|
 Little over a week after the ECB launched its 1 trillion euro
'quantitative easing' campaign, financial markets are fretting that
there is a shortage of bonds for the central bank to buy.
This has created a hiatus in the plumbing of the global financial
system that's seen bond yields and long-term interest rates vanish
across the spectrum and move deeply negative in some cases,
especially benchmark German bunds.
ECB officials insist this 'scarcity', rather than shortage, is a
deliberate part of QE and forces down yields on the lowest risk
bonds in order to push banks and investors into riskier lending more
useful to the economy.
But the stimulus to cash flows around financial markets rather
through the high streets has been far more seismic.
"ECB QE will not have a significant effect, at least in our view, on
the real economy - but it is having a massive effect on financial
markets," said Phil Poole, head of Research at Deutsche Asset &
Wealth Management.
"There is clearly a distortion in the market which is leading
investors generally to take more risk or buy less liquid assets in
order to generate a return."
Some experts beg to differ with the ECB and say a growing shortage
of top-rated bonds, particularly AAA-rated German bunds, is playing
havoc with the way the financial system generates money within
itself by the pledging and re-pledging of top quality bonds as
collateral in return for cash.
Any shrinkage of this securities lending market, a giant
moneyspinner with 5.5 trillion euros outstanding in Europe alone,
has been a concern ever since the global credit crisis and
subsequent regulation cut the range of bonds and counterparties
involved, and limited the amount of times bonds are typically
repledged for cash.
For example, a drop in the re-use rate of collateral in this way
from about 3 times to 2.4 times over the four years after the crisis
involved an evaporation of $5 trillion in the cash generated by
banks, according to IMF estimates.
The concern is that QE, by draining markets of the top-rated
collateral itself, has a similar effect and offsets the intended
injection of new cash into the banking system.
As a result, the ECB's 1 trillion euro cash creation could be
dampened by the net removal of bunds and other government bonds that
can raise more than twice their face value in cash via repo markets.
DEEPLY NEGATIVE
The particular squeeze on the benchmark German bund market from the
ECB buying plan, which according to its so-called 'capital key'
formula targets more bunds than the likes of Italian or Spanish
government bonds, has driven yields on about of a third of euro
government bonds into negative territory.
JPMorgan analysts estimate that as ECB kicked off QE last week,
almost 4 percent of 4.6 trillion euros of government bonds between
the targeted 2 and 30 year maturities - and as much as 20 percent of
the 800 billion euros of German bunds in this area- had negative
yields greater than 20 basis points.
[to top of second column] |
Given that the ECB is not even able to buy bonds with negative
yields any larger than 20bp, then the skew in supply and demand is
pretty obvious and yields on longer-term bunds have sunk further too
on the assumption that the shorter-term paper is already too
negative to be eligible for ECB bond buying.
"The stock of bonds eligible for ECB purchases is diminishing as a
result of the price action, a self-reinforcing but unstable
dynamic," Goldman Sachs economists told clients.
Driving this is the fact that, unlike the Fed's QE program, the ECB
will be buying more euro governments bonds than the amount of new
bonds being raised by euro capitals over the period of the
purchases. Barclays estimates the overall effect will be to remove a
net 560 billion euros of government bonds from investors, or shrink
the market by that amount.
Claiming German bund market liquidity dried up considerably last
week, the JPMorgan analysts wrote: "The ECB not only creates
scarcity of one form of collateral versus another but it also
creates shortage of collateral by replacing high efficiency
government bond collateral with lower efficiency cash collateral."
The ECB has said it will lend back key securities to the market if
stress occurs in particular areas of the bond market, but analysts
reckon this would likely involve the exchange of one scarce bond for
another and not change the collateral pool materially. Few expect
the ECB to cut its campaign short either, at least not in the
absence of it getting inflation back to the 2 percent target early.
Perhaps the effect of pushing banks and asset managers out of such
deeply negative yields into long-dated and riskier debt, equities
and even foreign bond markets - hence weakening the euro - may
simply be seen as the main prize. The near 25 percent drop in
euro/dollar since the middle of 2014 shows that's well on the way.
"The principle impact on the real economy is through the exchange
rate and that's what we are seeing," said Poole at Deutsche AWM.
(Additional reporting by Nigel Stephenson; Graphics by Vincent
Flasseur; Editing by Tom Heneghan)
[© 2015 Thomson Reuters. All rights
reserved.] Copyright 2015 Reuters. All rights reserved. This material may not be published,
broadcast, rewritten or redistributed. |
