October 23, 2015 / 2:31 PM / 2 years ago

Severe widening could make dollar market unfeasible

4 Min Read

LONDON, Oct 23 (IFR) - Public sector issuers this week priced US dollar bonds at spreads dramatically wider than they achieved in the summer, triggering worries that funding in the currency may become uneconomical if the trend continues.

European and American SSA issuers completed benchmark deals last week, but at a much higher cost relative to swaps than they managed earlier this year.

KfW, for example, printed a US$4bn 1.125% Nov 2018 Global at 17bp over mid-swaps - a far cry from the swaps plus 1bp pricing level of a US$6bn three-year it sold in early July.

"The asset swap valuations have widened in the second half of the year," said Klaus-Peter Eitel, vice president, new issues at the German agency. "This is putting a lot of pressure on all Libor-based issuers, but there's still a funding advantage versus three-year funding in euros."

The spread on KfW's three-year US dollar bond roughly translates to a funding level in the mid 20s below euro mid-swaps, according to IFR calculations. Eikon prices had KfW's euro-denominated 1.125% Oct 2018 bond trading at a swap spread of minus 20bp on Friday.

The question is if this advantage will last.

"The cost saving issuers used to benefit from has eroded at a very fast pace. Although for some issuers there is still a benefit I wouldn't be surprised if we see more euro issuance going forward," said Asif Sherani, a syndicate official at HSBC.

But an expensive US dollar market would be a blow to SSA issuers, who have come to rely on the currency this year in the face of a distorted euro market.

The European Central Bank's quantitative easing programme pushed spreads so tight that the single currency became all but impossible to access in the first half of the year.

Though this has improved significantly since the summer, there is no guarantee there won't be further distortions, particularly with ECB President Draghi adopting an extremely dovish tone after this week's monetary policy committee meeting.

Root Cause

A combination of factors has led to the sharp rise in spreads in the US dollar market. Monetary policy has played a part, in the shape of uncertainty over a potential US rate hike.

Also, swap spreads have outperformed US Treasuries, and have even gone negative further along the curve.

The five-year spread, for example, is currently at 2.5bp, compared to 13.5bp in early August and 20.25bp a year ago. Spreads from seven-years out are in negative territory, complicating issuance at longer tenors.

Premium Value

Issuers are also having to pay significant new issue premiums. Bank Nederlandse Gemeenten, for example, this week priced a US$1.75bn three-year benchmark at swaps plus 29bp with a 7bp new issue premium. In June, the issuer printed a US$1.5bn three-year at swaps plus 4bp, paying a 2bp-3bp concession.

"From an issuer's perspective, dollar funding still offers a good arbitrage and perversely you've seen more execution certainty in the euro space, but we're still at a point where it makes sense to issue in US dollars," said Kerr Finlayson, director of SSA debt syndicate at RBC.

"But it's hard to tell if it will last as new issue premiums rise."

Issuers are keeping their options open. EDC, for example, priced a US$1bn Nov 2018 deal this week, but agreed that the market could become uneconomical in the future.

"It's hard to predict where spreads will be in two or three months' time and I think issuers in the US and Canada will be looking to other markets or other types of issuance," said Susan Love, vice president and treasurer at the Canadian export credit agency.

"I think for EDC, we will try to stay consistent with our past practices but will also look at tapping other markets if there's demand. I do think it's a possibility we would look at issuing in other currencies," she said. (Reporting By Abhinav Ramnarayan, editing by Alex Chambers and Julian Baker)

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