Ever since the start of ECB’s QE, one of the biggest concerns has been how will the ECB continue monetizing €60 billion in debt in a market that is increasingly illiquid and running out of collateral. Moments ago we got the answer when the ECB not only went even deeper into negative rates territory, cutting all three of its main rates, but boosted QE by €20BN.
To be sure, if the ECB had maintained the universe of eligible assets as currently, it would immediately drain the govie market of what little liquidity there was, sending the Bund curve negative until the 30Y. Recently Goldman Sachs Group estimated that had it boosted QE by just €10 billion with the same collateral pool, the ECB would run out of German government debt to buy in 10 to 12 months.
Which is why the ECB had no choice but to expand its universe of eligible securities to include EUR-denominated, European non-financal Investment Grade bonds.
In doing so Draghi has officially opened the Pandora’s box of purchasing not only sovereign securities but corporate ones, something the BOJ has been doing for years with REITs and ETFs, and leads to the question: once the bonds the ECB holds are equitized (along the lines of what China announced earlier today), will the European Central Bank be an active, or passive, equity shareholder. Better: if the ECB is buying IG bonds, why not Junk, or stocks, or oil, or anything else?
Actually, there is no definitive answer, which is why sooner or later the ECB will do just that.
Here are some more thoughts from Bloomberg:
The next target for the European Central Bank’s expanding asset purchase program: the region’s 900 billion-euro ($980 billion)corporate-bond market.
The ECB will buy investment grade euro-denominated bonds issued by non-bank corporations established in the euro area, according to a press release on Thursday.
Corporate bonds are the latest assets to be added to a growing list of securities, from government debt to mortgage-backed notes, the central bank is snapping up to combat weak growth and inflation. Buying company bonds may also demonstrate a greater tolerance for risk at the central bank as the securities are typically unsecured.
The ECB has bought 786.8 billion euros of assets since October 2014. It expanded its purchasing target to 80 billion euros a month starting in April, according to the statement. Government bonds have accounted for the largest portion of ECB acquisitions, at 77 percent, while asset-backed securities account for less than 3 percent.
The central bank has already dipped its toe into the water of corporate debt markets by adding state-backed company bonds, including securities from Italian utility Enel SpA, to the list of assets eligible for purchase last year.
The following, however, is paramount, because there is no such thing as a free lunch, especially when Central Banks are going all in into a market which no longer has any liquidity:
ECB purchases of company securities could serve to limit liquidity in a market where investors say it’s become harder to trade after banks cut their bond holdings to preserve capital in response to tougher rules.
Finally here, courtesy of Goldman, is a snapshot of the total size of Europe’s Investment Grade market: this is where the ECB’s trading desk will now be actively buying.
It is unclear what happens to those IG bonds that the ECB has purchased if and when they get downgraded to junk.
Within 6-9 months we expect to add a chart showing Europe’s junk bond market which will be next on the monetization menu, followed shortly after by equities and kitchen sinks.
The only thing the ECB will never monetize, however, is gold – perhaps because it is the only asset class that does not need central bank support?
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