The pain for U.K. corporate bonds in the immediate aftermath of the Brexit referendum seemed like it was going to be short-lived -- within days of the vote, sterling investment grade credit spreads raced tighter in anticipation of Bank of England purchases. Governor Mark Carney complied, and all seemed in order.
Well, spreads are racing back out again -- that's not a good result, for a program that's intended to lower company borrowing costs. The strength of the sterling rout may have left this element of the bank's quantitative easing as no longer fit for purpose.
European Central Bank President Mario Draghi's Sept. 8 remark that officials haven't discussed extending their bond purchases was a key moment in the recent turn in local fixed-income markets. But that sterling corporates were so badly hit was surprising, given that the BOE was getting ready to start buying. You'd hope that a central bank would be a more forceful presence than that.
The damage can also be seen in the U.K. high-yield market, where issuers had benefited from the squeeze on yields for higher-rated corporates.
True, some pullback was to be expected -- it's fairly usual for investors to rethink their enthusiasm on other central banks' bond purchases soon after the fact.
But the main story here is the recent selloff in the pound, which has clearly driven most fixed interest sterling assets wider. The inflationary impact also weakens the case for another rate cut.
For corporate credits, it's a double hit -- when interest rates rise, yields tend to rise further and faster than those on underlying government bonds.
Prime Minister Theresa May isn't helping. Her public expressions of concern about the "bad side effects" of central bank asset purchases certainly don't tend to establish QE as a durable feature of the bond landscape.
This is compounded by the BOE selecting what is indeed an odd list of corporate bonds for potential purchase. It's hard to see the political argument for the U.K. central bank lowering the cost of funding for the German railway system, to take one example. And traders are scratching their heads on how to deal with tiny securities, such as Birmingham Airport's 105 million-pound issue.
Whatever the merits of bolstering foreign companies with cheap cash, the separate question is getting them to visit Britain for their bond sales. And the argument isn't compelling.
With sterling so weak, and its prospects getting weaker, the return from converting proceeds back into home currencies is shrinking. At this point, it makes sense for multinationals to tap the U.K. only if they've got local operations to fund. And that's rarely how multinationals work.
Unless the pound stabilizes or starts showing signs of heading on a clear upward path, these global issuers might well give Britain a miss.
It all adds up to a rough patch for the U.K. corporate bond market. Considering that the BOE is only about one-tenth through its stated target of 10 billion pounds of corporate bond purchases, and it only started its actual buying just a few weeks ago, it may be a matter of managing expectations for the amount of stimulus that can be achieved through this channel.
And that would be a shame. The ultimate payoff of corporate QE is to burnish the allure of Britain as a destination for business. A hitch in the program at this early date chips away at this vision.
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