ECB largesse takes rocky road to redemption
Borrowers have learned some hard lessons from the onset of European QE as they attempt to remain relevant with historic investors while navigating ECB-induced distortions.
With all risk assets classes being battered by global volatility in the opening weeks of 2016, Europe’s SSA market proved to be one of the rare beneficiaries, owing its stability to the European Central Bank’s €60bn-a-month quantitative easing programme, which was the biggest event in Europe’s capital markets in 2015.
Massive order books for jumbo trades in January from eurozone sovereigns showed that primary deals are hoovering up liquidity, not just through the ECB, which typically buys around 30% of each transaction, but from a wider universe, particularly with the US markets suffering.
In February, Italy priced a €9bn 2.70% 30-year benchmark against an order book of €26.5bn. That followed a trio of eye-catching deals – Spain sold €9bn of 1.95% April 2026 bonds on a final order book of over €29bn, Belgium recorded its largest order book for a syndicated transaction since the 2008 financial crisis, while Portugal did its largest deal in at least half a decade. With expectations rising that the ECB will introduce further monetary policy easing in March, issuers are striking early.
“Investors see sources of uncertainty around the world and had been looking to Europe’s government bond markets as a flight to quality, or at least a haven of more predictability,” said Lee Cumbes, head of SSAR origination at Barclays.
It is a far cry from the situation last year, when one of the unintended consequences of the launch of the ECB’s QE programme was to trigger a dramatic tightening in the paper of those agencies included on the list against their respective sovereign curves.
Such distortions forced private investors onto the sidelines, bringing the new issue market to a near standstill, and forced issuers and syndicate managers alike to rethink their approaches. But a year later and bankers feel that lessons have been learned that will avoid a repeat of some of the pitfalls.
“The idea that QE would cover supranationals and agencies was anticipated to some extent, but it still seemed to come as a surprise in that many in the market weren’t fully positioned,’ said Cumbes.
Coming to terms
Issuers and investors alike have had to come to terms with a significant new player on the SSA buyside, one that accounts for roughly one-third of order books but whose involvement on individual transactions is opaque.
The warning signs came when outstanding bonds from agencies such as KfW and the European Investment Bank were trading flat to Bunds.
“The market got ahead of itself and it became hard to understand what represented fair value,” said PJ Bye, global head of public sector syndicate at HSBC.
One of the early consequences of QE was to push out real money investors, causing deals to stall. Days after the ECB put Bank Nederlandse Gemeenten on its extended list last May, the Dutch agency had to lean on lead managers to get its €1bn 10-year trade away. From that point, there was not a single agency euro deal.
“The second quarter of 2015 was very difficult – yields became so low that private investors stepped back,” said Cumbes. “That was one of the lessons for the market – that private investors remained crucial but had limits.”
Issuers became understandably reluctant to pay up for access, given that they now had a lender of last recourse in the shape of the ECB, and the market effectively closed for a month after KfW priced a €2bn seven-year at the start of July.
Ultimately, BNG reopened the market for euro benchmark trades and received an encouragingly strong reception after paying up for access. It priced a €1.75bn 0.5% August 2022, opting to issue in euros rather than dollars to achieve a longer tenor, a crucial factor in its decision to break the market deadlock.
Apart from the concession to its euro curve, it was more expensive for BNG to issue in euros than it would have been in dollars.
With spreads looking attractive again, investors returned in November, piling into euro deals from BNG, FMO and L-Bank after ECB president Mario Draghi offered a dovish update that appeared to hint at further easing. Draghi’s words prompted an increase in order books but the feeding frenzy was short-lived.
Praise replaces criticism
On December 3, the ECB cut the deposit rate to a record low of –0.3% and Draghi said that the bank would keep buying €60bn of bonds each month as far out as March 2017. But he fell short of expectations for a €10bn–€15bn increase.
“It seems harsh to blame Draghi for the fact that analysts got their predictions wrong,” said one banker.
Instead, bankers have praised the ECB for its decision at the end of last year to include regional bonds in its asset purchase programme.
According to data from Thomson Reuters IFR, almost US$500bn-equivalent of bonds issued by European cities and regions are in circulation. The iniative covers cities like Paris, although it is not without its political tensions, as it benefits debt sold by Germany’s 16 federal states, helping to alleviate the bottlenecks faced by the Bundesbank, which is opposed to further easing, and the ECB when it comes to buying German bonds.
“It might only be a small part of the overall programme but it’s a big avenue in the SSA market,” said one syndicate head. “I’m not sure there’s much scope for extending asset classes in QE.”
And QE continues to pose a challenge for price discovery.
“Where is the right value for World Bank, which lies outside QE, versus KfW, which is inside QE?” asked the syndicate head.
This question will become increasingly relevant over the coming weeks as the pain felt in the US dollar market brought about by the Federal Reserve’s decision to hike rates in December draws more issuers to the relatively risk-free haven of euros.
“We expect to see more SSA issuers that are not QE-eligible come to the market,” said Bye.
In particular, Canadian issuers are being snapped up in euros because they can offer pricing that is not contaminated by QE.
There is anecdotal evidence from syndicate desks that the decision in February by the Bank of Japan to introduce negative rates has delivered a big boost to the order books for SSA issues, which are enjoying greater distribution among Asian accounts.
Aside from uncertainty over pricing, by far the most adverse impact of QE has been a further drain on the secondary market. By definition, the ECB’s status as a buy-and-hold investor has driven liquidity in the primary market, creating a virtuous circle that largely ensures the oversubscription of new issues.
While some deals have endured a mixed reception, SSAR issuance has enjoyed a strong start to the year, helped by the scarcity of the asset class but also by volatility across every other sector triggered by a cocktail of factors – the Fed’s rate hike, China’s growing pains and the seemingly relentless fall in the crude oil price, all of which have a greater bearing on European spreads and, for that matter, the direction of global markets than QE.
“QE has kept the market open where others have struggled,” said Bye.
Amid the ongoing market turmoil, that constitutes a ringing endorsement for a programme that has been much maligned and whose efficacy has been called into question.