Low profile ECB, Focus on CSPP

ECB will remain in wait-and-see mode

No policy action, but easing bias remains

Corporate bond sector purchases to start; max. €10B/month?

New waiver on Greek bonds as collateral for funding

On Thursday, the ECB holds its 4th policy meeting of 2016. We think that Draghi and co will keep a low profile while emphasizing an easing bias if necessary, in part to stress differences in the ECB’s current policy stance to that of the US Federal Reserve. Attention still goes out to the implementation of the March policy decisions. Earlier the central bank said that it would start its corporate bond purchase programme in June. The first refinancing operation under TLTRO II will also be conducted this month. More details are expected. Finally, Greek bonds could get a new waiver to be used as collateral within the ECB’s regular refinancing operations, regardless of their credit rating.

 

Patience the watchword in April

The main message from the April ECB meeting was that the ECB is in wait‐and‐see mode. The central bank’s main task is putting in place the various measures announced in March and allowing time for the associated very accommodative policy environment to strengthen economic growth and inflation. A key consideration is that this process will take time. Mr Draghi acknowledged that ‘we should be patient about low inflation for a long time’. This is not unreasonable in view of the normal lags with which monetary policy operates and the many ‘headwinds’ in the current environment ranged against it. Moreover, Mr Draghi and other senior officials have repeatedly stressed such lags are likely to be longer as the nature of the current credit easing means that unlike an interest rate change which normally feeds through quickly to market rates, policy will progressively become more expansionary as the ECB increases its asset purchases each month until at least March 2017.

A second takeaway from April was the clarification that markets misinterpreted Draghi’s comments at the March press conference. The ECB president stressed that the era of ECB easing wasn’t necessarily over yet. If warranted, the central bank is committed to ease further by using all the instruments available within its mandate. ECB Praet recently said: “We have shown in the past that we can be very creative within our mandate. When people ask: “Are you ready for a new shock?”, I always answer: trust us, we always find the means within the scope of our mandate.”
The forward guidance about policy rates states that interest rates are expected “to remain at present or lower levels for an extended period of time and well past the horizon of our net asset purchases”. This particular wording gives the ECB considerable flexibility about the policy stance for the next year or two and they may be expected to use this flexibility as far as is possible in what is still a quite uncertain environment.

 

Inflation remains negative

Recent economic survey data are little changed, though the latest PMI data suggest that EMU economic growth slowed somewhat in the second quarter following a very strong start to the year as EMU Q1 GDP printed at 0.5% Q/Q. On recent trends , the ECB might even be justified in undertaking a notable departure from recent practice in the shape of an upgrading of its projections for economic activity for both this year and possibly next.

We don’t see a marked change to the tone of the ECB’s inflation projections but the recent rebound in oil prices might result in a limited rise to the projection for 2017.
Against the possibility that this could spark some market reaction, we think Mr Draghi will emphasise that inflation will remain subdued for a considerable time.

Inflation readings are still way below the ECB’s 2% inflation target and negative since February (‐0.2% Y/Y in April). We expect it to remain so for the next few months, before picking up towards the end of the year on the back of the recent comeback of oil prices. Core inflation dropped to 0.7% Y/Y in April, the lowest reading since April last year. Market‐based inflation expectations trade stable at record low levels between 1.4% and 1.5% since early February.
Current economic conditions thus prove why it’s essential for the ECB to preserve an appropriate degree of monetary accommodation in order to underpin the recovery and to accelerate the return of inflation towards the objective. It will be interesting to see though whether the central bank already gives some weight to the likely higher inflation rate at the end of the year and the extent to which Mr Draghi emphasizes differences between the ECB’s stance and the seemingly close at hand tightening of policy in the US.

 

Start Corporate bond purchases

At the March policy meeting, the ECB announced that outright purchases of investment grade euro‐denominated bonds issued by non‐bank corporations established in the euro area will start in June 2016. The CSPP will contribute to the overall size of €80B/month purchases of the ECB’s QE programme. Amounts will be published on a weekly and monthly basis. Last week, Reuters reported that the ECB aims to start small and then slowly raise the monthly purchases to €5‐10B. The purchases will be conducted in the primary and secondary market.

Filtering the corporate bond market on the ECB’s criteria, currently results in 1081 securities eligible for CSPP. The total amount outstanding of these bonds is €658B. Applying the 70% issue limit means that the theoretical maximum scope of purchases under CSPP is €460B. We stress that this is a theoretical number as liquidity is low for corporate bonds with outstanding amounts <€500M or even more.
Pension funds or insurance companies probably aren’t willing to sell all of their bonds in the low yield environment. Therefore we argue that the real issue limit will be around 25% rather than the theoretical 70% of the ECB. Based on our screening, we estimate the current available pool of assets to be around €165B. The ECB intends to run its asset buying programme at least until March 2017 (ie 10 months from June 2016). Taking that into account, we think that corporate bond purchases will likely be to the tune of maximum €10B on a monthly basis. Overall, we fear that the ECB’s CSPP programme risks further reducing liquidity in the corporate bond market.

In terms of sectors, the largest amount of available bonds is in the utility sector with slightly more than €172B outstanding. That’s 26% of eligible bonds. Consumer discretionary (€106B; 16%) and industrials (€79B; 12%) complete the top three. When looking at the country of risk, 4 countries account for 80% of eligible corporate bonds: France (€206B; 31%), Germany (€160B; 24%), Italy (€92B; 14%) and Spain (€63B, 10%). Even though the ECB aims to buy bonds with tenors of up to 30 years, it will be impossible to obtain a portfolio with duration in line with for example the government bond buying programme. The total weighted average remaining maturity of the PSPPportfolio was 8.08 years at the end of April 2016. Breaking down the eligible corporate bond sample shows that more than 55% of the outstanding bonds matures between now and the end 2021 (+/‐ 5 years). More than 74% of the bonds matures before the end of 2023 (+/‐ 7 years) and only 9% of the bonds matures more than 10 years from now. So the average maturity of the CSPP‐portfolio will most likely be less than 5 years.

Corporate bond markets reacted strongly on the unexpected announcement at the March ECB meeting of the CSPP programme. It triggered a significant narrowing of corporate bond spreads. A joint measure of investmentgrade, non‐financial EUR corporate spreads narrowed from 120 bps to 85 bps, but stabilized afterwards. We expect more additional spread narrowing in coming months, once the ECB’s CSPP effectively starts. A second side‐effect since the CSPP‐announcement is the gradual increase of issuance over the past three months.

 

Greek waiver?

Last week, the Troika completed the first review of the third Greek bailout plan. This resulted in the go‐ahead for the next €10.3B aid tranche and brings debt relief talks back on the table. The ECB might now decide to reinstall a waiver on Greek bonds, regardless the credit rating. That way, Greek banks can use them again as collateral to secure ECB funding at the regular refinancing operations (including TLTRO II) and become less dependent on more expensive ELA funding.

We don’t expect that the successful review will be sufficient to include Greek bonds in the sovereign bond buying programme. First of all, the Eurosystem already holds more than 33% of Greek debt (> issue share limit). Second, the ECB already said that to even consider buying Greek bonds, a separate ECB debt sustainability analysis is needed.