ECB commences covered bonds amid intrigue

Solomon Teague
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The ECB commenced its covered bonds purchasing programme last week, but no sooner had it started than rumours surfaced about a new plan to purchase corporate bonds. The fevered speculation demonstrates the lack of confidence in the ECB's existing plan, reviving questions about full-scale QE and its seniority in bond holdings.

Speculation that the European Central Bank (ECB) is considering extending its asset purchase programme beyond its originally intended scope of covered bonds and asset-backed securities (ABS), to include corporate bonds, triggered downward pressure on the euro this week.

The speculation seemed to underline persistent doubts in the market that the ECB's existing, official plan would be sufficient to stoke inflation in the eurozone, and deliver growth. 

The covered bond purchase programme officially launched last week, with reports suggesting the first acquisitions were made of Spanish, German and French covered bonds, while ABS purchases are expected in December. 

The impact on peripheral debt levels was negligible at best, with Italian, Spanish and Portuguese 10-year yields rising by 10 basis points, 9bp and 18bp respectively. German and US 10-year yields fell slightly.

"The move to buy corporate bonds could be justified on the basis of increasing the universe of assets that the ECB could buy to expand its balance sheet," says Abhishek Singhania, European interest-rate strategist at Deutsche Bank.


There is at present €1.1 trillion of non-financial and €7.9 trillion of financial corporate debt issued by euro-area residents, says Singhania, encompassing all forms of debt securities across the risk spectrum. 

"Even if we limit ourselves to non-financial corporate and bank debt, which the ECB currently considers as eligible collateral for its repo operations, the universe of bonds would amount to €3.6 trillion," more than tripling the size of the programme implied by the ABS and covered bonds purchase programme.

At first glance the furore suggests the ECB doubts the effectiveness of its existing ABS and covered bonds purchase plan, making full quantitative easing (QE) look more likely in the near term.

And it would not be the first time the ECB has articulated plans for a programme that appears to supersede its existing initiatives: its plan to buy ABS and covered bonds was announced before the targeted long-term repo operations (TLTRO) had been launched, and the purchases themselves began this week before the conclusion of the asset quality review and stress tests.

"This insistence on putting the proverbial cart before the horse fosters an environment that lends itself to speculation of even more measures," says Brown Brothers Harriman in a research note.

Other analysts suggest the speculation says more about the political difficulty the ECB envisages with sovereign bond purchases than a real desire to buy corporate bonds. The counter-intuitive interpretation is therefore that the news makes the prospect of sovereign bond purchases more remote.

Corporate bond buying

However, many observers dismissed the possibility of corporate bond buying as either a non-starter, or at least unlikely until the existing programme has been given a chance to work.

If the ECB believes sovereign debt QE is politically difficult, purchases of corporate bonds is one of its few options for expanding its existing programme. However, given that programme has barely got under way, it seems premature to plan its extension, says Derek Halpenny, European head of global markets research at Bank of Tokyo-Mitsubishi UFJ.

However, for traders looking for any evidence of action from the ECB to revive growth, especially in the aftermath of the market panic of last week, it was enough to generate considerable activity. Investors were clearly asking themselves if the widening spread between core and peripheral Europe had increased the prospect of imminent European QE.

Opinions on this were divided, with the falling euro suggesting many thought the answer was yes – either in the form of sovereign purchases or via some other alternative scheme. However, Société Générale (SG) argues the policy response to sovereign stress as experienced last week is more likely to come from the European Stability Mechanism, backed by the outright monetary transactions, rather than from QE.

If the ECB begins buying corporate bonds, it will be exposing itself to new risks. 

"Spreads on corporate bonds are already very tight and many liken the latest price action in eurozone credit market to a developing asset bubble," says Petr Krpata, FX strategist at ING. 

"Purchases of corporate bonds would expose the ECB to credit risk, while the bank may want to wait for the results of the second TLTROs take-up in December before making such a decision."

For some, the idea that the ECB is even considering buying corporate bonds only highlights the political difficulties it envisages in executing full-blown QE. The most obvious problem is the considerable divergence that exists in the credit quality of different eurozone sovereigns.

However, other problems also exist. When the ECB implemented the Securities Markets Programme, it was senior to private holders. When Greek debt was restructured in the private-sector involvement programme in March 2012, the ECB holdings were therefore excluded, increasing the losses borne by private investors.

"If credit risk no longer matters in the euro-area, then it can reasonably be argued that whether the ECB conducts QE on a pari passu basis or not is of little consequence," says Michala Marcussen, global head of economics at SG CIB.