It’s oh so quiet…low rate expectations becalm markets

It’s oh so quiet…             

Sovereign debt yields – including that of the recently shunned – have reached yet new lows. Major equity markets have reached yet new highs. Volatility has left the building. Such is the curious nature of the current monetary policy wonderland, and rising belief in the longevity of low interest rates, that markets can hold such contradictions and trade with such little drama. Yet again, we come back to echoes of the pre-crisis era and the ‘great moderation’.

Although, you get the sense that what is still a minor moderation will take much less to disrupt – one would hope with correspondingly minor ripples. The Bank of England and the Fed will certainly be thumbing their thesauruses, looking for just the right level of soothing expectation management – their minutes will take centre stage from here on in….18 June for the next UK instalment.

Everything but the (QE) kitchen sink

Two events have kept the low interest rate narrative alive last week. Friday brought a Goldilocks of a US job report for bond and equity markets, with rising employment to boost demand, but static wages to keep inflationary (read Fed) pressure low. However, the main event was the ECB’s monetary policy meeting, which cut interest rates to unheard of lows and set out measures to boost corporate lending.

It comes to something when you’re the first major central bank in history to introduce negative deposit rates, but it still doesn’t seem enough to fight chronically low inflation. However, interest rates were already exceptionally low and supply is just one side of the equation. Hence why Draghi’s: “We’re not finished yet” appears to be the new “Whatever it takes” in terms of market comfort. This could mean QE, although this isn’t a magic bullet – it hasn’t heightened inflation in the US or UK. But, whatever the meaning, it will be hard to back down from further action if inflation remains well below target – as the ECB forecasts it will be into 2016. The age of central bank Jedi mind tricks is over. Trying to get markets to act as if the QE bazooka is already in place, in order to avoid its actual deployment isn’t a long term strategy and the deflationary risk is too acute to risk a backlash.

A mixed economic verdict hasn’t dampened an enthusiastic market reaction, with equities and bonds in emerging and developed markets hitting numerous records. There is some nuance in the gusto. Peripheral yields have dropped to unheard of lows and below the equivalent US debt in some cases. Some headlines have proclaimed this a reflection of increasing confidence in the periphery. It’s true upgrades to Spain and Ireland’s credit ratings show progress; but sovereign debt yields have far greater subtlety. The fall in peripheral debt yield also reflects less palatable trends like low inflation and the incentive for Eurozone banks to ‘park’ their money in sovereign debt, rather than paying the ECB to mind it.

In M&A, more failure can be good

Of course, this market calm – albeit, perhaps before the storm – offers a window for companies, to float, raise capital and do deals. As companies trying to IPO will attest, it’s a little choppier of late out there. However, this isn’t due to a lack of appetite per se so much as increasingly full investors being faced with increasing choice at the IPO buffet. In the M&A market, recent data showing low completed volumes and withdrawals could also raise concerns – but a deeper dive into the data actually shows increasing health and appetite for deals.

Official UK data showing lower than expected M&A activity in Q1, is only really of historical interest, since it relates to completed deals. The recent rise in deal activity won’t come through until much later in 2014. Of course, there is always a question market hanging over how many announced deals will complete – especially given recent withdrawals. Data from Dealogic does show that 2014 has seen the highest volume of withdrawn deals since 2008. However, over a third of the $332.4bn total relates to the Pfizer-AstraZeneca deal, one of the biggest of all time and the second largest cancelled transaction ever. The fact we had such a deal in play suggests we’re not in a such a bad place. As we said last week, failure is not the trend. Indeed, a rise in the number of deal withdrawals can be a sign of health if it stems from an overall increase in activity and in contested bids. EY’s analysis of ThomsonOne data suggests just that. Contested deal volumes were four times higher in the first five months of 2014 than the same period in 2013 and the highest since 2007.

EY’s latest CFO Capital Confidence Barometer provides further confirmation of confidence, with 59% of CFO’s expecting the M&A market to improve in the next 12 months. CFOs are still concentrating on a select group of larger, transformational deals. More than two-thirds with M&A in progress have between one and three deals in the pipeline. It’s this increased stringency, focusing on a smaller number of higher quality deals, which Mckinsey believes will help deals to create more value in this cycle.

Secondary debt – too hot to handle?

What is good for the goose isn’t always good for the gander. A strong demand for secondary debt, driven higher by an increasingly anxious quest for return, appears to be pricing distressed investors out of the market. There is just too little upside left in single names – certainly, if ‘loan to own’ is the ultimate goal. There are also reports of ‘approved’ lists of loan holders for some assets. Faced with low returns and closed doors, distressed investors are turning instead to portfolios of debt being sold off by banks across Europe. This is an increasingly fertile market, due to the Asset Quality Review (AQR), which will force many banks to take a different view of non-performing loans previously subjected to forebearance policies.


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