Weekly Market Outlook

BOE Optimism Wilts in Long-Term Debt as Brexit Sparks Rout

Long-term sterling bonds suggest investors are quickly losing confidence in the Bank of England’s ability to support debt markets through the U.K.’s departure from the European Union.

Holders have lost about 10 percent in as little as seven weeks on long-dated notes issued by Vodafone Group Plc, British American Tobacco Plc and WPP Plc. The bond sales took place after the central bank announced plans in August to buy corporate debt, sparking investor optimism. The mood has since soured because of concerns about a so-called hard Brexit, sterling’s tumble and the outlook for inflation.

“With the benefit of hindsight, August was the best time to issue,” said Srikanth Sankaran, head of European Credit and ABS strategy at Morgan Stanley. “The market was more focused on the Bank of England’s support rather than the longer-term Brexit risk.”

Companies sold about 4 billion pounds ($4.9 billion) of bonds maturing in 20 years or more in the two months after the BOE’s Aug. 4 stimulus announcement, according to data compiled Bloomberg. That’s almost double the tally for the first seven months of the year. Issuers rushed to market as the BOE’s bond-purchase plan and an interest-rate cut helped push corporate borrowing costs to a record-low 2.06 percent, based on a Bloomberg Barclays index. Cigarette-maker BAT sold 650 million pounds of 36-year notes priced to yield 2.28 percent on Sept. 5. The yield has now surged to 2.88 percent amid the selloff. The London-based company has also announced plans to issue more debt to help pay for the $47 billion acquisition of outstanding shares in Reynolds American Inc. “We thought the timing was good” for last month’s bond sale, said Oliver Wolfensberger, BAT’s head of corporate finance and financial risk. “The decline is mainly driven by the movement in gilts.”

May Speech

The yield on 10-year U.K. government notes has surged to about 1.08 percent. It was 0.75 percent on Sept. 30, before Prime Minister Theresa May made a speech at a Conservative Party conference the following week suggesting she favored a hard Brexit, which may entail leaving the single market as well as the EU.
“Brexit was parked in September as not a problem for now,” said Ben Bennett, a London-based credit strategist at Legal & General Investment Management. “Then, all of a sudden, we had the Conservative Party conference and it came back to the forefront of investors’ minds.” The average borrowing cost for companies has climbed to 2.54 percent, more than reversing the decline following the BOE’s stimulus announcement, based on Bloomberg Barclays index data. The central bank has bought 1.56 billion pounds of company bonds since starting purchases on Sept. 27. Still, price swings are less of a concern to investors such as pension funds and insurers that tend to hold a large number of bonds to maturity. They do this as they need sterling assets to match against future liabilities. Corporate borrowing costs also remain below levels reached in the first half of the year, aided by the BOE’s rate cut.

Inflation Concerns

Bond yields have jumped because of sterling’s 6 percent tumble this month. The weaker pound boosts the cost of imports and it’s already starting to drive up retail prices. A pickup in inflation hurts long-term bonds because it reduces the relative value of future fixed-income payments. Vodafone’s 1 billion pounds of 40-year bonds issued in August have dropped to about 90 pence, according to data compiled by Bloomberg. Advertising company WPP’s 400 million pounds of 30-year notes have fallen about 8 percent from the Sept. 7 sale price. Both companies declined to comment on the market moves. “The speed at which sterling has devalued has surprised people,” said Juan Valencia, a credit strategist at Societe Generale SA in Paris. “If you bought into these deals in August, and you’re a total-returns investor, you’re hurting.



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