The Daily Update - New issues, scandals and the Fed

As Volkswagen’s litigation nightmare ensues, Norway’s sovereign wealth fund (the largest in the world, at USD 850bn) announced earlier this week that it is looking to sue the company over the emissions scandal. According to the FT, as one of the largest VW shareholders, Norges Bank Investment Management is to seek compensation by joining one of the class-action suits being prepared in Germany; having suffered hundreds of millions worth of losses resulting from the scandal.

Since the emission scandal broke out in September last year VW has put away ~EUR 16.2bn to cover the scandal costs. As such, Volkswagen Finance (China) Co., Ltd. turned to the renminbi bond market to issue its first bond to Chinese investors; a 3.6% three-year deal totalling RMB 2bn (EUR 270m). Rated AA+ by China Chengxin Rating Company, the issue was 2.2 times oversubscribed. We have never held any VW credit within our portfolios mainly because we do not believe the bonds offer much value; the USD 2.4% issue maturing in 2020 for example has a risk-adjusted expected return and yield of only 4% (the yield element is 2.8%) and only 1.3 credit notches of protection, if we use the higher rating of A3 by Moody’s.

Another surprise deal was the fourth-largest bond offering in history, by Dell on Tuesday. With $85bn of reported orders, the total issue size was boosted from $16bn to $20bn and made up of 6 tranches. Rated Baa3 by Moody's, the only non-callable bond issued is the 3.48% maturing in 2019 which currently yields 3.12%. According to our proprietary Relative Value Model, the bond is currently trading at a “fair value” spread of ~200 bps over Treasuries with no credit notch uplift; this just goes to show just how desperate for yield some investors are.

We would rather hold Baa3 rated state-owned-and-run development bank, VEB 5.942% 2023 which has been one of the best performing bonds so far this year; having rallied almost 15 points off the January lows, to yield ~5.7%. The Baa3 bond remains attractive, offering a far superior risk-adjusted expected return and yield of 14.6% with 2.3 notches of credit cushion.

Away from the excitement of the new issue market, the dated FOMC minutes from April’s gathering were released yesterday and erred on the hawkish side. Recent Fed rhetoric, where members have stated that anywhere between 2-3 rate hikes are possible this year, clearly indicate that the central bank is keeping the rate hike door wide open, allowing it the optionality to pull the trigger at any meeting. With further mixed US economic data out this month (May’s Empire Manufacturing reading plunged into negative territory which means a weaker ISM reading, for example), we are not quite sure how the central bank will manage this aggressive, not “gradual” path to normalisation, as we believe current economic conditions both domestic and global do not warrant a rate hike especially at June’s meeting.