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Higher borrowing volumes and much improved market sentiment have helped usher a promising start for issuers in 2024. With monetary tightening expected to ease and increasingly attractive conditions for borrowers, will the upturn in the bond markets continue as the year unfolds?
On this episode of Market Points, Patrick Dabiet, Managing Director and Head, Canadian Debt Syndication, and Fadi Attia, Managing Director and Head, U.S. Debt Syndication, discuss what’s driving the momentum in corporate bond issuance in the Canadian and U.S. markets. They also assess whether these trends will continue and the approach borrowers can take to access the market.
Patrick Dabiet: Fadi, we’re back at it again with another Market Points Podcast, looking forward to continuing our discussion on the bond markets for 2024.
Fadi Attia: Always a pleasure, Patrick. It’s going to be an interesting conversation for sure. And I’m excited to break down the themes that are driving the market and talk through the market conditions as it impacts our borrowers.
Where would you like to start?
PD: So why don’t we start by looking back at how 2023 wound up?
FA: So, 2023 supply in the U.S. ended up the year at $1.22 trillion, which was in line with estimates and represented the first year-on-year increase since the 2020s COVID fueled record volumes.
Corporates were actually very active, they ramped up their borrowing volumes by 16% year-on-year, while financials were less active, dropped 12% year-on-year. Market sentiment improved dramatically towards the end of the year, which frankly caught people by surprise, and that was prompted mainly by the December FOMC meeting here in the U.S., which signaled the end of the hiking cycle, and that fueled a higher degree of confidence for a soft landing scenario for the U.S. economy, underpinned by easier monetary conditions. This did result in a dramatic improvement in funding levels for issuers, and to put it into context, the U.S. Corporate Index snapped 30 basis points tighter in tandem with the 10-Year U.S. Treasury’s dropping 100 basis points lower during the last two months of the year, and it is very atypical to see a clean correlation between credit spreads and rates, especially when it’s a large move of this magnitude.
PD: It certainly was a storied and dramatic conclusion to the year from both a spread and a rate perspective.
FA: Well, how about the Canadian story, Patrick? Can you talk to us about the trends that are already having an impact as we kick off 2024?
PD: For sure, so supply came in lower year-over-year by around 15%. However, $109 billion worth of supply that came through was in line with our estimates. There was a late funding push from borrowers amid a more attractive rate and spread backdrop that you just spoke of, so we saw borrowers take advantage of that.
But I think of note when you drill through to some of the numbers, we saw an uptick in participation among borrowers. We saw 100 discrete borrowers in 2023. That was up from 87 the year prior. That still remains below the historical averages. I think some sectors are still grappling with operating their business in a bit of a higher rate environment, and so they remain on the sidelines, and I think as conditions continue to thaw and rates continue to move lower, I think we’ll expect to see a few more of those borrowers that have been on the sidelines re-emerge.
So, Fadi let’s talk about where we see 2024 heading. We’ve had a little bit of a window into how the markets performed thus far, but have they met our expectations and what’s the outlook for the rest of the year?
FA: Well, the constructive finish in 2023 has certainly ushered a pretty favorable funding backed up for issuers as we enter January, which did end up seeing a record number of volume, just under $200 billion of the issue supply in the investment grade corporate space. This actually puts January as the 6th busiest month of all time on a monthly basis.
Though we’ve had a pretty impressive volume go through the market, investors continue to be exceptionally engaged across deals. Order books demonstrate a significant amount of depth. Over-subscription has been over three and a half times the average level we’ve seen over the past six months, which is a big driver of concessions moving lower for borrowers that average about three basis points in the month of January.
Financials tend to be the biggest component of the January calendar that captured 70% of supply, just simply because corporate borrowers in the U.S. are in their blackouts and not able to access the market during that same period of time, and this does create scarcity value for corporate new issues, so that does support spreads moving tighter in that segment of the market. We estimate a trillion and a quarter for the 2024 IG volumes, which does leave a trillion for the balance of the year. This would net $530 billion of supply, which puts us roughly flat to 2023. There could be some upside to this estimate, and this upside would be driven by M&A activity if it continues to rebound further and support bond issuances.
We do also expect the financial sector to be more pronounced in terms of volumes this year versus last year and normalized towards historic trends as banks fund for their capital needs.
Patrick, on the Canadian side, how is supply and the market overall looking for borrowers?
PD: So, very similar to the U.S., we had the most active January on record, and that’s a function of borrowers taking advantage of the attractive rates on offer by the market.
We are expecting the market to continue to be active as issuers look to front load supply this year in light of a heavy election year globally. And in Canada, we’re looking for 115 billion of supply, which would be up marginally from last year’s volumes.
When you think about the split between corporates and financials, we do anticipate corporate supply to be flat year over year. They saw an increase in issuance last year while financials I think we’re anticipating to be a little bit more active this year and account for that incremental supply.
FA: Patrick, can you elaborate on some of those themes that are affecting the bond markets so far, and can you tell us if you think those themes will continue to have an impact on a go forward basis?
PD: Absolutely. So, I think what’s unique about 2024 in the Canadian bond market is there’s two key technicals that I think are driving the tone of the market right now, and the first is a supply demand imbalance. The second are cross-border flows that I think are going to be very topical and will be interesting to see how they play out.
So, on the first point on the supply demand imbalance, you’re looking at a record number of maturities and coupons being paid back to investors, and that should outpace the amount of supply that we see this year in Canada.
In addition, we’re anticipating investors to have a lot of assets and money to deploy into the market, as I think a lot of investors pile money into fixed income after a very strong close to the year in 2023, and so that will further exacerbate the amount of cash that investors have to deploy and will likely again continue to outpace the amount of supply in the market, and we’ve seen that already have a material impact in terms of how new issues have gone and how they performed in the secondary market. So, that relative imbalance and the timing of those imbalances for the course of the year are going to be really important to watch.
On the cross-border side, I think what’s most relevant is the fact that you have US Dollar levels offering a more compelling cost of funds for the largest Canadian corporates, and we saw someone like a Rogers Communications recently issue in the Dollar market and have tremendous cost savings versus their home market in Canada, and so that could continue to drive issuance out of Canada and into global markets, and that could, again, further have an impact on the amount of supply that investors have to play in here in Canada.
So, those two factors, I think, are going to be critical to see how they play out for the balance of 2024.
Fadi, shifting gears again to the U.S., at a macro level, what are some of those major factors that you think are driving sentiment in the U.S. right now?
FA: Patrick, monetary policy and its impact on rates is going to continue to be a big driver of sentiment, and subsequently it will have an impact on investor flows, particularly to fixed income. The market is currently expecting easing via the Fed’s rate cuts, coupled with the slowdown of the balance sheet runoff this year, that’s going to channel even more liquidity into the credit market, which will help support and underpin new issue markets with competitive funding conditions for issuers.
We do think the soft landing narrative for the U.S. economy is going to fuel investor demand for lower rated bonds, specifically BBBs, and crossover names in the IG space. This will be supported also for the bid on the longer end of the curve for longer maturities.
While this scenario is supported for most risk assets across the market, the bond market in and itself is an outside beneficiary because returns continue to be way more attractive versus, let’s say, equities from an investor’s point of view. But, it is important for us not to lose sight of potential risks, which can derail this momentum.
Markets continue to assess the health of the U.S. economy through an economic data lens. Rates are going to continue to be very reactive to government refunding, just simply given the focus on the outsized and historically large U.S. fiscal deficit. We can’t ignore geopolitical risks. So far, it had a muted impact on investor sentiment, which cannot be taken for granted, given that it’s very dynamic in nature.
The market has moved on from a broad panic approach to U.S. regional banks, but localized flare ups are likely to occur as commercial real estate exposure remains an area of concern.
It’s also an election year in the U.S., along with 60% of the world’s GDP, which is likely to bring into focus policy expectations, which would impact economic outlook and risk assessments.
PD: Yeah, clearly that’s going to be in focus for the market for the balance of the year.
So, Fadi, let’s talk about how U.S. investors are responding to these market conditions. How are they dealing with all these variables?
FA: Bond investors have actually displayed an impressive breadth in terms of type of participants, spanning asset managers, insurance, pension, and hedge funds, the graph for assets has been very pronounced ahead of what’s estimated to be a hundred basis points of rate cuts priced for the balance of the year.
The U.S. IG market being the largest and the most liquid in the world provides this added benefit for cross-border investors to access the US Dollar credit market and supplement the domestic demand, that’s just simply additive to the existing liquidity that sits within our system. And inflows have actually recently accelerated as more dollars are repositioning away from money market funds, which was a theme in 2024, and now looking for long term investments to lock in higher returns before rates continue to migrate lower.
This switch in and itself has been adding to the consistent and sticky demand that’s driven by yield hungry investors, which are typically the insurance and pension funds. Demand for longer tenors continue to expand, which is driving credit spreads flatter, and this basically means that it’s making funding opportunities in 10-Year and longer even more competitive for borrowers.
For example, if you look at the 10-Year to 30-Year investment credit curve, that averaged about 30 basis points in 2023, but since September of last year, that average actually dropped in half. It’s at 15 basis points with a handful of trades, which price in January of this year with less than 10 basis points.
So Patrick, what is the investor sentiment like in Canada?
PD: So investors have been very engaged to begin 2024, and again, that’s a function of the amount of cash they have to deploy in relation to the amount of supply that’s come through the market. And I think ultimately a lot of investors have been challenged to find opportunities to put that cash to work, and I think a lot of them have been forced to look outward beyond their traditional sandbox, and so we’ve seen a number of Canadian investors look to your market Fadi, the U.S. investment grade market first and foremost. We’ve also seen some Canadian investors turn to the private placement market or even the high yield market to try to find a hole for that cash in their portfolios.
And so I think ultimately that’s good news for borrowers as it means that investors are actively looking for these new issue opportunities. So, it’s been a really, really, I would say, robust start to the year in Canada from the investor perspective.
So, Fadi, this has been a great conversation.
Maybe a final thought from you when it comes to borrowers and the market conditions and the risks that they’re needing to navigate for the balance of this year. What should they be paying close attention to?
FA: Well, given the constructive market sentiment in the U.S., and observing where Investment Grade corporate spreads are trading, which is at a two year low, we would certainly be encouraging issuers to de-risk part of their funding needs sooner rather than later.
And we do think that accessing the market earlier in the year does allow issuers to stay ahead of the potential risks, which we discussed earlier, which may drive cost of funding higher or could potentially handicap market liquidity.
Issuers should definitely stay nimble in terms of rate hedging solutions. Volatility is likely to remain throughout the year and can sometimes create opportunities in the issuers favor.
We do like reopenings, that’s tapping existing benchmarks for new issues. That can be a very efficient approach for borrowers who are not looking for significant quantum in terms of funding. These bolt on deals can add to the secondary market liquidity of existing bonds and does give issuers maximum flexibility in terms of execution.
We also do like floating rate debt. It’s an efficient way, in terms of including that as part of the funding mix, it can help lower costs over time, particularly just given that the market is pricing rates to drift meaningfully lower over the next couple of years.
For frequent borrowers who have the ability and the access to fund by the structured market, they should take advantage of the cost savings as an efficient way to create excess capacity without impacting their unsecured funding levels.
And finally, for multinational issuers who also opportunistically access other global markets to compliment their core US Dollar funding, they should take advantage of competitive pockets of demand overseas.
So Patrick, what about the Canadian perspective? What should borrowers be thinking about for the rest of the year?
PD: I’m going to isolate on the rate outlook because I think that will be critical. It will impact both the supply and the demand side.
And on the supply side, specifically, we have seen a lot of movement in terms of the probabilities of rate cuts and the magnitude of those cuts. I think ultimately that could draw in more supply than the market maybe is anticipating, especially when you think about all those elections that are going to be taking place towards the end of the year.
I think on the demand side as well as we saw towards the end of the year and the platform that is currently on offer right now, a lot of that was buoyed by the fact that we saw a rate rally and if we see rates go higher, we think that that could potentially put pressure on the amount of cash that investors have to deploy in the market. So, I think again, that will be critical.
I think another element is the gap between Government of Canada yields in Canada and U.S. Treasuries on an absolute basis, and that we’ve seen has had an impact in terms of the absolute levels of spreads that will prevail in both markets and that could drive cross-border funding opportunities. So, I think closely monitoring that is going to be also very important.
All that being said, despite the potential for headwinds and rate volatility, we feel very confident that the market will continue to show its resilience as it has over the last couple of years, and will provide a very sound market for borrowers to tap into.
FA: That’s great, Patrick. It’s a very enjoyable conversation. I appreciate your perspectives and your views on what's ahead of us in 2024.
PD: Absolutely. It's always a pleasure to compare notes, Fadi. And obviously a lot to look forward to, and I think a lot to be mindful of as we make our way through 2024. But again, we’re happy to be able to help our clients navigate that.
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