The European Central Bank now holds more than €1.5tn of assets, which it has bought as part of purchases designed to kick-start the continent’s economy. Late last year, it announced it would extend purchases at the end of March, albeit reducing the rate from €80bn to €60bn a month.
The scale of these purchases has dominated prices in credit markets across Europe, from government debt to covered bonds. But how have European markets been changed by the ECB, and how will they react if and when its dominance begins to recede?
“There are not many debt markets that are not distorted in the euro area,” says Joost Beaumont, an analyst at ABN Amro.
Government bonds — €1.34tn
The majority of the ECB’s purchases have been in government bonds, which has helped force yields down and reduced the cost of borrowing across markets.
Investors have speculated over future decisions made by the ECB, which not only stand to influence yields on bonds but also on the eligibility of different types of debt instruments. In December, for example, the central bank announced it would lift restrictions on buying debt with yields below the eurozone’s deposit rate of minus 0.4 per cent.
The ECB purchases have brought the yields of different countries closer together, and a reduction in purchases will force the market to reassess country-specific risks, especially those associated with the rise of anti-establishment political movements, such as the Netherlands and France.
There are signs that issuer behaviour is also sensitive to ECB plans. Ahead of the reduction in purchases beginning in April, January was the busiest month on record for sovereign bond sales, according to Dealogic data.
Covered bonds — €228bn
Covered bonds, which are sold by banks and backed by pools of mortgages, date back to 18th century Prussia. For many European banks, they are a key source of funding for mortgage lending.
The ECB first announced it would buy covered bonds in May 2009. At the time, the motive was to stabilise European banks starved of funding in capital markets reeling from the financial crisis.
Two subsequent programmes were introduced, most recently in late 2014, where the motive switched to providing stimulus rather than preserving stability. So far, the ECB has bought €210bn of bonds under its third programme.
The ECB has now bought about 27 per cent of the entire covered bonds market, taking a big iBoxx index for the asset class as a proxy for the market.
Because the ECB has been buying covered bonds for so long, it has been subject to complaints of distortion for several years. The ECB buys in primary markets, when new bonds are sold, making it difficult for private investors to compete on price.
Analysts at ABN Amro estimate that the total outstanding covered bond market has effectively declined by €160bn over the past four years because of the quantity of debt now withheld by the ECB. This has reduced liquidity in the markets, which has compounded a broader retreat of investment banks from market-making over recent years.
“Investors have left the market, asset managers have left the market — we’ve reached a new equilibrium,” says Mr Beaumont.
Corporate bonds — €61bn
As with government bonds, ECB buying in the corporate bond market has encouraged investors to make decisions based on anticipating central bank policy.
At the beginning of 2017, investors weighed up the possible amounts of the reduction in purchases that would be made up by corporate bonds.
Analysts at JPMorgan this week, based on a comparison with the US Federal Reserve, suggested the ECB “will still be a very active participant in the market even once the net purchases have been tapered to zero, as it reinvests the proceeds from maturing bonds”.
This assumes the corporate bond-buying programme will grow to €150bn by June 2018, and that the ECB would subsequently make €15bn a year of reinvestments.
Bonds sold by financial institutions are not being bought by the ECB, and often come with higher coupons for similar ratings. As such, they are seen as a cheaper, attractive option by many investors. In the UK, investors have also focused on bank bonds, which are excluded from Bank of England corporate bond purchases.
Asset-backed securities — €23bn
Asset-backed securities, which consist of bundling payments from mortgages, credit card debt, car loans and other consumer credit, have been bought by the ECB since late 2014. This has been the most disappointing purchase programme, with the ECB buying a relatively small amount of bonds and failing to kick-start a flagging market.
However, the buying has still influenced investor perspectives, especially regarding the spread between bonds being bought by the ECB and securities outside of its remit, such as mortgage-backed securities in the UK.
As with financial bonds, one investor strategy has been to focus on the relative attractiveness of bonds not being bought by the ECB.
One of the most significant distortions created from bulk buying of government bonds and other high quality debt has shown up in Europe’s repo market, a key part of the continent’s financial plumbing. Government bonds are used as collateral for repurchase or “repo” trades — secured short-term loans between banks, investors and other market participants.
Because the ECB has bought so many government bonds, the availability of collateral has fallen sharply. This has coincided with rising demand for collateral, due in part to a host of regulatory requirements on banks. In turn pressure has increased within repo markets, pushing up the cost of borrowing bonds and prompting complaints from the industry.
The ECB launched in December a programme to lend out bonds it has bought, but as it continues buying more debt at a relatively high rate, even after April, a quick fix for the problem is unlikely.
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