Join +750K new investors every month who copy stock picks from billionaire's portfoliosSign Up Free

Sizing up QE2: How a new round of ECB bond buys might pan out

Published 27/06/2019, 15:34
Sizing up QE2: How a new round of ECB bond buys might pan out
BARC
-
DE10YT=RR
-
IT5YT=RR
-

By Dhara Ranasinghe, Virginia Furness and Ritvik Carvalho

LONDON (Reuters) - After this month's bombshell from Mario Draghi on further monetary easing, some investors are betting on a return to bond purchases by the ECB, with debate focused on what it should buy to make the most impact.

An interest rate cut is priced for September, and expectations that the European Central Bank will also launch another asset purchases programme - in which corporate debt will play a bigger role - has sent the iBoxx euro corporate bond index to record highs.

Asset-backed securities and covered bonds , have also soared in the past week while five-year bond yields in Italy (IT5YT=RR), also tipped as a major beneficiary of quantitative easing (QE), fell almost twice as much as Spanish, Portuguese, French and German counterparts on the day Draghi spoke.

One thing is clear: the ECB will have to think creatively, then act quickly and in size to generate traction. German 10-year bond yields, the euro zone's borrowing benchmark, are already at minus 0.3%. (DE10YT=RR).

"The ECB has to come up with something that wows the market. They need to provide more not less, be radical in terms of what they do and they need to be proactive in doing it," said Guy Miller, chief market strategist at Zurich Insurance Group.

(Graphic: The European Central Bank's QE programme link: https://tmsnrt.rs/2YgbrGJ).

Here's an indication of what is expected.

1. Sooner rather than later

Estimates as to when QE2 will launch range from October to the first quarter of 2020.

NatWest Markets expects QE to resume in October for six months, anticipating an announcement in September alongside a 10 basis point rate cut.

"Having already given the forward guidance for unchanged rates until mid-2020, the downside to strengthening that with asset purchases seems low to us," NatWest European rates strategist, Imogen Bachra, said.

Draghi's term expires in October and with one eye on his legacy, he could use that month's meeting to announce a November QE launch, said Jack Allen-Reynolds, senior European economist at Capital Economics.

2. Size matters

The ECB will likely kick off with monthly asset purchases of around 20-30 billion euros for six-12 months, three banks estimate.

In the first QE round, launched in March 2015, monthly purchases peaked at 80 billion euros in 2016, easing to 30 billion by December 2018 when the programme ended.

NatWest expects a six-month QE program worth 180 billion euros in total, while Barclays (LON:BARC) anticipates a 20-30 billion-euro monthly scheme starting in January.

ABN Amro though predicts a 630 billion-euro programme lasting nine months, so with purchases worth 70 billion euros a month.

3. Rewrite the rules

The ECB will certainly have to tweak its bond-buying rules. Currently, a "capital key" rule means the bigger an economy, the more of its debt the ECB buys. But it does apply 'flexibility' and will continue to do so, banks reckon. So QE2 could see it purchase more Italian, Spanish and French debt and less German paper.

Alternatively, the ECB could re-write the rules, one report suggests. It caps its holdings to no more than a third of each country's debt but raising this ceiling to 50% would allow new net purchases of up to 1.1 trillion euros before German paper becomes scarce, Berenberg estimates.

The issuer limit was designed to prevent the ECB from becoming a "blocking minority" and voting against any future debt restructuring proposals.

Under possible solutions being studied, this constraint may be circumvented by stripping central banks of voting rights.

(Graphic: ECB PSPP png link: https://tmsnrt.rs/2EfklfI).

Interactive version: https://tmsnrt.rs/2EgAulf

4. Keeping companies

The ECB owns around 178 billion euros in corporate debt, having added the category to its asset purchases in 2016 - only a small part of the 700 billion of eligible corporate securities and dwarfed by the around 2 trillion it holds in government debt.

That suggests company bonds could play a bigger role in QE2.

Allen-Reynolds at Capital Economics expects any new programme will be split 50/50 between public and corporate bonds, adding that increasing the share of corporate bonds could have a bigger market impact.

Buying corporate debt involves more risk, however. The ECB sold bonds from scandal-hit South African retailer Steinoff at a loss last year.

(Graphic: Frontloading a QE restart? link: https://tmsnrt.rs/2FEEjBo).

5. Buy...bank bonds?

A big question is whether QE might be expanded to include bank bonds.

Jeroen van den Broek, head of DM strategy and research at ING, estimates up to 305 billion euros worth of bank debt could be eligible for QE2 purchases.

However, buying bank bonds could be problematic because of the ECB's role as bank supervisor. Therefore it may not want to give the impression it is subsidizing the sector.

(Graphic: Could ECB QE target bank bonds? link: https://tmsnrt.rs/2ZRdCRl).

Latest comments

Risk Disclosure: Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.
© 2007-2024 - Fusion Media Limited. All Rights Reserved.