With a strain of populism spreading across Europe – one that threatens the very existence of the European Union if Marine Le Pen is elected president in France – one antidote for large regional corporations is get bigger or get acquired, a Bank of America Merrill Lynch report notes. With uncertainty in the region the only certainty and the prospects of the ECB tapering on the horizon, weaning markets of the placating forces of quantitative stimulus and negative interest rates, the brew being conjured up in Europe is particularly interesting and potentially volatile at the moment.
ECB tapering is coming
Barnaby Martin and his European Credit Strategy team at BofA have been outspoken in the past about the potential ravages that populism could represent to markets. Now add to this the unwinding of ECB stimulus, which could potentially see bond buying fall from €80 billion to €60 billion, a reduction that might be taken with greater care due to the political climate.
In a recent note, “Who’s afraid of the big bad taper?” the team says “Goodbye to the most predictable forces” notes one future event that is relatively predictable: the end of quantitative stimulus. “With ECB (and BoE) purchases slowing down from next month, ‘peak QE’ will soon be over. We think April 2017 will herald the start of weaker technicals for credit markets in Europe,” the team wrote.
Martin and his team do not know exactly how ECB tapering might play out, but one unwinding probability path involves cutting back on “corporate and covered buying to help ‘shield’ peripheral sovereigns amid French election worries.” If such a path is taken, it could represent a negative scenario for corporation credit spreads, they predict.
With ECB tapering and populism increasing, why are markets so calm?
The market reaction to ECB tapering is and the lack of volatility around it seems is concerning. The extent to which the markets have been
“The extent to which the markets have been passified by QE buying is somewhat alarming,” given that Brexit uncertainty reflected in the 6-month standard deviation of Sterling credit spreads is currently tight at less than two basis points. “The lows were 1bp just before the Global Financial Crisis erupted, and even then the index was trading at half the spread level it is today,” they noted.
Why are bond markets so non-pulsed amid historic events all around them? To this quandary Martin and his team have a central observation.
“Central bank asset buying has effectively suppressed market volatility by reducing the free-float of bonds for investors to buy,” the wrote. “The faster that central banks’ balance sheets grow, the quicker the free-float of bonds shrinks.”
Saying that Europe could now be at “peak QE,” the team is looking for “a period of less favourable technicals in fixed-income, we think, and the risk of spread widening in credit.”
With so many factors of change on the table at once, the BofA analysts ask the question: Are barbarians at the gate?
EU corporates should recognize that “barbarians” could be at the gate
With the rise of populism all around it, European corporate leaders have choices to make. Corporations across the European region need to get bigger to remain independent – or be bought up in the onslaught.
“With a weakening Euro and Pound, European issuers are starting to look tempting takeover targets for foreign buyers,” the report observed. “And in a world of populism, governments in Europe are starting to fret about losing their ‘strategic assets’ to outsiders.”
Corporate leverage in the US is significantly higher than that of Europe, so the runway for a buyout movement in the region is within logical grasp. And this creates the clear path:
But in today’s populist climate, we think this creates pressure on European companies to get bigger, to stop them from being takeover prey. That means pressure on European companies to acquire (“buy or be bought”), or to engage in leveraged recaps.