Bankers and investors were getting a sense of deja vu last week as news from Cyprus reminded them of the Grexit jitters almost three years earlier. “We can be grateful we have seen three years of very benign markets, but I’m not sure what would happen if the market sees some serious volatility,” said one syndicate banker in Hong Kong.
Some real-money accounts and even private bankers echoed his concern because they saw the possibility of a correction in the market, while uncertainty about the future of the eurozone returns to the fore.
“We have seen this before. First, you see volatility pick up just after a wave of supply and, then, there is a correction,” said a high-yield fund manager.
He was referring to the active primary market, which saw almost US$6.5bn in new dollar issues from Asia ex-Japan in the first three days of the week, topping a very active March. The region reached the quarter-end having printed close to US$42bn in dollar bonds, an absolute record for the period.
Amid so much issuance, it is surprising that the market is holding up as well as it is. “The credit market has been very resilient,” said another real money investor.
Still, that strength started to be tested last week with the volatility from a potential banking crisis in Cyprus finally spilling over to the rest of the world. The Asia ex-Japan iTraxx IG Index closed 7bp wider Thursday, at 123bp and JP Morgan Asia Credit Index finished the short week 21bp wider in yield terms.
The steeper drop on the cash side was evidence of one of the reasons for investor concerns. Asian markets remain illiquid and, although they have matured and grown of late, they still suffer sharp swings whenever there is a correction. Furthermore, institutional investors have become increasingly concerned about the build-up of leverage in the system as private banks and hedge funds buy bonds on margins of up to 90% at times.
Both factors together can exacerbate any correction something that was last seen after the downgrade of the US caused a selloff in the high-yield market. Investors admit that, if there is a correction, the high-yield side will take a bigger hit.
However, at the same time, the asset class is also the only one for which they still see some upside because of the looming rise in benchmark rates. “For the time being, people want yield and junk bonds still provide a better cushion against rising Treasuries,” said one real-money investor.
That dynamic, in fact, was seen in secondary markets last week, as the high-yield bonds ended the week above reoffer even as the rest of the market sold off.
The new five-year bonds of Tower Bersama Infrastructure, for example, closed the week at 100.25, 25 cents above the reoffer. Sunac’s deal, which was priced on Thursday, ahead of a wider market selloff, held the reoffer price on the break.
Citic Pacific’s new seven-year bonds ended their first trading session Thursday at 100.50, having priced at par. Even Greentown China saw its 2018s return to 103.00 Thursday after they were reopened at 102.50.
On the flip-side, investment-grade issues all widened. The five-year bonds of split-rated Bharti Airtel dropped to 100.25, below the tap reoffer of 100.625. SmarTone, which, in spite of being unrated, trades on spread and is, as such, an investment-grade credit, ended its first session 10bp wider than reoffer at 225bp over Treasuries. As for Suzlon’s bonds, with a backing of a standby letter of credit from State Bank of India, they never recovered the 20bp they widened on the break earlier in the week.
Clearly, investors do not seem to be positioning for a pickup in volatility, which would prompt an investment-grade rally. If anything, they seem more concerned about additional supply than headline risk.
One hedge fund manager was of the opinion that credit investors in Asia were in a conundrum right now. “If conditions improve, there will be a supply wall and that caps the outside; if volatility increases then we lose anyway,” he said.
However, their bet on high-yield, ultimately, points to strong faith in the ability of central banks to keep pumping money into the system. “You cannot fight the Fed, especially when it is acting in tandem with the Bank of Japan and the ECB,” said one private banker.
A credit analyst in Singapore said that data in the US was looking better and that, if the world’s largest economy started picking up the pace, Asia would benefit. He added that, if Europe saw more volatility, investors were even more likely to park their money into Asian assets. “Asia and EM will both benefit from continued monetary easing,” said the high-yield manager.
As long as the Fed continues to ease, it seems, any volatility will merely be a hiccup.