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Covered bonds to lead FIG tighter

ECB 230x150 euro sculpture
By Bill Thornhill
19 Sep 2019

Although the European Central Bank (ECB) hasn’t said yet how it intends to split buying across the €20bn of net asset purchases that it plans on making each month, it is likely covered bonds will form an integral part. And if covered bonds tighten, that probably means much else will be dragged along for the ride.

The financial bond market has been reinvigorated with a series of deals this week enjoying a conspicuous improvement in demand as investors bet spreads will tighten when the ECB’s net asset purchases recommence in November. Demand was visible across a wide range of bonds including those that outside the central bank’s scope. 

The ECB buys up to 5% of primary covered bonds and this could rise to 25% along with a step-up in secondary market purchases. Yet, with supply likely to fall sharply from September’s brisk pace, a technical squeeze is in the making. 

Certainty of execution was concrete this week in the covered bond market compared to before the ECB wheeled out its latest monetary easing plans last Thursday, when yields were also lower. At that time a number of thinly oversubscribed Pfandbriefe attracted little more than 30 investors.

But this week, higher yielding covered bonds such as Liberbank’s inaugural €1bn 10 year enjoyed strong support, perhaps because dealers can now be confident they will be able to resell them. And bonds ineligible for the purchase programme, such as Met Life’s first negative yielding senior unsecured deal, NN Bank’s conditional pass through and UK covered bonds from Lloyds Bank and Virgin Money were also in high demand.

The only plausible explanation for this change is that buyers can bid with confidence knowing they have an out when the ECB opens up its wallet. They clearly think the whole market is going tighter. Yields may be low, but with spreads almost 20bp wider than their January 2018 nadir, there is still room for performance.

By Bill Thornhill
19 Sep 2019