The ECB last week wound up – for the moment at least – one of the most remarkable experiments in financial markets history, ironically at a time when some bankers say its QE programme is needed as much as ever.
The central bank stopped its Asset Purchase Programme, although it will continue to reinvest proceeds from maturing bonds in primary and secondary markets. The ECB will also continue to reinvest proceeds from its Pandemic Emergency Purchase Programme "until at least the end of 2024".
"The fact that the central bank was buying a large portion of fixed income assets was not normal," a senior DCM banker said. "We're now going through a rocky ride but over the long term, it's for the best. The tricky part is coming off the drug when there are a lot of risks around. There's also the risk of sticker shock when the moves can overshoot ... If you look at the magnitude of the moves recently, they've been huge."
The total stock of the APP, which comprises programmes for the public sector, investment-grade corporate bonds, covered bonds and asset-backed securities, stood at over €3.4trn at the end of May. The ECB began buying securities through the APP in October 2014, initially in the covered bond market. The vast majority of its holdings came through its Public Sector Purchase Programme, which could only invest in secondary markets.
The ECB has stopped net purchases through the APP once before – between January and October 2019. But last week still marks an end of an era, even if bankers and investors had been given ample warning. The ECB had been tapering its net purchases from €40bn in April, to €30bn in May, to €20bn in June, and now to zero.
"The beauty of the [scheme] was to be able to say a deal is ECB-eligible," said another banker of the Corporate Sector Purchase Programme. And if a deal was eligible, the ECB would almost certainly put in an order. "Now we don't know if [the ECB] will come in. If it does, it will be a pleasant surprise. But in all likelihood it won't as it won't have that firepower anymore. It will be smaller and less predictable. So there's much more uncertainty."
Others say that the impact of the ECB's presence, especially in the corporate primary market, has lessened in recent months as volatility has surged. "I think the halo effect went a while ago in primary," said a third banker
He pointed out that the central bank's buying is very much skewed towards the secondary market, which accounts for 76% of its portfolio, resulting in "still tight secondary curves". But even its impact in the secondary market is being eroded by larger new issue premiums, he said. Almost every issuer in the euro investment-grade corporate market over the past couple of weeks has had to pay concessions of 20bp or more, with the notable exception of Volkswagen, as investors demanded a buffer against extreme market volatility.
"In short, markets will continue to revert to proper valuations without the distortions of the CSPP dominating – which is a good thing," he said.
Less ECB, more spread
Even so, there is an adjustment ahead. "We need to see how supply will play out in the next couple of weeks and how that will impact prices," one covered bond banker said. "If we see less supply, then maybe the impact of a shrinking ECB order might be limited. But nevertheless in this environment, less ECB means in turn higher spreads and higher concessions."
ABN AMRO analysts reckon the ECB will continue to be a big presence in the covered bond market, estimating that reinvestments in the sector will amount to roughly €35bn in 2023 and in 2024.
A €750m January 2026 Austrian mortgage-backed bond on Tuesday from RLB NOE-Wien was a case in point. It still saw good demand from the ECB even though the settlement date of July 5 was past the cut-off point of June 30 for net asset purchases. "The ECB is still involved," said a banker on the trade, who noted the central bank's order was for 20% of the deal.
Fragmentation
The ECB's new posture is likely to be felt most in government bond markets. Reinvestments from the PSPP and the PEPP will support yields to some extent, while the central bank is also designing a new policy tool to prevent fragmentation in eurozone government bond markets, especially between Germany and Italy.
The lack of any detail on the new tool, however, has led to speculation as to how the ECB will manage this, especially as it is also committed to hiking policy rates to combat higher inflation but also faces the challenge of weaker economic growth.
"We've got this weird fragmentation tool hanging over us with no proclamation on it," said the second banker. "QE would be the solution right now."
"The whole idea of government debt is that it's supposed to be a risk-free asset class," he said. "So when you have an economic downturn, government bond yields should rally and allow you to borrow to support the economy."
But with Italy, for example, trading more like credit than sovereign risk, that flexibility is stymied. "If you had QE and rate hikes, the ECB could target inflation [and tackle] market fragmentation," he said.
(Additional reporting by Helene Durand, Robert Hogg, Malicka Danna Sielinou)