Euro-borrowing pressure drives SSAs further afield
20 Jun 2011
Last week, the European Financial Stability Facility sold a new €5bn ten-year bond, adding another dollop of debt to an already stupendous eurozone bailout bill.
This funding vehicle, and the European Union, will be forced to return to the debt markets many times again if the eurozone is to be kept intact.
Greece needs another €60bn or so to avoid default before 2013 but, even if it does not avoid this deed of dreadful note, Portugal and Ireland are looming as the next costs to be entered on the
Both sovereigns leapt to over 800 basis points in the five-year credit default swap market for the first time last week, and eyes are now turning nervously upon Spain as contagion fears
accumulate. Greece, meanwhile, has widened to 1,900bp, and counting.
Late last month, the EU brought a jumbo €9.5bn five and 10-year funding package and, although the deal attracted a remarkable €23bn of orders, it has performed relatively weakly in the secondary
market. The 10-year tranche was deemed too expensive by some onlookers.
lack of performance may damage the reception afforded to future funding exercises by EU funding vehicles, and offending investor sentiment is something they can ill afford as they will have to
return to these investors on a frequent basis over the next few years.
The fantastic amount of borrowing looming over the euro-denominated bond market will also hit demand for triple A-rated supranational, semi-sovereign and agency issuers.
SSA names like the European Investment Bank, KfW, Cades and Rentenbank have traditionally sought the greater part of their funding needs in the euromarket but, at the moment, it looks as if there
might be simply not enough room for them.
That helps to explain why there has been so much issuance in the US dollar market by this category of borrowers so far this year, but they must look elsewhere as well.
A record amount of redemptions by public borrowers in Australian dollars in June has upped demand for debt from highly rated issuers in this currency. By the end of the first 10 days of this
month, KfW had issued no less than A$700m ($737m) in a series of large taps.
However the Aussie dollar market is unreliable as well. After the ruling concerning the status of debt issued by overseas entities made by the Australian Prudential Regulation Authority earlier
this year, demand for SSA bonds has been tarnished and has only picked up recently due to the higher than normal level of redemptions.
Moreover, a decrease in non-Australian dollar debt issued by the domestic banks has resulted in a substantial drop in basis swap prices. Five-year Aussie dollar basis swap spreads have declined
from 22.5bp at the beginning of May to around 14bp mid-market.
While the funding requirements of the big four Australian banks have declined lately, due chiefly to high saving levels, there has been a steady drip-drip effect on basis prices from Kangaroo debt
issuance. These lower prices make it less attractive for non-Australian borrowers to swap out of Aussie dollars.
Casting the net further afield, there has also been a marked increase in SSA issuance in New Zealand dollars. At the beginning of this month, the EIB sold a NZ$200m ($160m) 10-year floating rate
note, and this followed deals in the currency from Kommunalbanken and the Nordic Investment Bank.
Kiwi dollar swap spreads
The rapid rise of New Zealand dollar interest rate swap spreads has galvanised demand among SSA issuers and made the market suddenly cost effective to these borrowers.
For months, Kiwi dollar swap spreads were in negative territory, making issuance by non-New Zealand borrowers very expensive. But New Zealand government bonds have been rallying hard lately,
pushing swap spreads wider.
At the beginning of May, the New Zealand debt management office announced that gross bond issuance in the 2011/2012 fiscal year would decline by one-third, so laughingly awash with liquidity is
the New Zealand exchequer.
The prospect of less issuance and the consequent narrowing of yields allowed swap spreads to move wider, and last week three-year interest rate swap spreads were at 12.5bp and five-year spreads
were at 8.5bp.
Basis swap prices in New Zealand dollars are also wider than in Australian dollars, although they are also moving tighter. Three-year Kiwi dollar basis swaps were around 21bp at the end of last
week, with five years at 30.5bp and 10 years at 36bp, and so offer an attractive pick-up.
The Swedish krona market has also seen an increase in SSA issuance in recent weeks, for the same reasons. Sensible fiscal policies have reduced government debt needs, flattening government bond
yields and widening swap spreads.
So, at a time when they need it most, cost-effective funding opportunities in sometimes ill-favoured markets have begun to present themselves to European agency and semi-government
But to assume that these fringe currencies can make good the lack of opportunity in the euromarket which has been created by the huge cost of sustaining the single currency, come what may, is naïve. There is only one way for these borrowers to turn, and that is westward to dollars.