Falling yields

Central Banks Distorting Bond Markets

ecb
Forming a tight bond: Mark Carney (l) and Mario Draghi.
  • Why it matters

    Why it matters

    Central banks are pushing investors out of the market for well-rated corporate bonds, which could have present major future problems for companies.

  • Facts

    Facts

    • The European Central Bank has bought €27.9 billion ($31.3 billion) in corporate bonds since the beginning of June.
    • This week the Bank of England launched its own corporate bond-buying program, which aims to buy £10bn ($13bn) in bonds by 2018.
    • By the time their programs end, the ECB will own 7.7 percent of euro-denominated bonds and the BoE 6.4 percent of outstanding sterling-denominated bonds.
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    Audio

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Even before the Bank of England’s bond-buying program got properly under way, it was already having an impact on the bond market.

At the beginning of August, the Bank’s governor, Mark Carney, unveiled the new program, which follows in the footsteps of the multi-billion euro action beign taken by the European Central Bank. Like Mario Draghi, president of the ECB, Mr. Carney wants to intervene in the bond market to lower capital costs for companies.

In doing so, he hopes to promote lending and boost economic growth, seen as threatened by the result of June’s Brexit decision. The reaction from a number of companies was swift: They immediately increased issuance of sterling-denominated bonds.

“Since then, we’ve seen new issues with a volume of around £12 billion ($15.6 billion),” said Philip Payne, a bond fund manager with Henderson Global Investors in London. This was a good sign for the bond-buying program from the Bank of England, or BoE. An increased supply of corporate bonds could help limit the market distortion that experts fear may result from the bank’s injection of demand into the bond market.

“The ECB and the Bank of England are distorting the market, and lower yields no longer adequately cover investors’ risks.”

Ben Bennett,, Bond strategist, Legal & General Investment

On Tuesday, the British central bank launched its bond-buying program in earnest. Information on the precise volumes purchased will not be available until the end of the week. But over the next year and a half, Mr. Carney wants to buy corporate bonds to a total value of around £10 billion.

This is considerably less than the €27.9 billion (£24 billion, $31.3 billion) that the ECB has spent on corporate bonds since the beginning of June. But the relevant market for euro-denominated corporate bonds, which does not include the banking sector, is more than 3.5 times greater than the equivalent sterling-denominated bond market.

If the ECB ends its bond-buying program in March 2017, as scheduled, it will by then own 7.7 percent of all outstanding euro-denominated corporate bonds, according to research by the American bank Morgan Stanley. By the end of its program, the Bank of England will have around 6.4 percent of the sterling corporate bond market, Morgan Stanley adds. Both central banks buy bonds from companies whose credit is ranked at “investment grade” by at least one rating agency.

The BoE’s intervention has made issuing sterling-denominated bonds more attractive, said Ryan Staszewski, bond expert with investment fund Threadneedle. Previously, companies had favored euro-denominated issues, which had offered better value, because of the ECB program. Now that the Bank of England has entered the market, the difference is less marked.

What worries investors are other effects, which are already becoming apparent. “The ECB and the Bank of England are distorting the market, and lower yields no longer adequately cover investors’ risks,” said Ben Bennett, bond strategist with the British asset manager Legal & General Investment.

This year, yields on well-rated euro-denominated corporate bonds have indeed fallen from 1.5 percent to around 0.5 percent. Many bonds are now yielding negative. In Britain, average yield has fallen from 3.5 percent at the beginning of the year to its current average of 2.1 percent.

But investors won’t accept just anything. This week, Lufthansa — whose bonds are included in the ECB buying program — tried to issue 7-year bonds worth more than €500 million, at a rate of around 0.5 percent. But the sale was cancelled. Sources in the banking industry say the return was simply too low for investors.

As a result, the rating agency S&P cut Lufthansa’s debt outlook from “stable” to “negative,” giving the company a “BBB-” rating, the lowest level still considered “investment grade.” Rival agency Moody’s already considers Lufthansa to be “sub-investment grade.”

But even if investors are not blindly buying anything on offer, lower yields are increasing the pressure to buy riskier bonds, said analyst Thomas Klee, of Landesbank Baden-Württemberg, a regional German bank. In other words, central banks are pushing investors out of the market for well-rated corporate bonds.

The problem is intensified by the sheer breadth of the central banks’ bond-buying programs. They are not limited to bonds issued by companies in the euro zone (for the ECB) or the sterling area (for the BoE). “In the case of the ECB, just under 6 percent of all purchases are of bonds issued by companies based outside the euro zone,” said Sven Kreitmair, head of bond research with Unicredit, an Italian bank.

These include bonds issued by U.S. oil company Schlumberger and by British-based companies Unilever and the Relx Group, as well as bonds from the Swiss companies ABB, Nestlé and Roche. All of those companies have subsidiaries within the euro zone, through which they issue bonds. That is enough to make them acceptable to the ECB program.

In this respect, the Bank of England is going even further; its key criterion is whether a company makes a “significant contribution” to the British economy. And so bonds from British companies, in a strict sense, make up only 60 percent of the BoE’s shopping list. Bonds from French and German companies each make up 10 percent of BoE purchases, while American companies comprise 16 percent.

With its looser definitions, the British central bank is able to buy bonds from companies such as French power generation company EDF, German giants E.ON, Daimler and BMW, and from American-as-apple-pie companies such as Apple, AT&T and Walmart. Major British companies on the BoE list include GlaxoSmithkline, Vodafone, Southern Electric Power and tobacco maker BAT.

The BoE’s list of companies may grow longer in the coming months if it doesn’t succeed in buying some of its initial targets, said Alix Stewart, a bond fund manager with Schroders. For example, bonds from the British supermarket Morrisons or the Spanish telecoms firm Telefónica seem to fit the Bank’s criteria, but they are not as yet on the purchase list.

Still, Ms. Stewart is quite certain: “Expansion and adjustments of the list are going to happen,” she said.

 

Andrea Cünnen works at Handelsblatt’s finance desk in Frankfurt, reporting on the bond markets. Katharina Slodczyk is Handelsblatt’s London correspondent. To contact the authors: cuennen@handelsblatt.com, slodczyk@handelsblatt.com

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