The European Central Bank has not responded to rumours that it is considering reinstating its covered bond purchase programme, which expired in June last year. But the market has rallied on the fact that it has not been denied.
Banks’ wholesale funding markets clearly need a kick-start — there have been no deals in senior for three months and although the covered bond market saw three trades on Tuesday morning, all were defensive.
Last time the ECB bought covered bonds a rally in their spreads quickly led to a similar trend in senior, and the pricing differential between the two asset classes tightened sharply.
But this is not 2009. The macroeconomic background is more negative than ever, and deeper regulatory concerns around senior unsecured, such as bail-ins, mean that this time around any such recovery is likely to be muted at best — and definitely slower to take hold.
So why focus on covered bonds, where there is still demand, where there is still a market? Senior unsecured has been out of reach for banks for much longer than the sporadic covered bond market has remained closed. From a market perspective, it could be far more helpful for the ECB to buy senior FIG debt, which is the source of much of the malaise affecting bank finance.
History shows that when central banks start buying something, that something tends to trade well. And if the senior market improved, the covered bond markets would likely follow. By contrast, there is always the chance that the benefits of ECB intervention in covered bonds might not filter through to senior.
Such a move would further push the ECB’s remit beyond its day job of monetary policy and maintaining price stability, and would be a step beyond the already extraordinary Securities Market Programme. Clearly the ECB prefers to buy securities with at least some collateral attached but the question could be asked whether taking senior paper from the strongest banks is really too risky.
Buying covered bonds could lead to a deluge of liquidity in a parched market. But at times like these, grand gestures are needed. If it is the ECB’s place to do so, it must go the whole hog and restore confidence in senior unsecured, rather than settling for a slice in the form of covered bonds.