European companies hoping to fund M&A and capital expenditures on bond markets this year are facing a sudden jump in borrowing costs and wary buyers after the ECB’s shock pivot towards tighter monetary policy.
Bond issues are a key source of funding for companies and have grown in importance relative to bank loans in the euro zone, particularly since the financial crisis.
Caught out by European Central Bank President Christine Lagarde’s hawkish tone after the bank’s February meeting – which opened the door to rate hikes this year – bonds from investment-grade (IG) European firms have seen yields surge 60 basis points.
Euro credit had been less hit by January volatility stirred by the US Federal Reserve’s hawkishness, with IG bonds delivering less than half the losses in the United States.
But those falls accelerated post-ECB and yields have more than doubled this year to as high as 1.18 percent, the highest since May 2020, according to BofA.
That’s still extremely low, but a sudden jump in borrowing costs is significant. If continued, it can impact companies’ ability to invest, eventually slowing economic growth, so central banks watch credit spreads carefully.
Nearly half of investors in BofA’s February credit investor survey said IG spreads rising to 150-175 bps, from around 110 bps currently, would prompt a dovish turn from the ECB.
A mergers and acquisitions boom and the need for capital investment has been seen by many as driving a rise in European corporate bond sales this year — JPMorgan for instance expects a record 645 billion euros of IG issuance.
While moves so far are not enough to derail those expectations, Helene Jolly, head of EMEA IG corporate syndicate at Deutsche Bank, said borrowers and investors were adjusting to “the new normal”.
“Corporates have had to look at the new levels of coupons that are being required because of the rates being paid… and investors have had to think about what does this mean for me, what’s my outlook on rates now and where do I want to play,” Jolly said.
Sentiment has turned rapidly — just 16 percent of European credit investors are positioned net long on IG debt, the lowest since 2019 and down from 27 percent in December, while corporate debt funds are holding more cash than they have in years, BofA’s survey found.
One consequence has been declining bond sales — in the two weeks since the ECB meeting companies have raised around 9 billion euros, similar to volumes in the single week up to the meeting, according to Refinitiv IFR data. Several sessions delivered zero issuance.
Because many companies borrowed cheaply and abundantly during the pandemic, there is no panic over their ability to refinance debt, even for sub-investment grade, “junk” issuers.
