QE indigestion for corporate bond investors

Record low eurozone borrowing costs for companies has triggered a bout of indigestion for bond investors.

The launch of quantitative easing last month by the European Central Bank has continued suppressing government borrowing costs, but the same cannot be said for corporate debt.

In recent weeks, investors have seen the value of their holdings decline as prices have fallen, reflecting a rise in investment-grade yields. The culprit has been a rush by European and US companies selling euro-denominated debt in the run-up to the launch of QE and beyond.

"It feels like the loser has been credit markets," said Barnaby Martin, strategist at Bank of America Merrill Lynch. "I would blame supply - that's one of the consequences of QE. It has made credit markets in Europe incredibly cheap for everyone across the globe."

So far this year, high-grade issuance has run 55 per cent higher at €121bn, compared with the same time last year, according to UBS, although the rate of sales has slowed this month.

"The pace has been way too high, particularly in March," said Hyung-Ja de Zeeuw, senior credit strategist at ABN Amro.

European credit markets are now paying the price for a frenzied first quarter. Investment grade yields have risen 22 basis points since the start of QE in early March, according to the Barclays EuroAgg index, while German and French government borrowing costs have declined.

Thibault Colle, strategist at UBS, said: "We had a lot of inflows when QE was first announced, but then issuance caught up with inflows a few weeks later. I definitely think oversupply has had an impact on the market and ultimately outweighed the inflows."

Record low borrowing costs in the wake of the ECB announcing QE in January proved very tempting for companies and not just household names in Europe.

The likes of Berkshire Hathaway, Kellogg, General Mills and Moody's sold bonds - deals known as "reverse Yankees" - and in February Coca-Cola's €8.5bn issue was a record-sized sale. The State Grid Corporation of China and BHP Billiton have also jumped on the bandwagon, as global attention focused on Europe's QE suppressing borrowing costs.

"Parameters become more uncertain when you're trying to forecast not just European companies but every company around the globe," said Mr Martin.

Many of the reverse Yankee deals were notable for having long-dated maturities, which helped push the average bond maturity to a record high in the first quarter. But the price of long-dated debt is very sensitive to a change in yields, and these bonds have underperformed as interest rates have risen.

Spreads have widened on almost every reverse Yankee deal, with Berkshire Hathaway up 33 basis points, Priceline up 30, PPG up 24, Kellogg up 15 and Coca-Cola up 14, as measured using Bank of America Merrill Lynch indices.

"Because a lot of them had longer maturities, one of the consequences of the reverse Yankee phenomenon and the following indigestion is a widening of spreads at the long end," said Mr Martin.

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