Over the last eight years the ECB, through its Asset Purchase Programme, has provided an era-defining bid for euro-denominated bonds, making the currency a natural choice for European benchmark bond issuers looking for where best to fund.
As QT replaces QE in Europe and geopolitical pressures drive a search for security a US dollar bond market offering term interest rates not seen for over a decade has become increasingly attractive for investors – and borrowers.
“We’re at a turning point in terms of funding,” said Petra Wehlert, KfW’s head of capital markets. “With the ECB being an active buyer, attractive euro swap spreads and the basis swap from US dollars moving against us, it was obvious for issuers like KfW to move its funding strategy in the last years more towards the euro market. But since the middle of this year, we see the market turning and the dollar market becomes more and more attractive.
Dollar relations
KfW is one of the few benchmark issuers from Europe with a well-established relationship with the dollar bond market. Registered with the SEC since 1988 and providing comprehensive transparency through its 18-K filing, it has access to a broad US domestic investment community. It is also seen as a safe and natural asset for those international investors needing to hold dollars as a reserve currency.
It introduced its dollar benchmark programme in 2002, a year after its euro benchmark programme was established, committing itself to issue large transactions in both currencies on its way to achieving a borrowing target of around €85bn-equivalent per year.
“Historically, the dollar market was a win-win for us,” said Wehlert. “It gave us access to international investors, we could launch deals in big size, and it provided good post-cross currency swap funding.”
The attributes that made the dollar market important to KfW’s funding programme in the past are returning.
Despite an ongoing reassessment of its position as the dominant global trading currency, the IMF reported that the dollar still accounted for 58% of official reserves in Q4 2022, so there is a natural bid for paper from central banks.
“We also see bank treasuries and asset managers increasingly participating in our dollar deals,” said Wehlert.
In September, it issued a US$5bn 4.625% three-year bond at mid-swaps plus 25bp. Banks bought 48%, central banks 36%, and asset managers 12%. European investors took 52% of the deal, America accounted for 35%, and Asia for 12%.
“It’s the dollar market that makes KfW truly international,” said Wehlert. “We had about 200 investors in the deal and that’s a big book – much more than we’ve seen in the last order books in the euro market. It shows the growing strength of demand for dollar assets.”
Performance pick-up
The pick-up in interest from dollar investors is also a result from the performance of KfW bonds in the secondary market.
“All our dollar bonds have performed well, whereas the euro market has weakened,” said Wehlert, “It’s another indication of us reaching the turning point in sentiment.”
That’s not to say the euro market isn’t functioning. More, it marks the end of a period when the euro was a focus of attention for KfW and its peers.
“We’re already seeing smaller books in euros while dollar books are getting larger and deals are performing well in secondary,” she said.
A change in investor behaviour provides KfW with a greater degree of flexibility in its funding.
“Euros and dollars together represent 80% of our funding programme but we do not really have specific targets for euros, dollars or any other currencies,” said Sven Wabbels, head of public funding at KfW. “We carefully monitor the market and issue where it makes sense to do so.”
Monitoring the market, particularly during times of interest rate volatility and without the support of QE-related central bank buying, entails greater direct interaction with investors.
“Without central bank intervention, every issuer has to make more effort with their investor base,” said Wabbels. “It’s a changing environment, but it’s a healthy one. We have regular contact with an established investor base and that will benefit us in the future.”
That approach was enhanced in recent years when KfW intensified its investor relations work worldwide – including in the important US market.
“We are well covered by the big investment banks, but it’s important for us to have direct contact with investors,” said Wabbels. “We have a strong investor relations team, which has grown in the last two years, and we have closer contact and closer communication with investors so as to better react to changing market conditions.”
Candid interaction allows KfW to better understand the needs and interests of investors. This understanding is crucial as, with every transaction, the bank’s reputation as a borrower is at risk. The feedback received from investors guarantees that the most suitable product is chosen at the right time.
“Our relationship with KfW allows us to provide clear and transparent feedback regarding pricing, curve points and market colour,” said Sukhdeep Sambhi, portfolio manager at Wellington Management. KfW and Wellington, a significant investor within the SSA landscape, have had a longstanding mutually beneficial relationship, during which the investor has provided liquidity to KfW through its benchmark primary transactions and reverse enquiries.
“We value the dialogue between the institutions,” said Sambhi. “And we look forward to growing this relationship in the coming years.”
Innovation
Responding to a new market dynamic, however, will not see KfW changing from its traditional approach to the market. Its benchmark bonds will largely be targeted at the deep, fixed-rate investor base and focused on the customary three and five-year maturities, alongside the two-year point on the curve, where it can raise large volumes.
“Floating-rate issuance might be an option and there might be some innovation on maturities,” Wehlert said. “We potentially look at the seven-year and we’ve already had great success with our first 10-year dollar benchmark in five years.”
The US$4bn issue, which priced in July at 45bp over mid-swaps, attracted more than US$10bn in demand. It won’t herald a focus on the longer end of the curve for future dollar issuance as its target average duration is between five and six years and assets on its loan book do not need balancing with long-dated liabilities.
“The 10-year is always a prime product for us,” said Wehlert. “Investors want a liquid bond, a safe asset and a reliable issuer. With KfW, they know what they are getting and that’s more important than being innovative for the sake of it.”
As a systemically important issuer, KfW is set to continue with its flexible funding approach in the strategically important euro and dollar markets, providing investors with accessible and liquid benchmarks along the curve. That approach will ensure its ability to deliver funding in size at any required moment.
Sven Wabbels
Petra Wehlert
