September is here, the schools have re-opened and some of us venture back to the office this week for the first time since March when your Centrus housing team is holding an “off-site” at our offices, such are the strange times we live in and the novelty of that location for those of us now used to working from home.
We wish a warm welcome back to those clients who participated in the quarantine lottery by heading to sunnier climes as well as those who participated in the weather lottery by holidaying in the UK, where the long and largely uninterrupted stretch of fine weather in Spring and early Summer seemed to give way to more usual and less certain British Summertime during August. This provides us with a crafty segue into the long-dated gilts market. The chart below shows that the yield on the 30-year gilt was relatively rangebound between 0.6-0.7% for much of June and July.
However, market sentiment shifted rapidly in the early part of August and by the end of the month, yields had risen to their highest level since 20 March – 0.969%, the increase of 31bps being the largest monthly spike in yields since October 2016. This rapid move came on the back of dovish comments from Federal Reserve Chairman Jerome Powell, signalling a policy shift by suggesting that the US central bank would be willing to allow inflation to rise above its 2% inflation target.
Earlier in the summer, a number of issuers managed to hit the sweet spot of low gilt rates and rallying credit spreads to issue long term debt at sub 2% coupons. With gilt yields backing up during August, this window disappeared, temporarily at least. While missing out on such staggeringly low rates might be irksome, treasury times aren’t that tough if you end up issuing 30+ year debt at 2.1/2.25/2.5% rather than say 1.95% and we suspect that most, if not all of our clients recognise this in its context.
More pertinently from a treasury governance perspective is that sharp movements in rates like this can often catch borrowers on the hop in terms of delegations to price deals within certain yield parameters. Good governance in this area requires boards or treasury committees to minute the basis upon which HAs may enter into financing transactions in order to ensure that they are within the context of the broad pricing and terms anticipated when the decision was made. As advisors, we would seek to ensure that a sensible balance is struck between good governance and the practical flexibility to allow execs to execute transactions which deliver agreed business objectives.
Our general advice on this for corporates is that making judgements on the direction of markets in the context of a particular transaction is a somewhat dangerous activity and one which carries potentially asymmetric risks. After all, apart from kudos and the satisfaction of making the right call, there is limited upside if rates move in your favour, whereas a decision to hold off may frustrate the delivery of agreed investment priorities and be somewhat career limiting. The key message is – applicable to bilateral negotiations as well as engagements with the faceless “market” – to try to avoid situations where key decisions will be driven by events over which you have no control.
Therefore, borrowing decisions are generally made taking account of various factors, including:
- Investment requirements and opportunities
- Liquidity requirements
- Borrowing costs vs business plan funding cost assumptions
- Interest rate risk management factors
Looking at the corporate sector generally and to a limited extent at housing associations, we have seen some more “opportunistic” borrower behaviour, i.e. taking a view that borrowing costs present such a great opportunity that it is worth the cost of carrying additional liquidity for a period in order to secure long term rates which will ultimately be business enhancing. In that context it might be reasonable to set a rates target where the borrower is genuinely in a position to take it or leave it. However, most borrowing is at least somewhat driven by investment, ratings / regulatory or liquidity requirements and the nuances of whether your coupon is above or below 2% are less of a driver to a decision whether or not to proceed.
The other factor at play will be the nature of the instrument being used to access the funding. Generally speaking, more involved processes with a long build up and multiple parties involved – say a bond issue or a private placement – tend to be rather more like the proverbial oil tanker in the sense that once you reach a certain speed in the latter stages of the process, stopping or changing direction is rather difficult. Generally, we would only ever advise not proceeding with such a transaction if market conditions suggest that the borrower’s interests would be best served by waiting for more receptive conditions to return. We saw examples of this earlier in the year where clients held off on launching deals and returned as the market recovered.
On the other hand, where a borrower can access the market in a more responsive manner – think retained bonds, shelf arrangements or drawdowns from EMTN programmes (which are steadily becoming more popular in the housing sector), this offers a higher degree of control over timing of market entry and pricing.
Ultimately, each decision needs to be taken in its own context and in the best judgement of those tasked with taking it. We are as ever happy to discuss and provide independent support, advice and indeed challenge, as required.
Financial Markets & Economic Overview
Markets are braced for a rise in volatility, after Brexit risks returned to haunt the UK currency and put a stop to the strong performance of the currency during the summer, when traders largely ignored Brexit- related headlines. The losses come after it was reported that the UK government was planning legislation that would override key parts of the withdrawal agreement.
Coronavirus continues to grab headlines. After having appeared to stabilise in July and August the number of new cases of COVID-19 globally has edged up to new highs in the last fortnight. Nevertheless, death rates in the US and western Europe have fallen suggesting that more effective shielding of vulnerable groups, improved treatments and increased testing are paying off.
Policy has been eased, but not uniformly. Following, the EU leader’s agreement in July for a historic €750m stimulus package, financed for the first time by collective EU borrowing, Germany and France announced significant new spending measures and tax cuts. In the US, the Federal Reserve last month switched from a 2.0% inflation target to targeting an average inflation of 2.0%.
Low interest rates and monetary stimulus has fired up prices to the point where some investors are willing to accept a loss for buying them, once inflation is taken into account. Real yields on government debt have been negative for most of the year but now the pandemic sends real yields on some high-quality US corporate bonds into negative territory.
Global equities rose over the summer, lifted by buoyant US tech stocks and a reviving Chinese equity market. The UK FTSE 100 has had a torrid few months and is now trading about 10% below levels seen in early June.
However, the near-term outlook for the UK economy has brightened. The “Eat out to Help Out” initiative subsidised 100m restaurant meals in August and has helped to lift retail activity.
The reduced rates of stamp duty have helped increase housing activity. UK mortgage approvals rebounded sharply in July to near pre-pandemic levels, Nationwide’s measure of average UK prices hit a record high in August up by 2.0% from July, the biggest month-on-month increase since 2004.