Ahead of this week's FOMC rate announcement of a half-point increase in US policy rates, dollar reference yields continued their upward trend, with the ten-year US Treasury yield briefly trading above 3% for the first time in four years. In parallel, two and 10-year German Bund yields reached 0.3% and 1%, while spreads on peripheral Eurozone risks have widened. As an example, the 10-year spread between Italian government bonds and German Bunds reached 189 basis points on 4 May, versus a one-year low of around 85 basis points.

Similarly negative trends are present in equity markets. After Amazon's shares fell 14% in price on 29 April, with Apple also recording a 3.7% drop, following worse than expected results, the Nasdaq index recorded a 15% decline in total during April. This left it 21.2% lower in 2022, versus a 13.3% decline for the S&P500 index. The Renaissance IPO Index for the US lost 36% in 2022 to end-April, falling 43% over a 12-month period.

Despite the substantial worsening in reference rates and key equity indices, sizeable transactions continue getting completed successfully. In the bond markets, TenneT, which operates electricity grids in the Netherlands and Germany, set a record on 3 May for ESG issuance in the Euro-denominated sector. It placed EUR3.85 billion in a four-tranche deal spanning maturities of 4.5, 7.5, 11 and 20-year terms, with coupons of 1.625%, 2.125%, 2.375% and 2.75%. The issuer's statement refers to "solid investor demand", with orderbooks "touching the EUR8 billion mark" after final pricing.

The 20-year tranche revived the "long-end" segment, where activity has been constrained in recent weeks by the bond market sell-off, but the tranche also illustrates worsening margins and coupon levels. Bloomberg reported the 20-year tranche was priced at 110 basis points over mid-swaps, 20 basis points tighter than initial guidance, but it noted that TenneT had paid a 67-basis point spread for a comparable term roughly a year ago. As a further measure of market deterioration, its late-May 2021 package of EUR1.8 billion had included 6.5, 10 and 20-year terms with coupons of 0.125%, 0.5% and 1.125% - although demand (of EUR4 billion) was roughly half the peak level achieved in the current sale.

Equity market developments also show growing investor caution and reduced receptiveness to new share sales, with two major deal withdrawals in the last week for diverse reasons, although this has been counterbalanced by a notable secondary success in Europe:

• BASF announced on 29 April that it has halted its plans to list Wintershall Dea, its oil and gas business. CEO Martin Brudermueller notified BASF's AGM that it continues to "want to list the company" but explained that as "it has interests in production facilities in Russia…this makes an IPO difficult at this time".
• NYSE-listed Chinese internet trucking firm Full Truck Alliance - which runs a mobile app for truck transportation services - also has withdrawn a sizeable deal, its planned Hong Kong listing worth USD1 billion. Since it raised USD1.6 billion in a NYSE IPO last June, its shares have fallen to almost one-quarter of their value at the time of the sale (USD4.95 versus USD19), driven by an investigation into its activities by the Cyberspace Administration of China to "prevent national data security risks". The firm has hoped for this - and any penalties - to be resolved by end-March. The investigation has been ongoing since July 2021 and prevents the firm accepting new customers.
• Finnish insurer Sampo has completed its disposal of shares in Nordic bank Nordea by doubling a planned secondary offering. Initially this was announced as covering 100 million shares but was doubled to raise EUR1840 in gross proceeds. The transaction was increased in response to "strong market demand". Sampo initially announced its intention last year to dispose of a 15.9% stake in the bank to focus on its core insurance business. Prior blocks were offloaded in early September and late October 2021.

Our take

This week's developments with underlying reference rates are unsurprising, with high and persistent inflation pushing central banks towards a tougher monetary policy stance, including larger and faster policy rate increases and earlier, more rapid reduction of central bank balance sheets. Markets improved after the FOMC announcement after Federal Reserve Governor Powell indicated that further acceleration in monetary tightening - to increases of 0.75 percent - were not planned at present.

As in recent weeks, the market correction has not prevented the generation of sizeable investor demand for new capital market transactions, but at higher cost. TenneT's ESG sale highlights this, with demand double the level it achieved for a multi-tranche Green bond sale in May 2021, but with a far larger coupons, including substantial widening of the margin for the 20-year trance.

Despite this, for higher-rated borrowers, the impact on debt sustainability appears quite limited in the near term. There are several examples where the maturity of outstanding high-coupon liabilities and its replacement at current levels is permitting continuing reduction in the average cost of the borrower's debt. This is exemplified in a Cinco Días analysis on 26 April looking at Spanish borrowing costs:

• Using Spanish Treasury data for April, it calculated that the cost of new borrowings - across all maturities from short term bills to long-term debt - had risen to +0.39% during 2022 versus an average of -0.04% during 2021, the first time Spain achieved a negative borrowing cost during a calendar year. The upward trend points to Spain paying the highest cost or new debt since 2018, when its average cost was 0.64%.
• Term rates have risen far more sharply, with Spain's 10-year yield deteriorating from 0.565% at end-2021 to 1.85% at the time of the article, having recently traded above 1.9% for the first time since 2015.
• Despite this, the average yield on Spain's full debt stock has declined from the end of 2021, when it stood at 1.64%, to a record low of 1.55%. This reflects the maturity of old high-coupon debt, such as a 5.85% issue which matured in January on completion of its 10-year term, being replaced with a new syndicated deal priced with a 0.7% coupon.
• According to the Spanish Treasury's October Budget forecast, this process will continue during 2022: it suggested that "debt service costs relative to GDP have been falling despite the growth in the debt stock". The Budget had forecast that this ratio could fall as low as levels achieved in 2011 (when such costs first exceeded 2% of GDP) based on such substitution effects: Cinco Dias suggests that such substitution benefit will now be smaller, but that the average cost should continue falling near-term.
• As a further positive indicator, the average life of Spain's public sector debt reached 8.1 years in Q1 2022, versus 8 years at end-2021, having been at 6.5 years in 2015, according to the Treasury's 2022 debt presentation.

Such trends are replicated in multiple European markets. Overall, the average maturity of debt has lengthened in many European markets, a key difference compared to the GFC and eurozone crisis, with borrowers having reduced rollover and liquidity risks, and locking in historically low borrowing costs. Intra-eurozone sovereign spreads nevertheless are widening, related to the expected acceleration of ECB monetary policy tightening, howbeit on a more modest scale than in the USA. Adverse impacts from wider margins and higher base reference costs will be gradual, at least initially offset by the replacement of longer-dated historical liabilities.

By contrast, risks will be considerably greater for weaker borrowers, particularly if higher reference rates push the nominal cost of borrowing towards unsustainable levels - such as double-digit coupons for longer-dated dollar debt. Further increases in reference rates - especially if accompanied by widening spreads - would increase debt sustainability and default risks in both the Emerging Market and High Yield segments.

Posted 06 May 2022 by Brian Lawson, Senior Economic and Financial Consultant, Country Risk, S&P Global Market Intelligence

This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.