The UK has long been the featherweight of the $50tn global corporate bond market. Why would a company bother to sell debt in sterling when vast, ultra-liquid dollar and euro markets are on hand? Bank of England intervention has not changed the order of things, but it has encouraged new issuance. Now that it is over, record numbers of polled investors think sterling corporate bonds are overvalued. They have a point.
There is no doubt BoE purchases helped to inflate the sterling corporate bond market. A combination of quantitative easing and non-UK issuers taking advantage of exchange rates raised investment-grade bond issuance to £18.5bn in the first half of the year. While the total remains smaller than the US ($363bn) and Europe (€166bn), it is still three times the sum sold last year. Suddenly the sterling market can enable Belgium’s Anheuser-Busch InBev to comfortably issue more than £2bn — a sum barely thinkable a few years ago.
The effect has been to diversify what was a narrow market. Returns, however, are less impressive. Credit is measured by spread — the income on offer over government bonds. Compression means higher returns but for sterling bonds the spread compression has been smaller than that of other markets. That could mean more potential for returns later on, but total returns for the year to date are 1 per cent, against 5 per cent for US dollar equivalents.
The trouble is that the total market available to investors has not changed all that much once the BoE’s £10bn bond purchase programme is taken into account. Illiquidity tends to mean a wider credit spread. Barclays estimates that the premium attributable to illiquidity has doubled to 30 basis points in the past month.
The newly hawkish tone of some central bankers in the UK also threatens to put a ceiling on gains. Trying to decipher rate moves from policymakers’ remarks is often fruitless but split votes tell a clear story. Rising rates mean falling bond prices. The headwinds facing sterling bonds just got stiffer.
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