Declining bond yields

According to Tradeweb data, at end-May 48% of the Eurozone government bond market traded at negative yields, the highest proportion since late 2016. During May, the stock of negative-yielding Eurozone debt rose from EUR3.44 trillion to EUR3.71 trillion. On 31 May, the Netherlands' 10-year bond entered the negative-yielding group. On the same day, Germany's 10-year Bund closed at -0.20% yield, an all-time low, breaching the -0.19% established in July 2016. On 5 June it traded as low as -0.23.

The rally also extends to Europe's periphery, with Greece performing particularly strongly ahead of its anticipated general election. Greece's 10-year yield fell to 2.88% on 3 June, having been at 3.43% on 23 May.

Primary equity revival

Somewhat surprisingly given the rallying bond market and ongoing trade uncertainties, primary equity markets are showing signs of revival:

1. Volkswagen is progressing its previously-planned sale of a minority stake in its Traton trucks unit. It started pre-marketing for the IPO on the Frankfurt and Nasdaq Stockholm exchanges on 4 June. The deal is entirely a secondary sale by Volkswagen, which will retain a majority position. Unconfirmed reports suggest the deal will be smaller than the 25% of the company previously suggested, with recent Reuters reports suggesting some 10-15% of the firm is a more likely objective. Prior broker estimates have suggested Traton could be worth some EUR16 billion, and the deal is likely to be among the largest in Europe this year.
2. In a regulatory filing, Huatai (a Chinese brokerage firm) has confirmed its intention to list Global Depository Receipts on the London Stock Exchange. The offer is expected to be worth some USD500 million. The issue would be the first using the London-Shanghai Stock Connect program, designed to facilitate reciprocal trading links between the two markets. HSBC reportedly remains a potential candidate for a reverse transaction to list depository receipts in Shanghai.
3. Hong Kong-based property firm ESR Cayman is reported by Reuters to have opened books on its IPO on 5 June, a few days later than planned. It is selling 560.7 million shares with indicative pricing of HKD16.2-17.4 per share (USD2.07-2.22). The deal is now due to price on 12 June with trading from 20 June.
4. On the same day, China East Education Holdings raised USD625 million from a Hong Kong IPO, placing 435.8 million shares at HKD11.15 each, versus price guidance of HKD9.80-12.26. The deal is the largest offering to date involving an education company according to Bloomberg, which cited a USD490 million IPO for Laureate Education in 2017 as previously having held that position.
5. Pan-African mobile operator Airtel Africa also is floating its shares. It plans to raise USD750 million from a flotation in London to reduce its debt. The company specified on 4 June that it will float up to 25% of its capital, with a 15% green-shoe. Pricing is still to be established.
6. Lastly, Russian financial services company TCS Group Holding is seeking USD300 million from a London placing of Global Depository Shares.

Our take

We have commented previously that ongoing trade uncertainties increase downside risks for economic growth. Against this background, there have been increasingly-frequent calls for the Federal Reserve to make further adjustments to its policy, with suggestions that its next rate change should involve cutting rates, rather than increasing them as in 2018. On 5 June, Federal Reserve Chair Jay Powell stated that the Fed will "act as appropriate to sustain the expansion". The European Central Bank will soon be conducting targeted long-term repurchase operations to add to banking sector liquidity. With monetary policy potentially moving to an easier stance, and growth prospects looking worse, there are growing expectations that the rally in "safe" instruments - US Treasuries and Bunds - will continue.

So far, this clearly extends into the remainder of the Eurozone, although in some areas - like Greece- there is a growing risk that prevailing rates will fail to reflect underlying risk fundamentals. Although its yields also have improved, we expect ongoing underperformance by Italy. An adverse indicator in this regard has been recent parliamentary discussion of the creation of a new Treasury Bill instrument - called "mini bills of Treasury" - to be made available in small denominations to pay state liabilities to businesses. This effectively would represent an alternative currency instrument to the Euro and raises the concern that its use might be applied more widely over time.

Over time, worsening in global trade disputes is likely to have greater impact on emerging market debt. Although the search for yield is likely to continue to help support demand, a rapid deterioration in exports would be damaging for underlying credit fundamentals and could thus prove negative for countries' access to bond markets. This "two- way pull" will require careful monitoring.

The extensive and diverse primary equity calendar is quite surprising given the underlying market volatility, which shows no sign of immediate resolution. Chinese equities appear obvious candidates to be hurt by increased trade barriers. According to CEIC data, foreign investors reduced their holdings of Chinese equities by some USD12 billion between April and May, although net inflows remain positive for 2019 overall, at around USD8 billion, after a clearly-positive first quarter. Successful completion of the IPOs listed would be an encouraging indicator of primary equity-market resilience, especially after the poor performance of Uber, Lyft and other recent flotations.

Posted 07 June 2019 by Brian Lawson, Senior Economic and Financial Consultant, Country Risk, S&P Global Market Intelligence