The covered bond market has had a good run, with some French five year euro benchmarks tightening by more than 35bp since their launch in early April.
Moreover, covered bond redemptions will double over the second half of the year from what they were in the first and, with issuers taking ample liquidity from the ECB's Targeted Longer-Term Refinancing Operations, supply forecasts have been cut by about €20bn, to about €110bn this year.
That leaves little more than €40bn to be issued over the rest of the year, of which the ECB will take at least half.
The market is still about 10bp wider than levels seen in early 2018, meaning there are hopes it may have further to go — particularly over summer when supply comes to a halt but ECB buying does not.
But following agreement of Europe's €750bn recovery fund this week, the EU is about to ramp up its bond market funding by hundreds of billions.
That supply deluge will take supranational and agency spreads wider, dragging covered bonds along for the ride.
And if the ECB improves deposit tiering terms this September as some bankers now expect — from six times banks’ minimum reserve requirement to 12 times — many more institutions will be able to deposit cash with central bank at 0% instead of buying negative yielding covered bonds, impacting on the demand side of the equation.
What had looked like a pretty convincing bet in May could be about to unravel.