Issuers are being advised to prepare for higher new issue premiums when approaching the primary market, following unexpectedly hawkish ECB comments yesterday (Thursday) that pushed yields towards their highest levels in three years and implied a possible earlier than expected end to APP.

Although no formal changes to monetary policy were announced, European Central Bank president Christine Lagarde in yesterday’s press conference cited “unanimous concern” about inflation, with the ECB expecting the uptick in prices to be higher and persist for longer.

In the wake of her comments, markets moved to price in a 10bp rate hike as early as June and around 50bp by year-end. The yield on the 10 year Bund rose some 11bp and then a few basis points further this morning to around 0.18%, its highest level since March 2019, while the five year Bund is at its highest level since April 2018, having backed up around 0.40% since the beginning of last week to around minus 0.03% today.

“If you’re going to go that fast, we basically get back to zero in the Eurozone by year-end,” said one market participant. “It’s not impossible, but that’s quite a move from where we were.

“The ECB has been behind the curve – and is in good company with the Fed there– but from where we’re sitting, it feels different in the Eurozone.”

The ECB’s hawkish tilt put pressure on financial credit spreads, with higher beta products such as AT1 and Tier 2 worst hit, but also senior non-preferred closing 3bp-8bp wider yesterday and senior preferred 2bp-5bp wider, according to one syndicate banker.

Another banker said that although spreads had been marked wider, little selling was seen, while covered bonds were resisting the widening. The most recent long-dated trade, a €1.25bn 11 year for Crédit Agricole Home Loan SFH, was quoted at 5.5bp/3.5bp after having been re-offered at 5bp on 18 January, while five year paper was said to be stable.

“It’s clearly not covered bonds that have moved,” said the DCM banker.

He suggested the sell-off in rates at the short end was overdone, but that the long end could sell off further, and that the market needed time to digest the ECB’s new position.

“We’ll see how things stand on Monday,” said the banker. “I don’t think it’s going to shut markets for new supply – the money is still there. It’s just going to be even more a case of looking for a day of stability, and then I’m sure issuers will just say, OK, these are the new levels, they may be wider than they were last week, but I’m going forward.

“We’ll then have to see how these new issues coming at elevated spreads perform. I’m sure that trades will start out in the front end of the curve, but there are still some more yield-focused investors who are interested further up out.”

Other bankers echoed the need for pragmatism in pricing, with investors having the upper hand, and the expectation that the short end will be the initial focus when supply restarts.

At yesterday’s press conference, Lagarde also reiterated the ECB’s anticipated sequencing – whereby rate hikes will follow the end of its asset purchase programme (APP) – and should it stand by this policy and markets prove correct, the APP, including CBPP3, could in theory be ended as early as June, rather than year-end, which had been deemed the earliest end-date. Crédit Agricole ECB strategist Louis Harreau, for example, now expects the APP to end in December, but said there is a risk of it ending in September, with a rate hike possible in December.

Covered bond analysts had been expecting CBPP3 to support covered bond spreads through 2022, but Rabobank analysts said today that given that a more formal pivot towards tighter policy is now more likely at the March ECB governing council meeting, the odds of less support for the second half of the year have increased.

However, they flagged record-high APP covered bond redemptions of €41bn this year, saying this means support from the ECB on the primary and secondary markets will remain substantial.

“Hence, there will still be quite some support for spread levels in our view, even if purchases were to be scaled back later in the year.”

Photo: Sanziana Perju/ECB/Flickr