Credit

This Week In Capital Markets (12/11):

Bring Back the Bond Bulls
Ed ZwirnDecember 11, 2000

It seems the optimists may be back in charge.

And while things may get worse before they get better, there is reason to think that the funding situation for U.S. companies may ease in the coming months, and the economy may avoid a major credit and liquidity crunch.

Capping off a week which saw both huge bond issues and major market rallies, Friday’s employment numbers may be viewed as positive reinforcement for those predicting an easing of monetary policy.

It’s the classic “good news-bad news” scenario: The unemployment rate went back to 4 percent in November, from the 3.9 percent level which had prevailed for the past few months, and non-farm payrolls increased less than expected.

While these figures are far from startling and prompted only a lukewarm market rally after their release, they are important because they did nothing to contradict the growing perception that the Fed is changing direction.

Greenspan Changes Tune

This time, you can believe it because you heard it straight from the horse’s mouth:

Alan Greenspan, the same fellow who jawboned the market with his warnings about irrational exuberance a few years back, has finally changed his tune, if not his “bias.”

During a speech he made Tuesday before a conference of America’s Community Bankers in New York, the Fed Chairman spurred a major market rally with remarks clearly intended to downplay the Federal Reserve’s avowed leaning towards a monetary tightening and hint of possible easing in the future should the economy continue to slow down.

“The ‘wealth effect’ that spurred consumer spending is being significantly attenuated,” he said.

The immediate upshot saw the Dow Jones Industrial Average up some 338 points and the Nasdaq Composite gain 10.5 percent. The Treasury bond market also rallied sharply. Investment-grade corporate bonds, despite an avalanche of new supply, tightened by maybe five basis points relative to Treasuries.

On the other hand, Greenspan was careful to temper this signal.

Remember ‘Stagflation?’

Citing as “worrisome” the recent sharp rise in energy prices, he said that if this trend is sustained there could be both inflation risks and economic slowdown risks.

If energy prices, which are already hurting profit margins, continue on their present course and this is “accommodated by economic policy, the jump in energy prices could spill over into general inflation and inflationary expectations, as was so evident in the 1970s,” he added.

Taken at face value, the equivocating stance taken by the Fed chairman would at least augur for a shift to a neutral, from a tightening, bias at the next FOMC meeting Dec. 19.

But bearing in mind that both equity and debt markets appear to have priced at least this much of a shift into their calculations, Fed policy makers are really going to find themselves painted into a corner when they meet.

Anything less satisfying than a shift in the official bias statement could prove disastrous for both debt and equity markets.

Looking ahead, the only “surprises” that could juxtapose themselves between the current optimistic consensus and Dec. 19 are this week’s inflation updates.

The Producer Price Index is due out Thursday, Dec. 14, and the Consumer Price Index the following day. Any major upturn in inflation not easily dismissable by analysts could also derail a possible benign Fed move.

In the meantime, more speculative credit may be drying up, but the investment-grade bond market is certainly showing signs of friskiness.

Buoyed in part by the turnaround in sentiment and in part by huge spreads issuers were willing to offer investors, last week proved one of the busiest in months as far as bonds are concerned.

Large BT Deal Viewed as a Positive

The long-awaited $10 billion British Telecommunications deal, the largest dollar- denominated corporate offering ever, hit the scales at a much larger size than expected. Click here for more on BT.

Unlike October’s $7 billion Unilever deal, the tranches of which ranged from a two-year floater to a 10-year fixed, the BT offering, which included $2.8 billion of 30-year bonds, illustrated that corporations may still go to the market and borrow long-term.

Of course, the BT deal was still obliged to offer a much higher yield than those prevailing for comparable telecom issues. And the issuer, which had been downgraded four notches this summer, was forced to include “step-up coupon” provisions to reassure investors concerned about further downgrades.

But BT had been forced to cancel the same offering a few times over the past several months, and most are taking the fact that the deal could get done at all as a positive sign that maybe market volatility is lessening.

“An increase in the size of the offering from the $6 billion to $8 billion originally planned suggests debt markets are not closing,” John Puchalla and Kamalesh Rao of Moody’s Investors Service wrote in a report issued shortly after the bonds priced.

According to the Moody’s economists, the three- year floating-rate tranche, which totaled $1.1 billion, faced the most pressure due to the recent widening of short-term rates “in anticipation of a possible decline in short- term interest rates.”

Looking ahead, funding via both debt and equity markets is likely to slow down in the coming week.

The corporate bond market will be busy digesting a lot of new supply, including both BT and Verizon, which priced $4 billion of five-, 10- and 30-year A1/A+ bonds, up from $3 billion, via a private placement.

Looking ahead, AXA priced $900 million of A2/A- -rated 30-year subordinated bonds, up from $750 million, at 300 basis points over Treasuries on Friday. It is slated to conclude both a euro and a sterling tranche, for roughly the same aggregate amount, probably on Monday.

Tuesday or Wednesday will see Freddie Mac launch a $4 billion reopening of its 6.875 percent 10-year reference notes. The notes, which were originally issued in September, will have $10 billion outstanding following the reopening and will constitute “the largest non-sovereign U.S. dollar issue in history,” according to a Freddie Mac announcement.

But if funds may be relatively easy to come by in the higher quality segments of the capital markets, everything else still a proving to be a lot more difficult, if at all possible.

Equity Underwritings

IPOs, which have been hit especially hard by the Nasdaq decline, are increasingly being postponed or scratched altogether.

Last week saw no new IPOs filed while several were pulled.

Only three are known to be in the pipeline for this week:

  • Cellomics (CLMX), a biotech based in Pittsburgh, will offer six million shares via Prudential Securities at a price range of $11 to $13 per share.
  • GenVec (GNVC), another biotech (based in Gaithersburg, Md.) plans four million shares via JP Morgan at $14 to $16 apiece.
  • Resources Connection (RECN), a former Deloitte & Touche consulting subsidiary with more than 1,750 employees, plans to hit the Street with 6.5 million shares via lead CS First Boston at $12 to $14 a share. The firm is based in Costa Mesa, Calif.