Sweden’s $240 billion covered bond market has been left by the wayside amid unprecedented central bank government-bond buying. That could come to an end next month.
“Covered bonds look a bit cheap at this stage when you look at their relative valuation,” said Mats Hyden, chief analyst at Nordea Bank AB.
The market, which is more than twice the size of the Swedish sovereign market, has taken a beating as Riksbank implements its pledge to buy as much as 90 billion kronor ($11 billion) in government debt to drive down long-term rates and revive inflation.
Yield spreads are the widest in more than two years, according to Nordea. The gap between the securities and 5-year government bonds is almost 80 basis points, or 0.8 percentage point. That’s about twice what it was in January.
Conditions may now be turning in their favor. With signs that its bond purchases are working, the central bank is expected to take a break in July from extraordinary monetary easing. Consumer prices unexpectedly rose again last month, prompting all of Sweden’s biggest banks, as well as Danske Bank A/S, to rescind predictions for another rate cut at the next meeting in July as inflation topped estimates.
Covered bonds will also benefit from shrinking issuance, according to Hyden.
Mortgage credit institutions usually offer as much as 35 billion kronor a month to refinance maturing securities and fund new lending, he said. Yet so far this year they’ve sold more of the securities than usual, and that may push down issuance this month to as low as 25 billion kronor.
Banks also are opting more often to issue unsecured debt to fund mortgages amid investor demand and to tap deposits. That’s shrinking the total pool of covered bonds.
There were 213.9 billion euros of the securities outstanding at the end of March, according to the Association of Swedish Covered Bond Issuers. That’s down 3.8 percent from a year earlier.
The Riksbank’s buying, meanwhile, has helped shield Swedish government debt against the global bond slump that buffeted the country’s covered papers.
The second quarter may be the worst for government bonds in almost 30 years, after Bank of America Merrill Lynch Global Government Index declined 2.9 percent since the end of March.
That means sovereign debt yields may yet go higher, Hyden said. With covered bonds, “there’s already priced in a yield increase to a larger extent than in the government bonds.”