Ahead of the meeting, there was a lack of consensus among market participants as to what the ECB would announce. Some said the central bank would announce a new round of bond buying of €20bn-€60bn for a period of nine to 15 months. But others thought it would hold back until next year.
Instead, the ECB announced that net asset purchases would restart at a pace of €20bn per month from November and were intended to “run for as long as necessary to reinforce the accommodative impact of its policy rates, and to end shortly before it starts raising the key ECB interest rates”.
It said reinvestments of the principal payments from maturating assets purchased under the ECB’s previous quantitative easing programme would continue “in full, for an extended period of time past the date when the Governing Council starts raising the key ECB interest rates, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation”.
The ECB has also extended the possibility of buying assets with yields below its deposit rate to all parts of its asset purchase programme. Previously, this was reserved for the ECB’s public sector bond buying.
There was no detail provided on what type of assets the ECB would buy. However, at the press conference, president Mario Draghi said they would “by and large be the same as the purchases in the past”.
The ECB also updated its forward guidance on interest rates “to remain at their present or lower levels until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within its projection horizon, and such convergence has been consistently reflected in underlying inflation dynamics”.
“In our view, linking the length of the asset purchase programme more directly to interest rates and omitting a more defined time horizon is a significant move,” said Marilyn Watson, head of global fundamental fixed income strategy at BlackRock, in a note.
At the press conference, following the meeting, Draghi said there were three elements that prompted the ECB’s decision: a greater protracted slowdown in the eurozone economy than expected, the persistence of downside risk from trade tensions and geopolitical risks, and a downward revision in projected inflation.
Draghi said that there was “full agreement” on the need to act, but some members of the Governing Council had been cautious about whether to act now.
Rates rally, but not for long
There was little movement in core and peripheral eurozone bond yields in the run-up to the meeting, with the 10 year Bund trading at minus 0.55% and 10 year BTPs at 0.98%.
But immediately following the announcement, the yield on the 10 year Bund dropped to a record low of minus 0.64%, while the 10 year BTP dropped to 0.81%, also a record low.
“Overall the market is positively surprised,” said a head of public sector debt capital markets, commenting on the rally.
But the rally in eurozone government bond yields did not last, as market participants began to question the details of the ECB’s stimulus package.
Later on Thursday afternoon, the 10 year Bund rose to minus 0.5%, the highest level since early August, while the 10 year BTP rose to 0.9%.
Yields also rose in the long end, with the 30 year Bund rising to minus 0.01%, after dropping to minus 0.12% earlier in the day.
“We are still discussing internally what this means,” said a syndicate banker. “Nothing is set in stone.”
“The ECB has yet to confirm the details of the composition of the new asset purchase programme, and it is unclear for now whether the ECB has decided to change issuer limits,” said Rosie McMellin, fixed income portfolio manager at Fidelity International. “These details will be crucial in determining how much room the ECB has to increase net asset purchases further at a later stage, if economic conditions continue to disappoint.”
Some market participants also said the €20bn per month of QE was not enough.
“Maybe at first glance €20bn a month is a little on the low side, and maybe the market was expecting a little more,” said a head of SSA syndicate.
Some market participants were expecting as much as €60bn a month of QE.
Others also questioned the size of the rate cut.
“The fact the rate cut was only 10bp seems to have pushed people out of the front end of the yield curve,” said a bond banker.
In the weeks leading up to the meeting, some had been expecting a rate cut of 15bp-20bp.
SSAs spreads to narrow
Nevertheless, bankers and analysts expect SSA spreads to narrow across the board.
“I expect SSA spreads to tighten but we need to see some more trading in the secondary market before assessing the impact,” said a head of public sector debt capital markets.
In a research note published on Thursday afternoon, analysts at Nord/LB said they expect supranational issuers to experience the “strongest spread narrowing” in the range of 10bp.
It will not be long before issuers test out the new environment, with market participants expecting a surge of supply in the euro primary SSA bond market next week.
“I expect a busy week in the euro market,” said an SSA debt capital markets banker. “We need either KfW or the European Investment Bank — or even both — to reopen the market and come and set the tone for the others.”
KfW and EIB are the two largest borrowers in the euro SSA bond market, with funding programmes of €80bn and €50bn in 2019, respectively.
Speaking to GlobalCapital on Wednesday, Petra Wehlert, head of capital markets at KfW, said they would “wait to see” how the ECB meeting would unfold before deciding “whether to be active in the euro market next week or in the near future”.
In addition to tighter spreads, Austrian export credit agency, Österreichische Kontrollbank, will also benefit from now being eligible for the ECB’s PSPP.
OeKB was added to the ECB’s list of eligible agencies under its PSSP on August 5.
“Whether we do more euro benchmarks will depend on what the yield curve looks like, and of course on the all-in cost of funding in comparison with other markets,” said Anish Gupta, managing director, treasury at OeKB. “At the moment, you need to go pretty far out on the curve to issue with a positive yield in the euro market.
FIG and ABS concerns
With the ECB having made the terms of a third series of targeted longer-term refinancing operations (TLTRO III) longer and cheaper, market participants expect there will be less need for banks to access the market for covered bonds, senior debt and asset-backed securities.
Delegates at the European Covered Bond Council and Euromoney’s Covered Bond Congress on Thursday said that a lack of supply would help spreads tighten even further in the asset class.
Timo Boehm, a portfolio manager at Pimco, said he had been concerned that banks would not have taken up TLTRO III if the ECB had been offering only two year funding at the rate of its main refinancing operations plus 10bp.
But he said that more banks would be able to benefit from the ECB’s newly announced terms: three year funding at the level of the main refinancing operations rate.
Market participants did, however, have some concerns about what impact the TLTRO, and the ECB’s broader package of measures, might have on market liquidity.
With less supply in the market, investors expect to find it harder to source bonds. This could be exacerbated if bank treasury investors, traditionally big buyers of covered bonds, end up scaling back on their holdings in the asset class.
This was noted as a possibility at the Covered Bond Congress on Thursday, given that the ECB will be offering banks 0% interest on some of their excess deposits to mitigate the impact of negative rates.
Covered bond investors feared the introduction of tiering could incentivise bank treasuries to switch out of covered bonds for a better rate in ECB deposits.
Meanwhile, participants expect ABS issuance to dry up following the TLTRO package as banks are given access to an easy source of funding.
“It is more than certainly I was expecting,” said Gordon Kerr, head of DBRS. “I would say it is disappointing from a securitization and even from a covered bond perspective.”
An investor said that the announcement “does mean less supply from the more established banks” as the TLTRO package means funding is more easily accessible.
“It is very much a supply shock in terms of lowering [ABS] supply,” said the investor.
“You have central bank funding playing a large role in encumbrance levels in some countries, largely through retained securitizations, so you will still see those markets maintaining that central bank support and not coming to the market for funding,” said Kerr.
The QE package will also dig into the supply of deals qualifying for the new ‘simple, transparent and standardised’ (STS) regulatory framework which went live on January 1, 2019, and has seen only €3.2bn worth of issuance as of September 11.
IG corps underwhelmed
In investment grade corporate bonds the market seemed satisfied, with credit spreads tightening. The IHS Markit iTraxx Europe main CDS index dropped 4bp to 45bp, compared with Wednesday.
However, corporate bond bankers weren’t convinced the ECB’s announcements were that radical a shift.
“I am not sure if minus 50bp is a game changer,” said one of the deposit rate. “Our economists mentioned something like minus 60bp, which would be a surprise.”
He added that the €20bn promised by the central bank each month looked a bit small compared with the amount of overall corporate bond issuance recently.
“If you see what has been printed in the past three weeks it has been over €50bn,” he said, “I am not sure whether this is the big bazooka, or a little knife being brought to a gun fight.”
The banker added: “The positive is it [removes] speculation, but I’m a little bit surprised they will start doing it in November. It looks a bit like rushing, but maybe it’s my personal interpretation, as I thought they would be set on January 1.”
There was also some scepticism that the ability for the ECB to buy negative yielding corporate bonds below the deposit rate would shake things up much. “It might help credit spreads tighten a bit, but they are still at about their five year average,” said one portfolio manager.
He added that corporate bond issuance was also unlikely to change much. “There’s a really strong pipeline, and quite a few opportunistic issuers came ahead of today. I think it will carry on a bit like this, and then it will die off as it does seasonally, anyway, towards the end of September.”
EM divided
EM bankers are divided on the effect that the ECB announcement will have on issuance plans for natural euro funders in their region.
One syndicate banker in London who called the moves “overall neutral to positive, though not ground breaking”, said that he expected the announcement to kick-start euro issuance from the region, even though he felt it was too early to tell the full effect of it.
“There will be more euro deals now, for sure,” he said. “Not because the ECB was amazing, but because some people were waiting for that to get out of the way.”
But an EM DCM banker disagreed. He saw the ECB’s moves as more dovish than projected. Though the stated €20bn a month asset purchases were lower than the €30bn he had expected, he said the lack of an end date for the buying far outweighed the smaller number.
However, even though he saw the ECB’s move as positive — and said that the parts of EM most directly affected by the ECB moved around 10bp-15bp tighter on Thursday as a result — he did not expect this to be a trigger for EM borrowers wanting to print in the currency.
“Most of it was already priced in,” he said. “The market was so bulled up that, in fact, what we saw in the corporate investment grade market was that people were worried that the ECB meeting wouldn’t deliver so were funding ahead of it.
“If the ECB had disappointed, the effect would have been disastrous. We haven’t really seen that in EM, but I think that’s just down to lack of appetite and low funding needs in the currency. Borrowers in the CEE region just do not have a lot of funding to do, though we might see some pre-funding for next year.”
Most EM borrowers fund in dollars. Therefore, a weaker euro would make funding in the currency more expensive for them, if they were to swap the proceeds back.
“It makes Reverse Yankees a lot less attractive again,” the DCM banker said, “which is how a lot of EM issuers use euro funding. It has put up a much bigger barrier between the dollar and euro markets.”
HY and CLO boost
Meanwhile, the high yield bond market is hoping to reap the benefits.
“The central banks becoming more accommodating again increases the desire for people to invest in assets that generate yield,” said a syndicate banker. “So, it’s a very good time for new issuers to come to the market.”
The high yield market has already seen coupons that are usually the preserve of investment grade issuers. Packaging company Smurfit Kappa recently issued an eight year €750m bond that pays just 1.5%. Negative yields in the IG primary markets are, however, unlikely to spread to the speculative grade markets any time soon.
“Maybe the best companies could do it now if they issued a two-year bond with no calls but we tend not to see those,” said another syndicate banker. “Unless there’s a CFO interested in doing this type of scientific experiment, I don’t see it happening.”
In the CLO market, the announcement is set to be a boost for a sector that has seen increased investment owing to the prevalence of Euribor floors included in the majority of deals.
The number of managers opting to refinance or reset CLOs has been increasing over the summer. This number is likely to rise as rates sink further below the Euribor floor.
“Refis should become very attractive to some of the issuers,” said the investor. “I think it would make sense for CLO supply to increase in the coming six weeks or so.”
“I hope from a securitization perspective that things continue to come to the public market and that STS overpowers the ECB’s actions,” said Kerr.
‘Good outcome’ for equities
“That was a good outcome for the market overall,” said a senior equity capital markets banker in Paris. “I think it should on the one hand help things, but on the other it’s worrying because it indicates that the European economy isn’t doing very well.
“The ECB cut its growth forecasts and cutting rates indicates that it thinks the economy needs a stimulus, but the markets have taken it as good news. The whole turning Japanese theme — aside from the fact that it is a great song — is something that is happening to the European economy.
“It is a little worrying as savings for retirees depend on fixed income assets, so it’s not great, and it also creates asset bubbles. It creates downside risks and unintended consequences, so we will have to see how those crop up in the coming years. But right now people want to party like it’s 1999.
“People have to look for yield somewhere, so for equities there is a lot of upside. High yield bonds and equities will be two of the biggest beneficiaries.”
“A year ago people thought going below minus 100bp was only acceptable in extreme situations, whereas now it is becoming the new normal,” said an equity-linked bond banker. “Our market has digested that, but how deep it can go is to be determined. Equities going up further may balance it out.”