For many periods throughout the last year the only buyer in the street was the European Central Bank, which bought as much as 75% of its €150bn in covered bond purchases in the secondary market. But since the end of last year, and so far this year, it has focused much more on the primary market and it has bought less overall.
In the latest reporting period it bought an estimated €114m per day in the secondary market, according to analysts at Barclays research. This is sharply down from the peak of over €700m per day seen this time last year and an average of €356m per day over the life of the programme.
Over the course of January as a whole it bought an estimated €7.2bn across both primary and secondary markets. This is well below the €11bn monthly average in the first half of the programme and more consistent with the overall amounts bought in November and December. The ECB could have bought much more if it had wanted to, as the market has been more active over these past three months than at any time since 2011’s supply peak.
The effect of the ECB’s scaling back has been palpable with spreads widening back to levels that real money investors have started to find interesting.
According to a research note from JP Morgan, secondary market widening affected all jurisdictions with core countries such as France moving 9bp wider, and Germany and the Netherlands moving out by 6bp each. UK paper, which never relied on artificial central bank support, has performed relatively better, widening by only 4bp during the month.
The ECB has however maintained its overall monthly rate of purchases under all programmes at around €60bn.
It has achieved this by buying more debt through the public sector purchase programme which was expanded to include regional public debt in December. Because of the ECB’s greater focus on public sector markets, covered bond spreads begun to look more appealing compared to government bonds, which has helped draw buyers back.
This phenomenon was particularly conspicuous in the €1bn seven year trade from BPCE, priced on Tuesday.
The deal offered a spread of 31bp over the French government, enough to entice a wide range of about 95 investors to get involved in the deal. The last time a French covered bond with a maturity longer than five years attracted this many investors was in February last year when the same borrower issued a €750m 0.5% October 2022 at 1bp over mid-swaps. Since then the number of accounts has consistently fallen and in the last five French covered bonds the average number of orders has been below 50.
This isn’t a one off either.
The ECB’s deliberate effort to scale back purchases has had boosted other recently issued seven year deals eligible for central bank buying from AIB Mortgage Bank and CaixaBank. Between them the three deals attracted over 300 orders.
That compares to the 30 investors seen in La Banque Postale’s seven year issued at the start of this year, 40 in Société Générale’s seven year issued a week later and 52 in Santander’s 10 year.
The spread widening has also provided some welcome flow in the secondary market. For the first time this year traders are reporting fairly decent two-way flows. If deals are being transacted on both sides of the market that should help lower the gap between bids and offers and make it easier for investors to execute. This creates a virtuous circle as more returning investors creates a deeper pool of liquidity.
But, for most of the past year liquidity has been confined to large and recently issued bonds from regions that are not affected by the covered bond purchase programme (CBPP3) and do not incur high capital charges, such as those from Nordic countries.
For the rest of the covered bond market offers have largely been determined by where the central bank was prepared to buy. And since its mandate was concerned only with quantitative easing, it was really only concerned with volumes not prices. In other words, the secondary market for ECB-eligible bonds was so distorted it was illusory.
Though matters have improved, it’s too early to say whether this rejuvenation will last long.
The central bank’s overriding mandate is to expand its balance sheet and if it starts to run out of public sector assets, which some analysts expect, covered bonds will again be in the firing line.
The ECB knows it chased investors away and it could do so again, but this week it showed it can also entice them back.