Draghi QE Crusade Challenged by Hoarders Amassing Bonds

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ECB President Mario Draghi
Mario Draghi, president of the European Central Bank. Photographer: Martin Leissl/Bloomberg

As if Mario Draghi doesn’t have enough problems already.

Europe is trying to avert a crippling bout of deflation. Germany wants austerity and less stimulus. And Greece is demanding to renegotiate the terms of its bailout, a move that has revived the risk of the euro area splintering.

Now, there’s yet another: the European Central Bank president’s unprecedented plan to jolt the euro zone out of its economic malaise by buying 1.1 trillion euros ($1.3 trillion) of bonds may be hamstrung, even before it starts next month.

The reason? A dearth of new supply and a lack of willing sellers. Morgan Stanley estimates net issuance from governments will be negative for the first time, once the ECB’s plan is taken into account. The resulting scarcity makes hoarding of the safest euro-area securities by banks, insurers and pension funds all but inevitable, hindering ECB efforts to buy in 19 months roughly the same proportion of those bonds as the Federal Reserve accumulated in almost six years of Treasuries purchases.

“If it becomes at all clear that the ECB is struggling to buy a sufficient quantity of bonds, it makes it even less likely that anybody will want to sell,” said Michael Riddell, a money manager at M&G Group Plc, who also said he’d been telling clients the ECB may have difficulty with its purchases. “This would scupper their attempts to boost inflation,” he said. London-based M&G oversees the equivalent of $395 billion.

Careful Calibration

The program has been carefully calibrated to take account of the size of different markets, an ECB spokesman said by e-mail on Monday. The central bank is not at all worried about its success, and operational details will be regularly reassessed, the spokesman said.

While the ECB faces economic risks akin to those in the U.S. when the Fed started quantitative easing, global debt trading has evolved.

A tighter balance between supply and demand has pushed up prices, helping send rates in Europe to record lows and leaving 1.2 trillion euros of the region’s sovereign bonds yielding less than zero. That may make holders of the securities more reluctant to sell.

“We have institutional investors, which are desperately looking for yield,” said Franck Dixmier, chief investment officer for fixed income in Europe at Allianz Global Investors, a unit of Europe’s biggest insurer. “They will not sell. Because what really matters for a pension fund or an insurance company is the yield at the time you purchase the bond -- and there’s the question of reinvestment for those investors.”

Crimped Availability

Of the ECB’s 60 billion-euro monthly plan, about 45 billion euros probably would be sovereign debt, a central bank official said Jan. 22. That implies an intention to purchase 14 percent of euro-area government bonds outstanding by September 2016, or 18 percent of securities from Finland, Germany, Luxembourg and the Netherlands, the only nations with two or more AAA ratings from the three major credit-assessment companies.

It took the Fed almost six years, and three rounds of quantitative easing, to boost its holdings to about 20 percent of U.S. Treasuries.

The Bank of England owns about 31 percent of Britain’s gilts and the Bank of Japan is still adding to holdings of that nation’s debt. Together, those purchases are crimping the amount of securities worldwide that are available for trading.

Finding Sellers

Reduced government spending is likewise contributing to a global dearth of sovereign debt. Germany is due to curb the amount of conventional bonds outstanding by 8 billion euros this year. In Spain, where Prime Minister Mariano Rajoy’s People’s Party has implemented the deepest austerity measures in the nation’s democratic history, the net issuance target for 2015 is 55 billion euros, down from net sales of 97 billion euros in 2012.

Including ECB buying, net issuance of euro-area sovereign bonds will decrease by 259 billion euros in 2015, Morgan Stanley strategists, including London-based Neil McLeish, Anthony O’Brien and Serena Tang, forecast in a Feb. 9 note. The ECB may struggle to find sellers, leaving its target in jeopardy, the U.S. bank’s Maggie Chidothe and Anton Heese wrote in a Feb. 13 report.

Draghi’s competition for purchases may come from banks requiring bonds to meet regulatory rules, pension funds who need to match their liabilities, passive investors who track debt indexes and other central banks, which buy European securities as part of their balance-sheet management.

Demand Mismatch

Demand for debt securities globally will outstrip supply by about $400 billion in 2015, according to data compiled by JPMorgan Chase & Co. last year.

“We have no interest in selling parts of our portfolios to the ECB when QE starts,” said Francisco J. Simon, a money manager at Santander Asset Management Espana in Madrid, which oversees 14 billion euros in fixed-income funds. “Instead, we’ll keep managing funds based on how we see interest rates evolving. That means, should we foresee interest rates declining, we would even increase our exposure” to Spanish debt, he said.

The ECB can draw encouragement from the trillions of dollars of bonds successfully bought by the Fed, BOE and BOJ. It may be ready to pay higher prices for the securities in order to meet its goal of pumping money into the euro area’s financial system.

Reach Target

ECB Governing Council member Jens Weidmann said Feb. 12 that he is “confident that we’ll manage to reach the volumes we announced,” for the plan.

The program will have its greatest effect by encouraging investors to shift funds into riskier assets, such as loans to companies and households, Executive Board member Peter Praet said the same day.

“Presumably they’ll have to bid aggressively,” said Johannes Mueller, the Frankfurt-based chief investment officer for Germany at Deutsche Asset & Wealth Management, which oversees the equivalent of about $1.2 trillion. “Depending on where prices are, alternatives start to look attractive. We don’t buy into the theory that there’s going to be a shortage of sovereign bonds.”

The ECB announced its debt-purchase plan on Jan. 22 to counter the threat of a deflationary spiral by pushing more cash into circulation. Buying will continue until it’s satisfied inflation is back in line with its target.

Greek Crisis

Consumer prices in the euro region fell an annual 0.6 percent last month, according to a Jan. 30 report, matching the fastest decline on record. Tumbling commodity prices dragged down the rate, which has been less than half the ECB’s goal of just below 2 percent for more than a year.

Greek markets have slumped since January’s election of the anti-austerity Syriza party, reviving memories of the debt crisis that ravaged the region and pushed the nation into the biggest restructuring on record in 2012. Talks between the new government and euro-area creditors broke up on Monday without an agreement on a program of financial support to keep Greece afloat beyond the end of the month, when its existing bailout program expires.

Greece aside, European bonds have rallied, aided by the ECB cutting its main refinancing rate to a record 0.05 percent and lowering its deposit rate below zero. The average yield on bonds in the Bloomberg Eurozone Sovereign Bond Index fell to an all-time low of 0.68 percent last month. Germany’s 10-year yield ended at 0.37 percent on Tuesday, after declining to a record 0.297 percent on Feb. 2.

Calculating Targets

The exact proportion of ECB purchases of government bonds has yet to be officially specified because the total will include the debt of agencies and European institutions, as well as asset-backed securities and covered bonds.

“It’s a question quite a lot of people in the market are asking themselves -- who is actually going to be selling their bonds to the ECB?” said Bert Lourenco, head of EMEA rates research at HSBC Holdings Plc. “If you think about the roles that asset managers have you start running into roadblocks. The ECB probably will be fine initially but during the course of the next year and a half you might see some speed bumps.”

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