Photographer: Martin Leissl/Bloomberg

Bond Traders Return to Fretting as ECB Seen Unfurling More QE

  • Concerns over liquidity, bond scarcity seen if purchases grow
  • So far bond-buying is just `part of daily routine': Banca IMI

As the European Central Bank considers expanding its bond-buying plan, traders’ initial misgivings are resurfacing.

The first eight months of the $1.2 trillion program were an operational success, they say. Even so, the prospect of enlarging it has renewed concern that bonds will become scarce and prices volatile, anxieties that were commonplace in January when the ECB announced the start of quantitative easing.

While that foreboding may have been misplaced, it prevailed last week at a bond conference in Brussels of the Association for Financial Markets in Europe.

“The bigger the size of QE, the more there will be fears of further deterioration of liquidity, scarcity” of debt, said Zoeb Sachee, head of European government-bond trading at Citigroup Inc., the second-largest dealer of European fixed income, in an interview a day before the event.

As the ECB’s acquisitions reached 419 billion euros ($446 billion) last week, contrary to widely-held expectations, the purchases have not snarled up the availability of assets, he said.

"It’s almost inconspicuous by its lack of market impact," Sachee remarked. "I wouldn’t say that can continue forever, because there’s a net purchase by the ECB that’s more than the supply there is in the market” of bonds newly issued by governments.

By the end of 2015, net issuance for the majority of euro-area countries will be negative once purchases by the Frankfurt-based institution are taken into account, according to data compiled by Bloomberg. Germany is impacted most, with the ECB buying an estimated 105 million euros more of debt than its government sells.

Price Swings

Research by Deutsche Bank AG a year ago said that with only about 38 percent of the euro area’s higher-rated bonds freely tradeable, the central bank’s program would impair liquidity, distort market signals and increase the risk of volatile price swings.

“QE has become part of our daily routine, and it hasn’t had a shocking effect,” Gustavo Baratta, government bonds trader at Banca IMI Spa, said during a panel discussion at the conference. The biggest effect on markets was on the repricing of bond-yield curves when the plan was announced, he said.

“Now the main worry is the possible changes the near future will have: broadening the scope of the program, lengthening and increasing the size,” Baratta said. “This is what we are currently worried about.”

Investor Rush

Just before Europe’s QE began, investors rushed into the securities, sending yields tumbling across the euro region. In Germany, where the problem was perceived to be the worst, yields dropped below zero on securities maturing in up to nine years in the first few months of purchases.

By April, investors began to balk at minuscule yields and spurred a global selloff in fixed-income assets. The rout wiped more than 300 billion euros off of euro-area bond markets in the six weeks from the end of April.

Since then, yields have fallen back, bid-ask spreads have tightened, and the market’s eyes are now focused on Mario Draghi’s next move.

Last month the ECB president said policy makers will reassess the amount of monetary stimulus at their December meeting to combat slowing economic growth and low inflation in the region.

HSBC View

Fixed-income strategists at banks including HSBC Holdings Plc are predicting an extension of the purchase plan will be announced. The ECB may gradually face a scarcity issue as fewer investors will be able to sell bonds and net issuance declines, Bert Lourenco, head of European rates research at HSBC, said in an interview at the AFME conference.

Meanwhile, Nomura’s managing director for flow rates trading in Europe, Middle East and Africa, Paul Spurin, stood with the opposite view.

Spurin said he was confident liquidity can be maintained if central bankers and debt managers play close attention to market developments. However, he warned that a shift too far to having just central banks as the biggest buyer can lead to a “dead market. ”

The ECB’s QE has also caused little disruption to Europe’s repurchase market, where bonds are used as collateral for short-term loans, according to a survey by the International Capital Market Association. It was expected earlier in the year that the purchases would lead to a shortage of high-quality assets needed for the loans and so traders pushed general collateral rates deeper below zero.

Vied on Repos

Traders haven’t found a need for the ECB’s securities-lending facility so far as the repo market still functions efficiently, respondents said. In the future, however, the unharmonized lending program could still present challenges as less debt is available in the market.

The ECB’s head of euro-area bond markets section, Ralph Weidenfeller, said it had so far not experienced any problems buying the amount of bonds targeted. An increase in September made to the issue-share limit, a technical constraint around purchases, has increased the eligible universe of debt and buying can continue “as long as needed,” he said.

“Nothing will stop it for now,” Weidenfeller said.

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