Most things in the bond market have an analogy with cars. So when a car manufacturer’s sticker prices are slashed, don’t expect second hand car values to look too perky. Same for bonds; as we saw this week with Volkswagen’s jumbo $8bn deal. Thus, one of the most obvious risks for credit markets is the capacity for new bond deals to aggressively re-price the secondary market.
Issuers seem determined to raise finance. For VW they offered a discount of around 0.5% to where existing bonds trade. Issuance at borrowing levels that are almost irrespective of the current secondary market pricing does little for the existing bonds’ valuations.
This price insensitivity is a feature of the trickier market conditions that have prevailed over recent weeks. The impact of re-pricing not only impacts bonds from the same issuer (i.e. VW) or sector (car manufacturers), but increasingly also bonds of the same rating in different sectors (ratings of Single A or BBB). This development has been most clearly observed in non-financial credit. Or to get back to cars – don’t expect your BMW 3 series’ value to remain stable if Audi’s A3 is suddenly five grand cheaper!
As ever, identifying what is currently happening is the easy part; the more pertinent question is what to do in such an environment? The re-pricing of credit in the face of such cheap new bond supply we suspect is a trend that is likely to continue, which today encourages a more cautious stance. However, there will be occasional anomalies and opportunities that present themselves. Just because the discount is aggressive doesn’t necessarily mean it’s wise to ignore what’s on offer. After all, if you’re in the market for a car, you need a car and price will be a key component. And an active bond portfolio needs well-priced bonds. Er… Vorsprung durch Technik.