Morgan Stanley Sees Covered Bonds Joining Riksbank's QE Arsenal

  • Morgan Stanley recommends switching to covered bonds
  • Riksbank concerned over `very overheated' housing market

Sweden’s central bank may need to do something it really doesn’t want to.

After abandoning its focus on financial imbalances last year and unleashing unprecedented measures to combat deflation, the bank may soon need to add the purchase of mortgage bonds to its stimulus package, according to Morgan Stanley.

The central bank, which has said it will buy 135 billion kronor ($16 billion) in government bonds this year, will need to turn to other bond markets to avoid distorting trading. The bank is buying more bonds in Sweden than the European Central Bank is doing in any euro country, Morgan Stanley says.  

“We think the Riksbank will introduce a covered bond program in 2016,” Alexander Wojt, an analyst at Morgan Stanley, said in an interview. “This will cause spreads to tighten and we recommend investors to shift some exposure into” covered bonds from government debt, he said.

Policy makers meet on Wednesday and will announce their next rate decision the following day. According to a survey of analysts by Bloomberg, the bank will probably leave its rate unchanged at minus 0.35 percent. Four of the 16 surveyed forecast a reduction.

Spread Narrowing

Homebuyers could stand to benefit if the bank follows the ECB into the mortgage bond market. Since the announcement of the ECB’s program in September, yield spreads on the Bloomberg EUR Covered Bond Index have narrowed by 23 basis points, or 0.23 percentage point, to just 3 basis points more than the asset swap rate.

Even so, some of the key policy makers on the board would only reluctantly wade into the mortgage market amid concern over household debt growth.
First Deputy Governor Kerstin af Jochnick said on Aug. 21 that she is not too convinced about the potential purchase of mortgage bonds, considering that Sweden has “a very overheated housing market.”

The Riksbank can lower the repo rate further, buy more government bonds or intervene in the currency, af Jochnick said.
“So far our assessment is that we can buy government bonds, and that the market functions well,” she said. “It’s not like we have in any way hit the top.”

Obvious Risk

Not everyone agrees. Fredrik Joensson, head of the treasury at mortgage lender SBAB, said it’s “obvious” that Riksbank is affecting liquidity of the government bond market.

“The chances of a covered bond program are around 30 percent, maybe within a six- to nine-month horizon,” Joensson said. “Such a program would be very spread-positive, if announced. We would see a lot of tightening of covered bond spreads versus both swaps and government bonds.”
Household lending rose an annual 7.1 percent in July, while apartment prices jumped 14 percent.

A covered bond QE program would lead to even lower costs for mortgage issuers, which could “fuel house prices further and spur lending,” Joensson said. “If you compare Swedish mortgage rates to Danish ​mortgage rates, there’s still room for lower mortgage rates in Sweden.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE