Resistance is futile for European borrowers as yields soar

Higher borrowing costs may be biting the wider euro-zone economy, but at least its capital markets are functioning smoothly with corporates accepting the new environment of much higher yields and investors playing along.

With European bond yields at their highest level in a decade, you might expect corporate debt issuance would be slow to non-existent. Instead, new bond sales by companies actually exceeded those from financial and government-related borrowers in September for the first time this year. It suggests that corporate treasurers are accepting that higher interest rates are here to stay, and that there’s nothing to be gained from a delay in coming to market.

Nearly €43 billion ($45 billion) of new corporate bonds were minted last month, by 50 different issuers across 76 tranches. Consumer-related companies including Reckitt Benckiser Group Plc, Carlsberg Breweries AS, E.ON SE and BMW Finance NV were the most active, contributing more than half of the new deals.

This year has been the most active for new issues in a decade, setting aside 2020 and 2021 when borrowers of all flavors took advantage of a pandemic-driven surge in demand for fixed income. The most comparable year is probably 2019, and this year's total issuance exceeds that by 15 percent with more than €1.28 trillion of supply so far. However, the standout sector has been corporate issuance of €250 billion — nearly 50 percent ahead of 2022's pace. That’s especially impressive as governments globally are ramping up their own borrowing needs.

Just as importantly, corporate issuance has been widespread across the yield curve, and in all types of bond formats. Even though benchmark 10-year German yields have risen by almost 100 basis points this year to 3 percent, it hasn’t derailed bond buyers from taking on credit risk. So far, rising yields are attracting investors rather than scaring them away.

That’s despite year-to-date total returns in the global high-grade corporate bond market turning negative this week for the first time in 2023. Rising coupon income cannot overcome the push higher in underlying yields. That's all down to higher official rates as the European Central Bank has doubled its deposit rate to 4 percent this year in six hikes. But the euro bond market is taking it in its stride, and the pipeline for forthcoming deals remains strong. The average coupon on bonds in the euro corporate index, which has an average maturity of a bit more than five years, is currently 2.3 percent, but the days of cheap money are over. BMW’s latest deal maturing in October 2028 pays 3.875 percent, illustrating the jump in borrowing costs companies face.

Further evidence that Europe’s debt capital markets remain fully open is provided by nearly €10 billion of sub-investment grade bonds launched in 20 different deals last month. Furthermore, ESG-linked debt contributed a quarter of all deals, totaling more than €31 billion. There has even been a notable uptick in corporate hybrid deals with perpetual maturities, from household names such as Bayer AG, Telefonica Europe BV and Volkswagen AG.

Throughout this busy period, it might be expected that the yield premium corporates have to offer compared with government debt might widen. Instead, credit spreads have held in fairly well and are nearer the lows for the year than the highs. Although spreads are well above the tightest levels seen courtesy of pandemic stimulus, they are pretty much in line with the past decade’s average. Two-thirds of new corporate deals this year have tightened in spread since launch, a slightly better performance than other sectors.

Higher borrowing costs may be biting the wider euro-zone economy, but at least its capital markets are functioning smoothly with corporates accepting the new environment of much higher yields and investors playing along. With bank lending very weak, and money supply contracting, the ECB needs to step carefully to ensure that this channel for corporate borrowing remains open. If the hawks wrestle back control of the interest-rate steering wheel in Frankfurt, the dynamic in credit markets could change very swiftly — and not for the better.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Views are personal and do not represent the stand of this publication.

Credit: Bloomberg