ECB set to become long term fixture in corporate bonds
The European Central Bank opened its wallet again at the end of 2019 and started buying corporate bonds, but its largesse is a shadow of what it was. With inflation still a long way below target, it is expected to ramp up its buying in 2020
Europe’s high grade companies had plenty of time to prepare for the second bout of quantitative easing from the European Central Bank after it floated the idea over the summer of 2019.
But the market was still surprised at the early pace of the second Corporate Sector Purchase Programme. Many had forecast that the ECB would follow what it had done before, and spend about 10%-15% of its Asset Purchase Programme on corporate bonds, with the whole APP now to run at €20bn a month. But the ECB came out swinging, buying around €2.8bn of bonds in the first days of November.
Market participants make confident predictions for the ECB in 2020. “The rationale is there for more stimulus, with the ECB’s 2021 inflation forecast at only 1.5%,” says Matthew Bailey, European credit strategist at JP Morgan in London.
This is some way off the ECB’s target inflation of “below, but close to 2%”. One way to bridge the gap between target and reality is to buy more bonds. Some estimate it would take around €600bn of purchases to achieve every 0.1% rise in inflation. Though getting inflation to the 2% target this way is impossible — it would take €3tr of asset purchases to move the dial the 0.5% — there is clearly room for the APP to grow.
Market consensus has the APP increasing early in 2020, so that the CSPP expands to around €3.5bn-€4.5bn a month.
“They are also undertaking a strategy review,” says Bailey. “Our expectation is they are going to formally codify a symmetrical 2% target, rather than the ‘below, but close to, 2%’ target they have now, so they need to do more.”
A symmetrical inflation target would tilt the ECB further towards trying to raise inflation.
Get used to tightness
The ECB, then, is likely to be a long term fixture in the corporate bond market. This is a good sign for issuers wanting to print debt anywhere along their curves.
“We are positive and bullish on credit markets and conditions in general,” says Giulio Baratta, head of investment grade finance at BNP Paribas in London. “Companies are using the market wisely, taking advantage of lower rates. At short to medium terms you get lower coupons, and borrowers have been taking advantage of the very long end, which is very open in Europe. That is a comforting signal.”
The short end can suffer when the ECB becomes a bond buyer, as spreads and yields compress so much that issuers cannot find anyone to buy their short dated debt. This is a particular issue for very highly rated issuers, such as sovereigns, supranationals and agencies or the rare triple-A company.
But even though corporate spreads have moved in about 70bp from their widest point in 2019, and will probably tighten another 10bp in 2020, Bailey at JP Morgan says the market expects the short end of the curve to remain open to issuance. In the second half of 2019 the level of the corporate short end was determined more by ultra-low swap rates than ECB munificence, but this trend was easing up at year end.
“The push towards zero [percent yield] was helped a lot by the very fast decrease in swap rates in the latter part of July and August,” says Baratta. “Around four to five years was the sweet spot for a triple-B frequent borrower to target the 0% yield space. In the past 15 days, swap rates on five years is -17bp. It got to -28.9bp a few weeks ago.”
With 0% yields at the short end and issuers able to stretch out their euro curves, it would be logical to think that investors could at least expect to pick up a concession over the secondary market for buying new issues. Logic tends to vanish, however, when there is a buyer like the ECB warping techincals. Investors may find few of the bargains they can usually pick up around swings in the market.
“During periods of weakness, primary markets shut down or slow substantially,” says Bailey. “CSPP will buy more in secondary as there is less available in primary. That helps prevent spreads going much wider, but it creates an element of removing first seller advantage [for an investor selling ahead of the crowd] when the market starts to turn [negative].”
He adds: “New issue premiums will move towards zero or slightly negative as there is so much liquidity in primary.” GC