SEVERINO Other than confused? It certainly feels that central banks have done nearly enough tightening. Investors are looking at very attractive fixed-income markets and trying to decide when to either allocate more or get back in.

Inflation appears to be very sticky, though. Although it has declined quite a lot from the peak, core inflation is still stickier than expected. But there are quite a few signs that economies are slowing and I suspect inflation will feel a lot more comfortable to central banks later this year and into the first quarter of next. The US is leading, though the UK numbers released this morning were not very encouraging – so there is still work to be done.

One metric we look at to gauge the attractiveness of the market is S&P 500 earnings yield relative to government bond yield in the US. This spread is about as narrow as it has been in a very long time. Anyone concerned about a potential slowdown and recession should find fixed income quite attractive on this relative basis.

The US yield curve is obviously very inverted, which is a factor pointing toward a slowdown. It is also making money market funds very attractive, with the 2-10 year spread at around 100 basis points.

In the background, it has been one of the worst years for bank failures in the US. This is making borrowing conditions very difficult. There are pluses and minuses, in other words.

Overall, I think there still remains a chance of a soft landing. But if core inflation doesn’t start to come down, central banks are probably going to over-tighten. This will cause a recession. The speed of tightening, the inverted yield curve and what has happened to money supply in the US are three elements that have predicted almost every recession in the past.

DAY Even before the pandemic we were dealing with a global shortage of labour, which feeds through to wage costs and creates inflation. This is the case in the UK, which is extremely service orientated – core inflation is the main reason why inflation is so sticky.

Oil and energy prices may drop. But, to use the UK as an example, when average annual wages growth is at almost 7 per cent, it is very difficult to get from there to 2 per cent within a year. Average wages growth could reduce by 2-3 per cent but it is very difficult to envisage inflation suddenly landing on 2 per cent and staying there – without a recession.

This gets back to the role of fixed income. It has been such a good risk mitigant over the last 30 years because inflation has been low, central banks have been able to cut rates very quickly and business growth has been slow because inflation was down at around 2-2.5 per cent. Central banks no longer have that luxury.

Going back to March-April and the banking issues in the US, one thing the Federal Reserve said was that rate cuts were the last resort and there were lots of other levers it could pull before getting to that point. The main reason was inflation. Markets pricing in rate cuts quite quickly this year therefore didn’t seem realistic or rational to us.

Next year is perhaps a different story. But we have always been mindful that rates may stay higher for longer, even if they don’t go up much more. When pricing, as it is now, implies a few more rate increases this year and no cuts into next year, markets start looking a little more attractive.

Regardless of whether there is a recession, bonds look attractive on a standalone basis over the medium and long term. This is a good place to be as a bond investor, and it is somewhere we haven’t been for the past 30 years.

This has had a big knock-on effect on other asset classes, which have become less attractive. For example, when we ran into crisis in September last year in the UK, it was the first time anyone has ever come to my desk to ask me how to buy a Gilt. This implies the wider world is thinking about things the same way as the investment community. Equities are now relatively less attractive because there is little point taking equity or even credit risk when one can get 5 per cent with a T-bill.

GOEBEL It hasn’t been particularly challenging to get the funding job done. We saw some initial spread widening into January and the knee-jerk reaction was that a lot of borrowers piled into the market wanting to kick-start their funding programmes in good size. Since then, spreads have come back somewhat. We have seen limited volatility and the euro continues to provide size, duration and depth of investor base.

The flip side of this is that the euro has also typically been the most economical issuing currency for us – to the extent that we have found it difficult to get the usual currency diversification into our borrowing programme. We have borrowed in euros for about 70 per cent of our year-to-date issuance, and then just US and Australian dollars.

Many other currencies are either not there at all, like the Scandinavian currencies, or are only available in maturities up to three years – where we don’t really have a lot of borrowing needs.

As we swap proceeds back to euros, currency diversification is not ‘art for art’s sake’. But we want to supply product into our diversified investor base over the medium term, so the lack of currency diversification is an issue.

We are still waiting for quantitative tightening and the reduction of excess liquidity in the Eurozone to deliver normalisation of the funding cost between euros and other currencies. I wonder when we are going to get there.

BILL Our fiscal year has been relatively different between the second half of last calendar year and the first half of this year to date. We had the credit crunch environment in October last year, which was a sign of what can happen if the recessionary scenario unwinds itself.

We have also seen the effect of central banks’ policies working at a different pace in the markets we operate in, which is mostly related to the mortgage market setup in various economies. For example, the UK and Australian mortgage markets are more ‘risk resettable’ and the transition mechanism works faster.

Meanwhile, the US has a fixed-rate lending environment so policy arguably works with a delay. This can also cause a delayed effect in economic slowdown. When inflation comes down to levels where everybody starts to cheer that it has been overcome, this is actually when a recession can start. Lower inflation is also a sign of things really slowing down.

We are conscious of the possibility that market access can be challenged when this happens. We are therefore trying to work in preparation ahead of the start of our 2023/24 fiscal year.

For instance, the lesson of the last year is that there can be repercussions with respect to collateral: a stronger US dollar would increase our need to post. With our exposure to Australian swaps and the need to hedge our Australian dollar funding, this has been something we needed to get extra funding for on a couple of occasions.

With all this as the backdrop, the Australian market has been amazing over the last year. I think most of us at this table can attest to the fact that it has been a great year, offering an advantage over any other market in price and volume. We have had a really good year and we plan to continue issuing into the Kangaroo space.

HELLERUP The main difference for us is that private placement activity has been a lot less significant this year. We did more than 110 funding transactions in 2022 and we have done fewer than 30 so far in 2023. It seems investors do not need to sell options in connection with private placements this year. As a result, we have been much more active in public markets. We have done transactions in US dollars, euros, sterling and Swiss francs – for the first time in 14 years – as well as Australian and New Zealand dollars.

DOREY We are seeing a lot of demand across the curve – 10 years and longer. As an issuer, the question is whether we really want to issue at 10 years or more right now. We are more focused on 3-5 years. Longer-dated is interesting, given the depth of demand for this product and the outlook for the next few years. But it is not necessarily where we want to issue.

If an issuer expects to be very active, it should probably try to tap into all tenors. Our funding needs this year are higher than the last few years but still not at peak levels. This is also a balancing factor for us.

MORGAN Some of our SSA [supranational, sovereign and agency] peers did fantastic 7-10 year trades in US, Australian and New Zealand dollars at the start of the year. But we have seen investor focus shorten up over the last 12-18 months. We issued a five-year US dollar benchmark this year, but there have been times over the last year or so where even this tenor has been challenging. We have also seen a lot of three-year issuance in the Kangaroo market this year, a tenor not traditionally the most active.

This is not problematic for us as 3-5 years is our sweet spot. But it means that when the opportunity arises to add some duration, issuers need to be reactive and flexible in their funding approach. We did a longer-dated Swiss franc transaction recently and we will respond when we see demand in Australian dollars for our 2030 or 2032 outstanding lines.

We are still seeking to pick off longer-dated tenors – we just haven’t seen the critical mass of demand to do a A$300 million (US$200.3 million) 10-year transaction like some of the supranationals.

KOTAMRAJU This year has been constructive for us but it is similar to our experience in previous years. We have funded about US$20 billion to date and have sought to diversify our issuance across the curve.

Despite volatility in swap spreads, particularly at the front end, we continue to experience robust demand across the curve. We have had three US dollar global benchmark outings this year, the most recent being a two- and 10-year dual tranche deal. Demand was fairly balanced across the two maturities. In Australian dollars, we have also seen good demand across the curve having issued in three-, five- and 10-year maturities.

For private placements, we have experienced more demand at the front end, although we continue to issue across the curve. To Stefan’s point, while we have issued in more than 20 currencies this year, one currency we have not yet issued is euros. As a US dollar-based funder, euro issuance has been less competitive so far this year.

MORGAN It has been the same for KBN [Kommunalbanken Norway]. Euros has moved closer to US dollars at times, but it still remains challenging on a cost comparison basis. I also agree on the best demand in Australian dollars still being in the mid-curve but, as I said before, the amount of three-year issuance in the Kangaroo market has been really interesting. Historically, it was more predominately a five- and 10­year market.  

DORE There is still ample liquidity across the curve and we are seeing demand for our products across the maturity spectrum. While some investors have shortened the duration of their portfolios because there is no longer any need to extend maturity to enhance yield, there are still many natural buyers of duration.  

This year, we are delighted that we were still able to issue significant volume of long-dated bonds – seven-year-plus maturities. This is helping with our current strategy of lengthening the duration of our portfolio.

AINSLEY We have certainly had to navigate a couple of risk events, especially in the first half of this year. Traditionally, KfW [Bankengruppe] would start the year with a 10-year euro benchmark. At the beginning of 2023, we saw spreads widen and, when we assessed levels, 10 years looked a bit too expensive. In the end, we opted for a five-year euro benchmark instead, which is not very common for KfW: everyone expects a 10-year tenor from us at that time of year. However, it worked out very well.

Things have fundamentally changed in recent years. During the very accommodative monetary policy environment in the Eurozone, we were able to do a lot of very long-term funding in euros – 10 years and beyond – at quite attractive levels. We could provide a bit of yield, at least not negative yielding bonds.

Things have changed. We used to counterbalance long-term euro funding with short-term US dollar funding. Right now, we can do very successful trades at the short end in euros as well. We just did a very successful three-year euro benchmark.

AINSLEY We haven’t seen a lot of Japanese demand in our books for quite some time, because we haven’t issued much at the long end in Australian dollars for a while. We hope this will change, but pricing at 10 years has not been attractive. On the other hand, domestic participation has been very robust this year and stands at levels we haven’t seen since 2018 or 2019.

SEVERINO We manage Japanese funds on a discretionary basis although we also have some retail flows – and we are experiencing consistent demand for products that have Australian dollars. Overall yield in US and Australian dollars is attractive to Japanese investors at the moment and I don’t see any reason for this to abate. In fact, we are considering if this may be a good time to add Australian dollar retail-focused product in the coming months.

AINSLEY The international bid has been extremely good – particularly out of Asia ex-Japan, including Asian central banks and bank balance sheets in much higher volume.

A notable development we have observed is that order sizes are increasing. Where we were seeing orders of A$50-100 million, now we see orders of up to A$200-300 million. This has enabled KfW to issue good volume in the year to date.

Australian dollars can offer attractive opportunities on a relative-value basis to US dollars. We also now have more clarity about the Reserve Bank of Australia [RBA]’s interest-rate direction. This all filters through to the composition of our books.

DORE This year is one of our strongest in the Kangaroo market. We have issued almost A$3 billion already including a A$1.5 billion five-year at the beginning of the year and more than A$1.2 billion of 10-year transactions.

The notable change for us is the very strong bid for long-dated Australian dollar products and the increased diversification of investors participating in these long-dated trades. For instance, last year most of the bonds we issued in the 8-10 year part of the curve were sold to Japanese investors. This year, Asia ex-Japan investors have been quite active at the longer end. We have also had some domestic take-up, as well as new buyers – which is very pleasing to see.

KOTAMRAJU We printed a NZ$675 million (US$415.7 million) five-year in our first Kauri trade for the year, on 20 June. We saw strong support from domestic investors, including banks, as well as offshore investors. We had been monitoring the market since the start of the year and were cognisant of the RBNZ [Reserve Bank of New Zealand]’s ongoing liquidity policy review (LPR). But we are encouraged by the involvement of domestic bank investors in our five-year.

While our total issuance in the Kauri market is lower than the previous two years, we are encouraged by the reception to our recent deal and are keen to monitor opportunities for the rest of the year.

BILL We have accessed the Kauri market three times this fiscal year, most recently in May. Our strategy involves staying active and maintaining a presence across global markets, and New Zealand is an important part of this strategy.

We have also provided feedback on the LPR. We very much hope the review is resolved favourably, allowing as broad a group of issuers as possible into the market: a wide group of issuers, in my mind, promotes liquidity across the market.

A new strategy we have pursued this year is adding to existing lines, which is much easier to do regardless of the market backdrop. Investors’ willingness to invest at the long end has been more favourable again of late, but we are conscious that conditions can change over time.

MORGAN When we were in New Zealand in March, the message we received from investors was that there was a reluctance to go beyond a 2026 maturity until there was more clarity on the LPR. We issued a new NZ$300 million threeyear Kauri in April and, now we have now seen the successful five-year Kauri from Asian Development Bank (ADB), we hope we will be able to bring a new five-year later this year.

The Kauri market is a great source of diversification for KBN and we have built up a strong domestic investor base over many years, so it would be great to get another five-year done this year. I believe the market is capable of rebounding and a lot of issuers value the diversification given by the domestic investor base, so we are closely monitoring how the market continues to develop.

HELLERUP It is true that some investors are cautious on the long-end Kauri market. However, there is also demand in the longer end. We were very happy with the NZ$700 million seven-year Kauri trade we did in February, in which we also saw good demand from local bank treasuries.

DORE We have had a great year in the Kauri market. So far, we have issued more than NZ$1.5 billion across two tenors – three and five years. Almost NZ$1 billion of this volume was in the three-year maturity, which is quite unusual.

We believe increased demand in the short end of the curve can be attributed, to some extent, to the proposed regulatory changes. We hope the final regulatory decision will be one that helps enhance liquidity in the Kauri market and encourages the issuance of Kauri bonds.

FISHER We view SSAs as more attractive for clients that have capital charges against bond investments because of the high ratings of SSAs combined with the spread pick-up over similarly highly rated bond issuers.

These clients have demand in the 3-5 year part of the curve, so this is where our demand is currently for these issuers. But the overall yield environment means SSAs are also becoming more attractive as investors no longer have to go down in credit quality to achieve attractive returns.

RUDGARD We have seen the most anti-ESG [environmental, social and governance] sentiment and scrutiny in the US. This has affected US new issues: growth has slowed in the market for green bonds in the US and the greenium has eroded for labelled versus conventional bonds from the same issuer.

Europe has a more developed framework and a deeper investor base that is willing to look at these types of deals. In addition, regulation such as the EU taxonomy and SFDR [sustainable finance disclosure regime], and constraints on specific mandates, make for a deeper and more liquid market for sustainable investment in Europe.

EU regulation is bringing about more scrutiny through, for example, the Green Bond Standard (GBS). Whether regulation with stringent criteria will help attract more issuance that meets this threshold is yet to be seen.

FISHER The demand for increased scrutiny is coming from policymakers and investors. We use a standard to review green bonds, including that there must be a framework, before we can invest. We don’t necessarily require a second-party opinion, because we have our own highly experienced analysts who are capable of reviewing a framework to assess whether it is aligned with ICMA [International Capital Market Association] Principles.

If an issuer is going to spend money on verification, we would prefer that this was spent verifying impact. However, verification of impact reporting is unfortunately not mandatory under the GBS.

RUDGARD The GBS has been driven by policymakers seeking to add credibility to the green-bond market through the creation of a ‘gold standard’. However, its features are currently very restrictive.

From an investor standpoint, we welcome this: extra transparency is always helpful. Also, for investors with Article 9 funds, knowing that a transaction meets the criteria is very helpful. The challenge we are seeing is that not many issuers will be able to meet the GBS – which is potentially not what the EU was looking for when developing it.

DORE Our sustainable finance programme has been evolving for many years and we started our focus on reporting long before any regulatory changes were introduced. We have had a big emphasis on impact reporting and being transparent.

We started our labelled bond programme with a focus on green and have since expanded to a Sustainable Development Bond (SDB) framework that also includes a focus on social impact. As a development institution, we recognised the strong linkages that exist between green and social impact, which is why we are taking a holistic approach using our SDB label to highlight our entire balance sheet.

We use labelled bonds as an opportunity to engage with investors, highlighting specific themes and the impact of the work we are doing in our member countries. The themes we typically highlight are driven by investor interest. We expect this trend will continue because investors are interested in the issuer overall, as well as impact.

KOTAMRAJU ADB’s vision is to achieve a prosperous, inclusive, resilient and sustainable Asia Pacific while sustaining efforts to alleviate poverty. This suggests that all our issuance is ESG [environmental, social and governance] issuance. This said, in response to investor demand, we established our theme bond programme in 2010 and it has grown significantly over the years.

These deals have allowed us to highlight ADB’s initiatives in specific areas through our green and blue bonds, and theme bonds such as gender, health, education and water. These areas are in line with ADB’s operational priorities: if we weren’t issuing green, blue, gender or theme bonds, we would still be assisting our members in these areas.

We provide reporting on our issuance on an annual basis and our project loan documentation is accessible online. ADB adheres to strict environmental and social safeguards that apply to its projects. We have seen strong interest for our theme bonds across markets over the years and they have grown to be a significant part of our programme – especially in the Kangaroo and Kauri markets, where we have green, gender, health and education bonds.

RUDGARD The transition label is tricky and we don’t see a huge amount of issuance. We have seen some transition bonds out of Japan, but it has not been popular for issuers in Europe and the US.

My main question for an issuer seeking to bring a transition labelled bond is whether it has considered a sustainability-linked bond (SLB). The implication for issuers of transition-labelled bonds is that they are not meeting the threshold for them to be green issuance.

The construct of a sustainability-linked instrument is on an outcomes basis and this can incentivise an issuer-level transition. This said, it is also true that SLBs have drawbacks when it comes to getting the structuring right.

GOEBEL I think it’s a pity that there are some reputation issues for SLBs because it is this type of instrument that brings additionality. Additionality does not come from investing in a Rentenbank green bond that is refinancing a renewable energy project we would fund regardless of the type of refinancing, and at the same price for a green or vanilla bond. We have to get additionality into the system, and SLBs are a product that has skin in the game for both sides.

FISHER I agree that SLBs have the potential to help with transition but we also need issuers to be genuine about their plans. We examine issuers’ capex spend. If it is going predominately to new or existing fossil fuel projects, we know the transition isn’t genuine – and we will not invest in the bond. We also look at how ambitious the targets and KPIs are. If they are based on science-based targets, this gives the SLB enhanced credibility.

HELLERUP This is a hot topic being discussed by those involved in the ICMA principles. There are serious discussions about whether transition financing should be like green UOP transactions or whether it is better to have transition-linked instruments – whether they are UOP or sustainability-linked.

I agree that sustainability-linked products are good instruments. Nordic Investment Bank offers sustainability-linked loans (SLLs) on the lending side. We are now thinking about how to fund these loans, but it is a little difficult because there are no ICMA principles for this type of financing. It is not like UOP, because we are not funding projects – we are funding companies.

We are taking this up with ICMA and also with investors, to see if there is a way we can finance SLLs. Other issuers have funded SLLs via a bond, but the model has not yet been fully developed.

SEVERINO I personally believe SLBs are very good for transition and that they will evolve to become a key part of sustainable investment. However, for now, they provide some ongoing challenges. Given their hybrid nature, they don’t easily fit within our pure sustainable and ESG funds, and an instrument of this nature may not fit into a non-ESG fund either.

We still like green bonds. They are a pure play and their impact is very powerful: it is measurable and demonstrable to our investors. We have come a long way since first working with World Bank on green bonds and launching our first green-bond fund in 2010 together, and it is very exciting to think about the evolution of sustainable investment over this period.

DAY We take a very broad approach and have done for decades. We believe very much in a whole-of-company approach rather than in using specific instruments. There seems to be some belief that environmental impact can be lessened by putting something into the green-bond box. Issuers need to get over a bigger hurdle for us to judge them as sustainable.

RUDGARD This is what regulation is aiming for: to move on from assessing a green bond at the instrument level to assessing it at the entity level, as well as considering the issuer’s entire strategy.

DOREY We are currently in the process of updating our framework. Because there is increased scrutiny these days, we recognise that we need to be rigorous. Also, this is a fast-moving space with a big volume of data – which means it is possible that our framework for green issuance gets out of date more quickly.

With regard to things like green mortgages and sustainable financing, we are moving to a portfolio approach and this is how we will look at things going forward. We have increased ESG disclosure requirements already and we are focusing on ESG at issuer level in addition to the issuance level.

When it comes to ESG-related instruments, we have issued two kinds of labelled bonds – in 2014 and 2015. We haven’t been active in this type of financing since, but this is because we haven’t had any opco funding to do over the last few years.

If we issue green or social bonds it would typically be at opco level. As soon as our framework is completed, I’m sure we will look at labelled issuance.

DAY The risk of accidents is increasing. Even relating it back to the conversation about sterling versus swap spreads, this is all due to the impact of rate rises and inflation. There is just a lot more uncertainty.

The fundamental issue is that when real yields went positive it was accompanied by a shortage of capital. This means those that have benefited from cheap capital will at some point start to face serious challenges, as we saw in the UK in September with the LDI [liability-driven instrument] crisis. We saw it in the US, too, with regional banks attempting to use cheap finance to grow too fast.

The Credit Suisse situation could easily have been predicted many years ago. The risk of a repeat of a US regional bank collapse leading to contagion is the much bigger threat.

DAY Yes, but the key in bonds will be to avoid accidents – given there is limited upside in the asset class. It is also a question of where we are being paid. Bonds are attractive in most countries. The challenge is to find the currencies and the parts of the curve where we can get paid.

DOREY To the point on real yield, this is a positive development – because we want capital to flow to productive places. The issue we have had is the speed at which developments have occurred. We need to adapt the way we think about early warning indicators in light of the speed of movement of rates and deposits in an increasingly digital world.

SEVERINO I think Jon hit it on the head: any market player financing projects on a short-term basis – and commercial real estate is a great example – and therefore needing to roll, will find its cost has increased three, four or even five times. Some projects just don’t make sense anymore. Commercial real estate in the US is a big problem and the banks are very exposed.

Bank lending has become very restricted, and this will be a headwind on growth and markets. Eventually, once central banks are comfortable inflation is no longer an issue, the problem will become all the issues that stem from higher cost of capital.

The only way to fix this is to steepen the curve. In a year’s time I expect the curve will be much steeper, although most of the steepening may occur through front-end rates coming down.

FISHER We agree that fundamental credit analysis is key for alpha generation and avoiding losses in this environment. We prefer issuers that are less exposed to the higher interest rate environment, tighter financial conditions and a potential slowdown in growth. This means we prefer issuers that are not overly leveraged, and have conservative financial policies, strong cash flow generation and sound liquidity.

We also maintain a preference for Australian credit over US and European credit given valuations and the elevated level of protection carry it currently provides against excess return losses from spread widening. Although Australian credit can be expected to be correlated to global markets, we continue to believe local fundamentals are better placed with a lower risk of recession.

Nevertheless, we are building resilience by letting credit roll down, moving up in quality and opportunistically participating in the primary market when attractive new-issue concessions are on offer.

FISHER While we had been expecting that strong immigration and rising house prices would ensure the RBA maintained a hawkish bias for a while longer, we were surprised by just how much of a hawkish shift occurred throughout June. The Australian market now has fewer rate cuts priced into the forward curve relative to offshore markets.

However, we expect that more policy tightening now will lead to a flatter curve in Australia. We also see pockets of weakness in the Australian economy, including the latest GDP data showing negative per capita growth and consumer-related data indicating that discretionary spending is slowing quickly.

The question then becomes whether the RBA will maintain tight conditions in the face of slowing growth. We see two factors working against the RBA at this juncture, although both are slow moving. The first relates to the signs of weakness in consumer spending and the second is that there are signs inflation is easing offshore.

Where does this leave us? We think yield will fall over the next 12-18 months, but where to position across the curve remains important.

DAY The Australian curve has always been steep relative to the rest of the world. It is an outlier, particularly given how banks participate in the front end. There are opportunities in Australia, though.

The thing we are looking for in Australia that we thought we might have seen by now is when consumers will start to feel the pinch from increasing mortgage rates and house prices. The bias to the variable-rate mortgage is interesting, too, given examples and precedents around the world, including in the UK.

FISHER Australia has the same issue as the UK: housing supply is not keeping up with demand due lack of construction and elevated immigration. People need to live somewhere and when they can’t find property to rent, they may be forced into buying – if this is an option. This could provide some support to house prices in Australia, even as people struggle with higher mortgage cost.

BILL The problem of scarcity of capital doesn’t apply to supranationals. We are well-capitalised and our development capital was under-used in the low-rate environment, simply because we were to a degree crowded out by cheap capital from commercial money.

Supranationals are heading into a potentially recessionary period well prepared and with leverage available. From this perspective, we have observed an increase in demand for our lending over the past few months. Extrapolating this, we expect better times for IFC [International Finance Corporation], business-wise, as we have ample capital available to put to work.

SEVERINO One could say the same about consumers. They are well-capitalised from the pandemic, savings are high and monetary policy has rapidly increased. From the point where the curve inverts, historically it has been a year to 18 months before we see a recession. This could be nine months or a year from now.

To Jon’s point, we will continue to see these issues popping up in different sectors of the market. There will be issues as projects roll to the extent that, with the increased cost of capital, some of them will have to be abandoned.