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Gavekal-logoThe European Central Bank pushed further into uncharted territory this week when it made its first foray into the corporate bond market. Three months after announcing its new initiative, the ECB added the Corporate Sector Purchase Program, or CSPP, to its alphabet soup of monetary operations. Under the CSPP, the central bank will make purchases of investment grade non-bank corporate debt, to go with the sovereign debt, covered bonds and asset-backed securities it is already buying as part of its quantitative easing policy. Alongside the central bank’s new round of Targeted Longer Term Refinancing Operations, which guarantee bank funding, the new corporate debt program gives the ECB unprecedented control over funding rates across almost the whole economy, effectively capping borrowing rates in order to provide greater certainty for businesses looking to make long-term investment decisions.

Over the 12 months to the announcement of the ECB’s new program, investment-grade non-financial corporate bond asset swap spreads widened by between 50 and 90bp (depending on credit ratings) to the widest since 2012, mirroring declines in the equity market. In response to the ECB’s announcement that it would begin buying corporate bonds, spreads collapsed, with most of the earlier expansion now eliminated. From that perspective, the CSPP is already a success. The expectation of ECB purchases has brought down corporate yields, and ongoing buying will ensure that yields remain capped in the medium term. With funding for all sectors of the eurozone economy now effectively under direct central bank control and less vulnerable to spikes, the ECB says it will not need to introduce any new policy measures beyond possibly tweaking or extending existing policies. By imposing stability on corporate debt funding costs, the central bank hopes to heighten clarity and lend confidence to borrowers, encouraging them to invest.

Under the CSPP the ECB can buy euro-denominated investment grade bonds issued by non-bank corporations incorporated in the Eurozone. The ECB can buy in both the primary and the secondary markets, purchasing up to 70% of an individual issue. In contrast, under “sovereign QE”, purchases are restricted to the secondary market and to 50% of an issue. The ECB has not said anything about the volume of its planned purchases, but credible estimates point to monthly purchases of between €5bn and €10bn, or cumulative buying of between €50bn and €100bn by the time QE is supposed to end in March 2017. At first glance these sums appear relatively modest, accounting for only 5% to 9% of the eurozone’s €1.1trn corporate bond market. In comparison, by March next year, the ECB will hold more than 15% of the eurozone’s outstanding sovereign debt. However, the likely impact of corporate QE can be better gauged by comparing the size of the program with net issuance. The ECB’s sovereign QE is powerful because it more than covers net issuance (see Not The Usual QE). As the chart in the web version shows, the ECB’s corporate bond purchases should also be large enough to cover net issuance by corporations over the next 10 months.

Whether the ECB will achieve its secondary objective of channeling investors’ capital into riskier and higher-yielding investments is less clear. So far the evidence is mixed. Yields on junk bonds have fallen in parallel with investment grade yields as stability has returned to eurozone equity markets. But at the same time, investors have reached for yield in foreign debt markets, resulting in large capital outflows from the Eurozone. For credit investors, there is a greater value to be found in wider US spreads than in the Eurozone.

And while the ECB has achieved market stability, it does not necessarily follow that it will succeed in encouraging much higher investment in the real economy. Evidence from the US and the UK suggests that companies could use a cheap funding option to finance mergers and acquisitions or to reward equity investors through share buybacks and higher dividends. It is also possible that funds raised by Eurozone companies with foreign parents could end up financing investments outside the Eurozone. The real world impact of the program is also likely to be limited simply because European businesses tend to rely on bank loans as their principal source of debt finance. Although Eurozone companies have increasingly turned to the debt capital markets since the global crisis to bypass the impaired bank lending channel, with bonds rising from 13% of non-financial corporate debt in 2008 to 20% today, this is still a small proportion compared with the US. Of course, it is possible that one of the ECB’s secondary objectives in launching the CSPP is to support the trend towards a more diverse funding structure for Eurozone companies.

Naturally, the funding stability for markets and the broader economy that result from the ECB’s asset purchases and refinancing operations come at a price. Drawbacks include the potential for capital misallocation and deteriorating bank profitability. For now, these concerns are secondary, and the ECB remains intent on capping interest rates. If spreads in individual markets do widen, the central bank is likely to tweak its policies to target those specific areas. For example, Italian bond yields have widened recently compared both with German Bunds and swaps. If this trend persists, it would not be a surprise to see the ECB tweak its sovereign bond QE program specifically to push Italian yields lower.

[Source: Daily note from Gavekal Research ( – by Nick Andrews & Cedric Gemehl – Jun 10, 2016]


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