirus pandemic to bolster activity from lower-rated names.
And while they mostly expect that investors will be able to look through the current crisis – provided that it remains a conflict whose immediate scope is contained to Russia and Ukraine – they also note that it has not yet replaced existing inflationary concerns in investors’ minds.
Upcoming meetings in March at the European Central Bank and the Federal Open Market Committee were already causing jitters. Sanctions by Western countries targeting Russian banks and trade added to the worries on Thursday, although a reluctance by the US to disrupt energy markets eased some concerns heading into Friday.
“If the conflict stays a matter just for the two countries involved, then investors will be able to accept that it is of global significance, but not in an economic sense,” says one EMEA debt capital markets head. “But of course, the risks from here are that sanctions get tightened, and then there might be impacts on energy and food, or [that there is] some unpredicted escalation in the conflict.”
For all the talk of markets, however, many bankers are also the colleagues, relatives and friends of people now trapped in the desperate quagmire of a war zone.
“We have to remember that these are terrible events for Ukraine and its people,” says one. “Our job is to think about the markets, but this is also a human tragedy.”
One global syndicate head with Ukrainian colleagues whose families are in the country describes how communication channels between them are often restricted to social media. He says that in spite of the growing concern around the world in recent weeks, it was not until this week that many in Ukraine began to consider the worst outcome as a serious possibility.
“It was well telegraphed, but people just didn’t believe it would happen,” he says.
And a bad outcome it certainly is.
“What we are seeing – an invasion from three sides – was probably not the consensus in the market but the worst-case scenario from analysts,” says the EMEA DCM head. “With this being still so fresh, it is difficult to see what will happen, but markets have in fact been quite resilient.”
Quick recovery
Bankers say there has been no broad panic, with no widespread fire sales.
“There is a degree of questioning in the market about where central banks go from here, but fixed income has not moved in an extreme way and is proving resilient to the volatility that we have seen in equities, for instance,” says the DCM head.
Bankers described a strong turnaround in sentiment in US fixed income overnight Thursday/Friday. They expect something similar to come in the UK, but a slower reaction in Europe – partly because of a bigger perceived split between policymakers at the European Central Bank (ECB).
“What you hear will depend on which asset class you area speaking to,” says another European head of DCM. “In a typical flight to quality, you would expect the SSA [sovereign, supranational and agency] business to be OK and for investment-grade corporates to be OK.”
This banker says that as of Friday morning, the investment-grade market felt orderly, with decent two-way flows. But he notes that even the best names are unlikely to proceed to market with new issuance unless the worst volatility appears to have passed.
The pivot point has probably moved now, given the situation of the last 48 hours. While it was at the single-A level about a week ago, as of yesterday it would have been at the triple-A point
“With markets moving so quickly, it is almost impossible for investors to figure out fair value,” he says. “It would not be fair to ask people to stick a number on it, and investors will be asking for some stability first.”
Names directly affected by the crisis – borrowers from Russia or Ukraine – are clearly entirely off the agenda. But in any period of turmoil, market participants tend to talk of the flight to quality as if it were a static point, where certain names are always sold in a crisis and others are always bought. In reality, the point at which those moves happen continually shifts along a spectrum.
Two weeks ago, when the Ukraine crisis was brewing but not in such a stark phase, credit bankers were already seeing a risk-off attitude on the buyside. But last week, when single-A rated Siemens came to market with a five-year, it was able to print at a record tight level.
“The pivot point has probably moved now, given the situation of the last 48 hours,” says the same DCM head. “While it was at the single-A level about a week ago, as of yesterday it would have been at the triple-A point. Even double-As would have struggled.”
Just in time
Deals that got out just ahead of Russia’s devastating move now look very lucky to have done so – and have performed reasonably well. Double-A rated Deutsche Bahn’s €750 million 12-year was one of the last in Europe on Wednesday, tightening from 70 basis points over mid-swaps to price at 47bp over. Bankers saw it widen a little on Thursday but come back in again on Friday.
Unilever, a high-quality single-A name, was another to get away, pricing €500 million four-year, €650 million nine-year and £300 million six-year tranches.
“We were lucky with the timing on that deal,” says one banker close to the trade. “Could we do that deal for them next week? Yes, perhaps 10bp to 15bp wider, but that is still a low level.
“What I think is more in question is whether you will be able to do a deal where the borrower is looking for €3 billion to €4 billion. The quality has been there in orders this week, but in smaller size. Accounts that usually put in for €20 million have been asking for €5 million.”
The question now is when the broader primary market will re-open.
“It is a challenge to answer that,” says one of the DCM heads, although he thinks there will be names tapping markets next week.
He anticipates activity will follow the typical post-volatility pattern that starts with SSAs and investment-grade senior debt from defensive corporates and financial institutions, before migrating further down the credit curve. Demand for higher beta hybrid debt will take longer to come back.
Another banker says that US activity should recover quickly – one of the last to get out before the conflict broke was Wells Fargo, which printed a $3.5 billion 11-year on Wednesday at a deal that was seen flat to its outstanding 2031s.
“We are hearing very different feedback in the US to Europe, with investors saying they have a lot of cash to put to work. They will engage with the calendar but will be price sensitive,” says the syndicate head. “In Europe, it is a bit more mixed.”
In EM debt, names that are not in the immediate jurisdiction of the crisis should be able to access markets – single-A or double-A names from the Middle East could prove attractive.
“The emerging-market high-yield space will be tougher,” says another banker. “There will obviously be specific name-by-name considerations, such as whether you are an oil importer or an oil exporter.”
The syndicate head says that high-yield names will be most impacted not just because of immediate worries over the conflict but because of the increased sensitivity that leveraged corporates have to costs more broadly.
Back to inflation
The backdrop that fixed income markets have had for much longer than the Ukraine crisis – namely, the apparently endless debate over the persistence of inflation, and the willingness or ability of central banks to tackle it by turning off the quantitative easing taps – remains firmly in place.
“Don’t forget that you have the ECB meeting on March 10, the US Federal Reserve on March 16,” says the syndicate head. “You can solve an equation with one unknown, but here you have many unknowns.”
What bankers now worry about is whether or not the geopolitical crisis of Ukraine and Russia precipitates an economic one by disrupting the influence of hawkish policymakers from the Fed to the ECB in favour of dovish moves to delay tightening. Both sides are able to argue the same point: that their preferred approach would help settle the nerves of a market now rattled by a war.
Don’t forget that you have the ECB meeting on March 10, the Fed on March 16. You can solve an equation with one unknown, but here you have many unknowns
It is a reminder of fears in early 2020 that what had begun as a health crisis could quickly develop into a financial one. Crises, like viruses, are swift to mutate – and can become more transmissible as they do so.
When it comes to primary fixed income issuance markets, there is another reminder too. In the early days of the coronavirus turmoil, borrowers often tapped markets not because of conditions but in spite of conditions – and often when they did not need the funding. The same might happen again.
“You can talk about whether markets would be receptive to one type of name or another type of name, but there is also the question of what issuers want to do irrespective of whether markets are receptive,” says one of the DCM heads.
This banker had clients who did not need immediate financing in March 2020 because they were generating sufficient ebitda for their needs, and where secondary levels had moved because the pandemic had put a question mark on the sustainability of those cashflows.
“Those clients still went out and said: 'We don’t like these levels, but we want to borrow because we think it is prudent to raise that liquidity now',” adds the banker.
In March and April 2020 there were many deals at elevated levels but where issuer need and market access were both showing “green lights”, says the banker, with issuers prepared to pay a new price that investors were also prepared to accept.
This banker says that might happen now for similarly prudential reasons, with single-A or double-A names potentially finding good opportunities at the long end.
“That is my hope,” says the banker. “But to get to that point it will not be a straight line.”
