Stockholm (Ekonamik) – Over the summer fixed income markets have been dominated by the continued popularity of green bonds and by the rising concerns that interest rate differentials have flagged about the future path of the USA’s economy.
Green Bond Market Grows and Diversifies
Green bonds continued to gain ground during the first half of 2019, with global issuance reaching record highs of US$ 121billion during the first six months of the year, easily outperforming the previous US$ 103 billion record from 2018. This is consistent with the performance witnessed during the first quarter of the year when US$ 45 billion was issued across the globe. “This year has seen strong growth in the green bond market, and we are very proud to be among the banks globally leading this growth and enabling the transition to a greener economy,” says Lars Mac Key, Head of DCM Sustainable Bonds at Danske Bank, who kindly provided a review of green bond markets to NordSIP.
Among these issuers, Chile was the first ever American sovereign to issue a green bond. Korea, Hong Kong and the Netherlands also took their first steps into the green bond market. Returning issuers like France, Poland, Belgium and Indonesia maintained their presence while rumours of German, Spanish and Swedish bonds persisted. Social and Sustainability Bond issuance added another US$ 20 billion to the sustainable bond market, up US$ 5 billion from the same period in 2018.
Corporates continued to be the main driver of the euro green bond market with 31 issuers bringing € 24 billion to the market. Asides from repeat issuers like ADIF, Engie, Enel and Iberdrola we saw newcomers like Telefonica, Vodafone, ESB and Vattenfal.
SEK continued to be the Nordic driver of green bonds. The first half of 2019 saw the issuance of SEK 85 billion (US$ 9.2 billion), a whopping SEK 13 billion more than what was issued for the whole of 2018 and up 90% from the first six months of 2018. The market received a boost in the middle of the summer when the Swedish National Debt Office (Riksgalden) has announced it was tasked by the Government with issuing green bonds in 2020, at the latest. This followed the announcement by the European Union of the green bond taxonomies, which should streamline and standardise the definition and identification of green bonds across the region.
This market segment continues to grow and diversify. In the middle of August, Porsche issued a green Schuldschein the proceeds from which will exclusively be used to finance the Porsche Taycan, the first fully electric vehicle by Porsche, according to the car manufacturer. Meanwhile, some expressed some concerns of the appropriateness of a meat company, such as Brazil’s Magrig issuing sustainable bonds. Detractors noted that the meat industry is simply not consistent with meat production and that a bond issued by of the biggest meat producers in the world could simply not be described in those terms. The focus of the bond, which received a second opinion from VigeoEiris’s was to ensure the sustainability of the soil used and to ensure that farming did not encroach on the rainforest.
Diversity was also the name of the game as the China-led Asian Infrastructure Investment Bank announced a new partnership with Amundi to launch a new Asia Climate Bond Portfolio tied to the multinational development banks lending activities. The announcement was seen as another step in the direction of establishing China’s development bank as an alternative to the World Bank and other USA-led institutions at a time of trade conflict between the two world hegemons.
Diversity and Illiquid Alternatives in Fixed Income Markets
The growth and accompanying diversification of the green bond market echoes a wider trend. Jonathan Harris, Fixed Income Investment Director at Schroders highlights the way in which diverisity in fixed income markets can be harnessed to achieve strong returns while managing risk.
“The traditional view is that bonds broadly tend to do better when interest rates are falling and, as such, provide a useful counterweight to equities,” he explains. “However, we believe this rather limited view risks overlooking all the potential benefits the right fixed income strategy can offer. The diversity across and within the numerous sub-sets of global fixed income is significant.”
“The diversification possibilities from fixed income are significant,” he reminds prospective investors. “Most obviously, government, IG or securitised bonds can provide some downside protection against equities in the event of slowing or declining economic growth, when stocks would likely perform badly. Equally, there is also an array of options as to how much downside protection an investor can aim for in their portfolio versus how much return potential they want.” At the end of the spectrum High yield remains an appealing proposition. “HY has produced strong returns over the past decade and a half, at times comparable to the returns seen from stock markets. Like stocks, however, HY is susceptible to volatility (the degree of fluctuation in returns during a certain period of time) and to larger declines than other fixed income sub-categories. But, the drawdown (total decline from the high to low point) is smaller for HY than stocks, while the time it takes for HY to recoup losses is significantly less – over the past decade it has been less than half. This is evident in the 2009 rebound following the 2008 decline.”
Khalid Khan, Credit Structurer at Hermes discusses the (il)liquidity premium available in more alternative public and private fixed income markets such as in catastrophe bonds, leveraged loans and structured credit, or infrastructure debt. Khan finds evidence that the liquidity premium varies, increasing in times of stress and tightening in calmer periods, that it follows a term structure so that it “increases at longer maturities” and “becomes greater further down the credit-rating spectrum”.
Inverted Yield Curve Forecasts Recession
During the Summer, the US Treasury yield curve inverted itself both at the 3-month as well as at the 2-year short-end maturity. Looking at the US yield curve, the 10yr-3m spread, which was -28bps at the start of June, opened the September session at -56bps. Similarly, the 10yr-2yr spread, which started the summer at 72bps ended August at -3bps.
Consistent with the term-spread’s historical ability to predict recessions in the past, the August New York Fed Recession probability estimate projects a 37.9% chance that the US economy will hit a recession in 12-month’s time. This is the highest likelihood level since just prior the start of the financial crisis.
Among Swedish investors, Jonas Thulin, Head Of Asset Management at Erik Penser Bank, remains the most audible contrarian voice, still overweight in equities, and sees booming financial conditions and the risk of a US recession at 0-5% over the next six to nine months.