Wednesday19 February 2020 ★ FINANCIAL TIMES 19
MARKETS & INVESTING
J O E R E N N I S O N
The cost of insuring against the
default of some of the world’s biggest
corporate borrowers has dropped to
its lowest levels since 2007 as investors
bet that continued strongsupportfrom
central banks will keep credit markets
ticking over.
The CDX North American Investment
Grade index — which reflects the cost of
default protection on bonds issued by
125 US companies — fell to 43.81 basis
pointslastweek,implyingapremiumof
$4.38 to insure a $1,000 portfolio of
bonds.
That was its lowest level since July
2007, according to index provider IHS
Markit. The index has since nudged
higher to 44.62bpbut remains near
historictroughs.
An equivalent index tracking a group
of European credit default swaps
dropped to 41.26bpon Monday, also its
lowestlevelsinceNovember2007.
“Themarketisbeingdrivenbymone-
tary policy expectations,” said Gavan
Nolan, director of credit research at IHS
Markit. “Everything else is taking a
backseat.Alotofcompanieshavetaken
advantage of the easy money available
and lengthened the maturity of their
debt,whichleavesdefaultrisklow.”
Investors have been unnerved in
recent weeks by the potential impact on
the global economy caused by the
coronavirus — fears that caused the
CDX index to climb tomore than 50bp
onJanuary31.
But many have since been soothed by
dovishnoises from both the US Federal
Reserve and the European Central
Bank, which are committed to keeping
interest rates low for the time being
while also revving up bond-buying pro-
grammes to ensure aready supply of
cash.
The Bank of Japan, too, hasindicated
it is ready to cut ratesfurtherinto
negative territory ifinflation remains
wellbelowitstarget.
Credit default swaps were originally
designed to help investors protect
againstacompanyfailingtopaybackits
debts, offering to make them whole in
the event of a default. The higher the
index, the higher investors’ expecta-
tionsofmissedinterestpayments.
TheCDXNorthAmericanInvestment
Grade index peaked at 279.6bp during
the 2008 crisis. Its record low was
28.88bpinFebruary2007.
The market has shrunk significantly
since its heyday, reflecting declines in
trading activity by big banks on Wall
Street and concerns fromregulators
overpotentialmarketmanipulation.
Data collected by the Bank for Inter-
national Settlements showthat global
CDS markets have fallen from a high of
just over $60tn in notional amounts
outstandingin2007tounder$8tnatthe
endofJunelastyear.
Derivatives
Cost of corporate default protection
sinks to lowest level since financial crisis
S U N Y U— BEIJING
Companies across China are taking
advantage of the coronavirus outbreak
to shore up their balance sheets as
Beijing urges the issuance of cheap
bonds to support the world’s second-
biggest economy.
More than 25 Chinese businesses,
ranging from airlines to drug distribu-
tors, have raised Rmb24bn ($3.4bn) by
selling “virus control” bonds since the
startofFebruary,saidHuataiSecurities.
Another 20 have announced plans to
raise money in coming weeks as the
outbreakshowsfewsignsoftapering.
Regulators have encouraged the sales
of virus-linked bonds by cutting the
approval process from weeks to days
while urging state-backedbanksto buy
them.
To qualify for the programme, com-
paniesmustcommittospendingatleast
10 per cent of the proceeds on measures
to combat the epidemic, which has
already led to more than1,800 deaths
andmadeabigdentintheeconomy.
“The coronavirus has dealt a big blow
to the economy and that creates
demand for stimulus,” said Ivan Chung,
a Moody’s analyst in Hong Kong. “Virus
controlbondsprovideasolution.”
Issuers have been lured by the low
cost of servicing the debt. Coupons on
short- to medium-term bonds range
from 2 per cent to 4 per cent. That
compares with the central bank’s
benchmark one-year Loan Prime Rate
of4.15percent.
“This is a windfall for us; we can’t
obtain such low-cost capital from else-
where,” said an official atFuyao Glass
Industry Group, a manufacturer that
last week issued a three-year virus con-
trolbondwithacouponof3.19percent.
The company said 10 per cent of the
proceeds of the bond will be used to
makeglassforambulancewindshields.
Shenzhen Airlines, based in southern
China,saidlastweekitplannedtospend
the vast majority of the proceeds from a
2percentRmb600mviruscontrolbond
paying off existing debt that has an
interestrateof3.1percent.
The rest will go on refunding can-
celled tickets and transporting disease
controlmaterials.
The low rates on offer from the bonds
have failed to lure private investors,
leaving government-linked companies
toabsorbmostofthesupply.
An official atBank of China, a major
underwriter of antivirus bonds, said
state-controlled lenders and brokerages
arethebiggestbuyers.
Huang Da, owner ofQianyi Invest-
ment, a Hangzhou-based bond fund,
pointed to low returns as a reason for
stayingaway.“Marketforcesdonotsup-
portthesecurity,”hesaid.
Other investors questioned the finan-
cial health of companies issuing the
bonds. “There is no guarantee that dis-
ease control bonds won’t default,” said a
Shanghai-basedbondfundmanager.
Theinvestorsaidhehadpassedonthe
opportunitytoinvestinaproposedfive-
year, Rmb500m antivirus bond from
Shenzhen-basedTaiantangPharmaceu-
tical. The firm’s existing debttrades for
about 80 cents on the dollar, implying a
significantriskthatitwillnotberepaid.
Fixed income
Chinese companies raise $3.4bn with
virus bond sales to boost balance sheets
‘The coronavirus has
dealt a big blow to the
economy. Virus control
bonds provide a solution’
The Bank of Japan stands ready to
cut interest rates further if required
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TO M M Y ST U B B I N GTO N
Italy and Greece have experienced red-
hot demand for their bonds during the
coronavirus outbreak, underscoring
their transformation from high-risk
debtmarketstounlikelyhavens.
Both countries’ borrowing costs have
tumbledthis year as investors have
sought alternatives to deeply negative-
yieldingGermandebt.
Italian and Greek bonds “are trading
like Bunds [German bonds] on steroids:
safe bonds but with a bit more yield”,
said Antoine Bouvet, a senior rates
strategist at Netherlands-based bank
ING.
The frenzy has been evident in
demand for new debt. Italy racked up
morethan€50bnofbids,itsbiggestever
bookoforders,fora€9bnsaleof16-year
debtlastweek.
A 15-year bond from Greece, the gov-
ernment’s longest maturity since the
crisis, attracted €14bn of bids in late
January, which was another record
orderbook.
Theeurozonedebtcrisisdividedbond
markets into a safe “core”and a risky
“periphery”,comprisingPortugal,Spain
andIreland,aswellasItalyandGreece.
The recent behaviour of these mar-
kets, which saw them rally even while
the viral outbreak triggered a brief sell-
off in stocks, suggests that the distinc-
tion has collapsed in the minds of some
investors.
Buyers arebetting that the European
Central Bank, which is buying€20bn of
bondsa month and intends to keep
interest rates below zero for some time,
hastheirbacks.
Robert Tipp, head of global bonds at
PGIM Fixed Income, said he expected
somekindofreturntoconditionsbefore
the global financial crisis, when debt
markets across the eurozone traded
moreorlessinlockstep.
Although Greek 10-year yields are at
record lows and Italy’s are very close,
thecountrieshadfundingcostscloserto
Germany’sbefore2008.
“I don’t see why we won’t see them
converge again this time,” he said. “We
likeowningallofthem.”
TheeconomiesofGreeceandItalyare
in very different positions. The former
has emerged as one of the eurozone’s
fastest growing as it pulls out of a long
slump. The European Commission
expects Greece to grow at 2.4 per cent
thisyearcomparedwithjust1.4percent
fortheEUasawhole.
Meanwhile, much of the country’s
borrowing, which still amounts to more
than 180 per cent of GDP, is in the form
of cheap bilateral loans following a
series of bailouts. Bond investors are
happy to buy, in part because Athens is
notcountingonthemtopayitsbills.
Growth in Italy, by contrast, is fore-
cast at just 0.3 per cent in 2020, accord-
ing to the Commission. The country’s
debt of more than 130 per cent of GDP is
mostly owed to investors, making it
Europe’slargestbondmarket.
What unites the two is their extra
yield, known as a spread, relative not
only to Germany but also their former
peersintheperiphery.
In a world of negative interest rates,
Greece offers the prospect of enhanced
returns for investors who are not con-
strained by the country’s junk credit
rating. Italy, meanwhile, accounts for
about half of government bonds across
theeurozonewithayieldabovezero.
For fund managers who measure
theirperformanceagainstabondindex,
avoidingItaliandebtcanleavethemlag-
gingbehindthebenchmark.
“There’s just this dearth of yield in
Europe,” said Iain Stealey, international
chiefinvestmentofficerforfixedincome
at JPMorgan Asset Management.
“People are getting forced to search for
anythingwithapositiveyield.”
For some observers, this scramble for
yield is a side-effect of the ECB’s
monetary policy, which has numbed
investors to the risks of highly indebted,
politicallyunstableeconomies.
The recent enthusiasm for Italian
debt, for example, was fuelled as much
by asetbackfor the populist Lega party
in a regional election in late January as
bythebroaderrushintobonds.
Investors would be foolish to assume
that Italy’s bonds area one-way bet and
that the country’s volatile politics will
not seep back into markets, said Chiara
Cremonesi, a fixed income strategist at
Italian bank UniCredit. “One should be
carefulasthepoliticalpremiumembed-
dedinthemarketisnowverylow.”
A bigger test of the market’s confi-
dence in Italy and Greece could be on
the way if the eurozone’s economic
slowdown deepens, perhaps as a result
ofthecoronavirus.
“In the past [a broad slowdown]
would have caused spreads to widen,”
said Mr Stealey. “Now that markets feel
they have the support of the ECB, I’m
notsosure.”
Butthistendencytotreatgovernment
bonds across the eurozone as safe
harbours is likely to have limits. “Bunds
on steroids” could quickly revert to the
volatile assets of a few years ago if inves-
torsbecomemorechoosy.
Mr Stealey said: “It depends on how
severe a recession we are talking about.
Ifthingsgetbadenough,youwouldgeta
trueflighttoqualityandthatmeansjust
Germany.”
Former bond pariahs attract
record demand with buyers
counting on ECB support
‘People are
getting
forced to
search for
anything
with a
positive
yield’
Bubble fears:
some analysts
warn that it
would be foolish
to think debt
issued by Rome
is a one-way bet
Tony Gentile/Reuters
Fixed income.Enhanced returns
Greek and Italian debt turns
into ‘Bunds on steroids’
A N N A G R O S S
South Africa’s currency headed lower
yesterday after investors increased bets
that Moody’s would strip the country of
itslastinvestmentgradecreditrating.
Therandwasunderpressureafterthe
rating agency announced on Monday
that it was cutting forecasts for South
Africa’s economic growth this year,
prompting speculation that the move
would precede a downgrade of its rating
to junk — in line with Standard & Poor’s
andFitch,theotherbigratingfirms.
The currency has dropped about 1.
per cent over the past five days, making
it the second-worst performer among
dozens of emerging market peers
trackedbyBloomberg.
Moody’strimmeditsestimateof
growth to 0.7 per cent from 1.5 per cent
in September, citing stagnant private
sector demand and “the detrimental
impact of widespread power outages on
themanufacturingandminingactivity”.
South African equities also edged
loweryesterdaywiththecountry’sthree
main stock indices all falling more than
0.8percent.
The move by Moody’s came ahead of
the release of South Africa’s budget next
week, which investors expect will
present a bleak picture of the country’s
debtpositionandpotentialforgrowth.
Investors’ mood was not brightened
byaStateoftheUnionaddresslastweek
in which the government presented its
planstorestructurethestrugglingstate-
owned energy companyEskom. Some
analystssawtheplansaslacklustre.
“SouthAfricaisinthedoldrums,”said
Mohammed Elmi, London-based port-
folio manager at Federated Hermes,
which manages about $580bn in assets.
“Unless we see proactive growth
measures at the budget next week, the
situationisonlygoingtogetworse.”
The rand is down almost 6 per cent so
far this year, partly due to concerns
about the economic effects of coronavi-
rus, which have weighed on emerging
marketsmorebroadly.
In early November, Moody’s decided
to keep its rating of South Africa’s sover-
eign debt in investment grade territory
— meaning it is eligible to be bought by
most institutional investors — even
after a budget update from Cape Town
showed struggles with ballooning debt
andawideningfiscaldeficit.
Moody’s is scheduled to review its rat-
ing in March. A downgrade to junk
would mean automatic expulsion from
somebondindices,triggeringanexodus
of up to $15bn from ratings-restricted
investors, said Magdalena Polan,
emergingmarketsstrategistatLGIM.
“I think Moody’s will downgrade,”
said John Ashbourne, senior economist
at Capital Economics. “Even if they
manage to skip it this time, the [invest-
mentgrade]ratingwillbetakenawayat
somepoint.”
Currencies
South African
rand slides
after Moody’s
cuts forecasts
‘South Africa is in the
doldrums. Unless we see
proactive measures, it is
only going to get worse’
Borrowing costs converge in the eurozone
-year bond yields ( )
-
Italy
Greece
Germany
Source: Bloomberg
FEBRUARY 19 2020 Section:Markets Time: 18/2/2020-18:20 User:stephen.smith Page Name:MARKETS1, Part,Page,Edition:EUR, 19 , 1