By Mike Turner and Jon Hay of Global Capital
European bond issuance screeched to a halt on Thursday at the sight of Russian troops attacking Ukraine. But already determined borrowers are probing for market access, and there is a growing expectation that the violence on Europe’s eastern borders will delay central bank monetary policy tightening — and could even provoke a recession.
Russian troops moved into Ukraine from Belarus, Russia and Crimea on Thursday, with air strikes hitting Kyiv, among other cities, sparking a fresh wave of sanctions from countries across the globe — including, US president Joe Biden said on Thursday night, against Russia's "largest state-owned enterprises" and the bank VTB.
Alongside the terrible human cost, the Russian aggression sent markets into turmoil, with a dash to safe haven assets and a dumping of risk.
The 10 year Bund yield fell 10bp to 0.15% in the early session and dipped as low as 0.11% during the day before rising to 0.17% into the market close. In the US, the 10 year Treasury yield dropped as low as 1.85% intraday.
Equity markets across the world were plunged into the red, with the Dax closing down 4% and the FTSE 100 off 3.9%.
Senior credit was spotted 5bp-10bp wider, subordinated debt 15bp-20bp wider. The 10 year swap spread in euros flirted with an all time high. It was spotted at 70.2bp on Thursday mid-morning, just a fraction below its 71bp high in the depths of the 2008 global financial crisis.
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In the supranational, sovereign and agency primary market, Land NRW postponed a planned $400 million tapof its December 2023 floating rate notes while other markets were shut. Nonetheless, issuers are already looking to print deals, according to syndicate bankers.
“We think the market will open as early as Monday for mandates, with the first deal on Tuesday,” said an SSA syndicate banker in London, echoing similar views of rival bankers. “There has been some discussion [with issuers] about the type of deals that can come to the market.”
Defensive measures
SSA bankers were unified in the type of transaction they think will be successful: defensive. Numerous bankers pointed toKfW’s €5 billion long three year deal on Tuesday, which drew the issuer's largest ever order book, as the template other issuers should use.
“It needs to be market champions [to reopen the market],” said an SSA banker, echoing the sentiment of multiple rivals. “Someone like a European Investment Bank.”
Four other bankers named the EIB as the ideal candidate to reopen the market next week. The EIB did not respond to requests for comment.
But not everyone thinks only short duration trades will work. One issuer suggested very long duration debt might also have a place in such volatile markets.
“We have investors that need to buy long duration debt,” said the head of funding at an SSA issuer. “Pension funds have money to invest.”
For all that bullishness, the official said he had no plans to bring a long dated issue next week.
Long maturity investors are something of a guarantee in certain segments. In sterling, for example, the ultra-long end of the UK Gilt curve is frequently inverted because of the structural demand from institutions such as life assurers.
Raining sanctions
US president Joe Biden added VTB to the sanctions list on Thursday evening, freezing its assets in the US. Biden also said the US was sanctioning major Russian state companies in the same way as the sovereign, which on Tuesday was effectively blocked from issuing new dollar or euro bonds.
“We have purposefully designed these sanctions to maximise the long term effect on Russia," said Biden. "We will limit Russia's ability to do business in dollars, euros, pounds and yen. Stunt the ability to finance and grow the Russian military.”
Biden pointed to the rouble, which on Thursday hit its weakest level against the dollar in its history, of just 1.2 cents.
Biden said US forces were not going into Ukraine, but would defend Nato allies in eastern Europe: Estonia, Latvia, Lithuania, Poland and Romania.
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Meanwhile, UK prime minister Boris Johnson announced 10 new sanctions on Thursday evening. Like the US, this included freezing VTB’s assets immediately, as well as asset freezes against all major Russian banks, legislation to prohibit Russian companies from raising finance in the UK, and sanctions against the Russian sovereign to prevent it raising debt in the UK. Johnson has also pushed again for Russia to be banned from the SWIFT payment system, though it is understood there is opposition to this on continental Europe. "Right now, that's not the position that Europe wishes to take," said Biden.
Other sanctions focused on individual assets
In a special parliamentary session to discuss the invasion, Johnson received multiple questions about the UK’s use of Russian oil and gas, and whether it was morally correct to continue buying energy from the country. Johnson largely agreed that it was an issue, but did not push ahead with sanctions or a plan to avoid using Russian energy.
“Fully fledged sanctions by the West and ultimately a full cut-off of Russian gas supplies into Europe has become more likely,” said Commerzbank in a research note on Thursday evening. “This would probably trigger a full-blown energy crisis in Europe. Our commodities colleagues reckon that a sustained disruption of Russian gas supply to the EU would require immediate measures to reduce gas consumption, even in a scenario of increased [liquefied natural gas] imports.”
Stagflation
While this would further stoke inflation, already running at euro-era highs, the growing fear among capital markets bankers is of stagflation.
“It’s looking like a real possibility now,” said an SSA banker in London. “Especially if the ECB does raise rates.”
The European Central Bank, even its most hawkish council members, have repeatedly spoken about keeping flexibility in the ECB's approach to tightening monetary policy. However, coming into this week, many in the market had expected the first rate rises to come as soon as September.
Many think that is now less likely. “Sanctions inflation is not affected by rate rises,” said one syndicate banker. “So rates are the wrong lever to pull. I would have thought QE was the right lever.”
Reducing quantitative easing, by slowing or stopping net purchases by the ECB's Asset Purchase Programme, but keeping rates low would be seen as a market-friendly outcome, said the banker.
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Another banker in London said the ECB was “on a path of tightening that it can’t really turn away from now, but I think it might space out its rate rises a bit more. Maybe only one this year instead of two.”
A head of debt capital markets reckoned that “central banks are not going to signal rate raises as strongly, given the more uncertain economic outlook of sanctions.”
But Russia's invasion changes the scene fundamentally. For years, market participants have repeated the mantra that "central banks are the only game in town". This year, they have been playing against the market, rather than backing it, but it was still widely accepted that decisions by the Federal Reserve, ECB and Bank of England would determine the course and health of markets.
Bills, bills, bills
Now there is another powerful and unpredictable actor involved. "These geopolitical risks are not contained entirely to where they are happening," said Luke Hickmore, investment director at Abrdn in Edinburgh. He and colleagues had been thinking for weeks about the possible effects of an invasion — "the stagflationary impact, margins being squeezed, the consumer suffering — where does the stress come out? Middle income earners are starting to suffer from the cost of living."
He pointed to "the whole experience of filling your car up — whether you're filling it with petrol or electricity". Mobile phone contracts were often set to reprice annually at, for example, inflation plus 3.9%, he said. That could mean a 10% increase for some people.
Energy prices, as well as economic recovery, are already driving inflation, and this will be intensified by any stress in Russia, one of Europe's most important suppliers of oil, gas and cereals. The war in Ukraine, Hickmore said, was "adding to an already existing trend and exacerbating it."
Asked how the economy could shift from a position in which a strong recovery was driving inflation, forcing central banks into monetary tightening, to one in which they were coping with recession, Hickmore answered: "The same way everything has happened since the pandemic — quickly. This is about timescales. Maybe we had a recession coming anyway — all this has done is just push it forward."
A short, shallow technical recession could be the only way for central banks to choke off inflation, he said.
He pointed to the spread between two and 10 year Gilts. In May 2021 it was 80bp — it has fallen to 17bp. Hickmore said: "When that turns negative, you tend to get a recession six to nine months later."
For now, credit markets are disrupted, but not in crisis. Corporate bond issuance will be interrupted, and will only be able to occur on days when markets are feeling more optimistic. But the power to determine whether markets go up or down now lies, not in Frankfurt or Washington, but Moscow.
"There have been some very material moves," said a syndicate banker in London. "Investors have got to adjust to that, and get used to the fact that uncertainty is now insurmountable."
Asked whether he thought there could be unforeseen, indirect consequences from Thursday's events, the head of corporate syndicate at a bank in London said: "Yes. I'm worried about everything."