The extraordinary demand for Scentre Group’s initial debt raising tends to illustrate quite emphatically what the Federal Reserve Board’s Janet Yellen last week described as the “reach for yield”.
Scentre went to the European medium-term note market seeking to raise up to €2 billion. After being inundated with buying interest – reportedly there was as much as €5 billion of demand – it was able to get the issues away at coupons at the lower end of its expectations.
Successfully undertaking the largest European debt issuance by a non-bank corporate is a rebuff to critics of the merger of the Australasian businesses of Westfield Group and the Westfield Retail Trust, who argued that the new entity would be over-leveraged.
It is also, however, another example of how markets and investors are, in this ultra-low rate environment, completely re-pricing risk – discounting it to negligible levels, in pursuit of positive returns.
Yellen, in her speech last week, rejected arguments that central banks should begin shifting monetary policies from emergency settings focused on economic stability to avert the threat of asset price bubbles and ultimately another bout of financial instability.
That argument was most strongly put by the Bank for International Settlements last month in which the central bank for central bankers referred to “euphoric” financial markets and urged governments to end policies that risked fuelling asset price bubbles by raising interest rates too slowly and too late.
Yellen did acknowledge that corporate bond spreads and volatility indices had fallen to low levels in some markets, which suggested some investors might be under-appreciating the potential for losses and volatility in future.
She also said terms and conditions in the leveraged loan market had eased significantly as a result of the “reach for yield,” although the Fed at this point didn’t see a systemic threat from leveraged lending.
“But we are mindful of the possibility that credit provision could accelerate, borrower losses could rise unexpectedly sharply and that leverage and liquidity in the financial system could deteriorate,” she said.
Her preferred response to the apparent insensitivity of investors to the potential build-up of risks in financial markets is the use of “macro prudential” tools. One would, however, have thought that is exactly what the BIS has been doing since the crisis, with its toughening up of global capital adequacy, liquidity and leverage requirements for the world’s banks.
Within Scentre’s debt raising was €600 million of 10-year fixed rate notes with a coupon of only 2.25 per cent. That’s cheap funding by any measure (although not as cheap as the €600 million of six-year fixed rate notes with a coupon of 1.5 per cent that was also part of the raising). When Spanish bonds are trading at record low yields it is clearly a good time for corporates to be raising funds in Europe.
It is worth noting that Yellen isn’t alone in her view that the unconventional monetary policies that were put in place in the aftermath of the financial, and which have resulted in zero or negative real interest rates in the US, Europe and Japan, remain necessary even if they are creating asset price bubbles which might cause financial market instability/busts in future. European Central Bank president Mario Draghi and the Bank of England have made similar comments as they prioritise trying to get their real economies moving and growing.
At the moment the Fed is steadily reducing the scale of its quantitative easing program – which at the current rate of decline in bond and mortgages purchases ($US10 billion less each month) would cease before the end of this year. It has, however, committed to retaining the current zero to 25 basis point range for the federal funds rate for “a considerable period.”
It has generally been thought that US official rates wouldn’t begin to move up until at least 2016 but the stronger stirrings of life within the US economy have led to a number of analysts bringing forward that moment into the second half of next year.
Markets don’t wait for events; they anticipate them. If the markets become convinced that rates, in the US at least, are going to rise next year there will be pre-emptive action and the current environment of ultra-low risk premia in most asset classes and the near-complete absence of volatility might change quite abruptly.
There will be corporate treasurers looking at the success and the cost of the Scentre raisings and considering whether they, too, should strike while the window of opportunity remains open to raise longer term funding at historically low cost.
Others will look at the raising and the general pricing of debt, equity and other asset classes and conclude that low risk premia don’t mean that the risks don’t exist.