- by Suki Mann
|iTraxx X-Over Index
|10 Yr Bund
|iBoxx Corp IG
|iBoxx Corp HY Index
|10 Yr US T-Bond
Favouritism, fear of failure or just greed… Alas, it looks like the authorities are finally in the process of addressing the issue of allocations in the primary bond market. This matters, because all manner of decisions are impacted by allocation – to hold, to flip, to buy more, as well as what the success or failure of a deal means for the current state of the market. But it goes further. The current process, broadly speaking, sees to it that certain investors – usually the larger players – can effectively guarantee the success or perceived failure of a newly launched offering, market conditions aside. They are able to take a sizeable chunk of most deals, as they have the highest absolute skin (money to invest) in the game. One could argue they bear the brunt of much of the risk if the deal does not perform, so it is only fair. That said, not long ago, as part of the pricing (and deal sizing) process, investment banks used go on a ‘price discovery’ exercise with a number of ‘important’ market participants, especially in the case of borrowers perceived as being more ‘difficult’, or in times of market stress. After all, no one wanted a failed launch. However, this price discovery process has disappeared, as investors do not want to be wall-crossed. Still, once the deal is announced conversations can take place.
Who’s looking out for the little guy?… The story goes something like this: after some marketing, putting the deal on the screen, building books and so on, the allocation process usually sees that the ‘big guy’ gets his bonds (or a decent percentage of his needs) – still. Usually, he has put in a sizeable order (maybe a so-called lead order), which can then sometimes be communicated to the broader market. Or leaked. Anyway, going back a step, the book-building process sees that the size of the book, as it grows, is somehow communicated. We note that for an SEC-registered deal, you cannot do an update on book sizes until after pricing. That is an obvious first step for the euro market. Anyway, the ‘little guy’, fresh with this bookbuilding communication/information and not wanting to get left behind, then piles in. He is not going to be the mainstay of the deal’s success or failure, and a final allocation will usually see him get less than hoped for – or nothing. Therefore, he more often than not inflates his order, playing into the hands of the banks who herald the tremendous demand for the deal. So the book builds some more and other orders – usually inflated – follow. Voilà! A Eur500m deal is for example 4-5x oversubscribed, but the ‘real’ demand is actually much lower. Who cares? The borrower gets his funds and pricing is nearly always better than the initial price talk (IPT). Happy borrower. As for syndicates, we agree they only publish actually book sizes which are derived from client orders – concerned at the Market Abuse Directive (MAD) – and will not mislead the market. But they happily take inflated orders, take on no risk through this process and pocket their fees. Happy banks. The ‘little guy’ is left frustrated as the issue is launched, is free to trade, might trade up or down, and he has no control – and usually only a few bonds. Who cares? We move on to the next deal.
And the rest – well, it gets interesting… Manpower (Baa1/BBB) slipped in a deal ahead of the NFP numbers at the end of last week, confounding most that Friday would be a non-event. Mind you, the deal was only for Eur400m (on a Eur1bn book), so not in the benchmark, although it seemed reasonably priced before being tightened to midswaps+125bp (-15bp versus IPT) for 7-year funding. Away from that, equities chose early on to give back their gains of the previous session, and then gave back some more following the good but lower-than-expected payroll of 173,000 jobs added in the US (unemployment rate down to 5.1%). That’s effectively full employment in the US and an average run rate of over 220,000 jobs added in the last 3-months after revisions. The market now thinks a hike is coming in a couple of weeks, hence the ratchet lower in stocks (S&P -1.5%, Dax -2.7%). And it gets interesting now with a potential tightening of monetary policy in the US and room for loosening in Europe. The fork is skewered as we head in different policy directions. Until we get that Fed decision on the 17th, the markets are going to remain very edgy, while EM fund outflows could possibly accelerate into it. They certainly won’t slow. The likely defensive nature of investor dynamics/sentiment over the next two weeks will leave stocks volatile – the front of the US Treasury curve might see some weakness while the back end stays fairly anchored. In Europe, we will decorrelate from the US as govvie yields play to the tune of the data in the eurozone and potential for additional accommodative ECB policy. It’s a decent data week ahead as well, with trade and inflation numbers from China, and industrial output and trade figures out in the eurozone. The US is closed for Labor Day on Monday.
Finally for corporate bonds… We’re not going to ratchet tighter as far as spreads are concerned because macro uncertainty and equity volatility will act as inhibitors, but we should hopefully gain some performance. We closed a little weaker in corporate bonds across the board at the end of last week, the usual higher beta sector under most negative price action (CoCos and hybrids), with only the new issues really managing some obvious performance. We expect Europe will outperform the US in spread and absolute terms. Higher rates in the US possibly leading to higher yields will eventually eat into returns, for example. Euro-denominated credit will continue to benefit from low(er) yields while demand for corporate risk is going to stay robust in the face of a continued low-yielding environment and a need for a higher yielding, safe-haven investment.