- Yields on $453 billion of eligible bonds already below -0.3%
- German 5-year yield fell below current deposit rate on Friday
The European Central Bank risks staying one step behind the market, even if it lowers its deposit rate next week.
A 10 basis-point cut to the minus 0.2 percent rate, which acts as a floor for the ECB’s bond-buying plan, would at a stroke make $373 billion more securities available for the program. History suggests that amount could quickly evaporate.
The institution is already getting a preview of the likely reaction. About $453 billion of securities that are eligible in maturity terms have dropped below minus 0.3 percent since its last meeting, according to the Bloomberg Eurozone Sovereign Bond Index.
With the effectiveness of the central bank’s policy measures at stake, the institution may find itself in a vicious circle of having to keep cutting rates to free up more securities, only for bond investors to keep on pushing yields down even further.
“The benefit of further deposit-rate cuts on the availability of bonds will be at best temporary,” said Richard McGuire, head of rates strategy at Rabobank International in London. “The ECB risks running to catch up with itself on this and won’t be able to buy any bonds at the front end of the core-market curves.”
It probably makes more sense for the ECB to abandon the deposit rate floor, McGuire said.
Yields across the region have fallen to fresh records this week, and bonds with maturities as far out as 2020 now yield less than the deposit rate. The securities have been boosted as speculation intensifies that the ECB will extend stimulus next month to prevent too-low inflation becoming entrenched.
The German five-year yield dropped below minus 0.2 percent for the first time Friday, and was at minus 0.196 percent as of 4:39 p.m. London time. The yield on Germany’s two-year notes fell to minus 0.429 percent and France’s slid to minus 0.343 percent, both all-time lows.
A cut of 10 basis points to the euro area’s deposit rate is fully priced in, according to futures data compiled by Bloomberg, while some banks including Rabobank International and DZ Bank AG predict a bigger move. The ECB may also extend or expand its quantitative-easing program.
With such measures likely to weaken the euro, some central banks, such as those in Switzerland and Denmark, may increase their intervention through core bond purchases to minimize the effect on their own currencies, according to Commerzbank AG. Latest data from Germany’s sovereign-debt agency showed central banks bought 51.6 billion euros ($54.8 billion) more of the nation’s bonds than they sold in the first half of 2015, a 31 percent increase from a year earlier.
“There is an element of competitive devaluation here, and some central banks are explicit about this,” said Mohit Kumar, head of rates strategy at Credit Agricole SA’s corporate and investment bank unit in London. “The main benefit of negative interest rates for the euro zone is a weak currency. The impact on the availability of QE-eligible bonds however is limited.”
The ECB started buying government bonds in March as the region’s anemic recovery lagged the rest of the developed world. When the details of the plan emerged that month, including the use of the deposit rate as a floor, German two-year note yields fell further below minus 0.2 percent, and were soon joined by those from Austria, Belgium, France, Finland and the Netherlands.
Italy sold five-year notes at a record-low yield of 0.37 percent as it auctioned 5.2 billion euros of securities due between 2020 and 2025 on Friday.
While the first eight months of QE haven’t created any significant disruption in the market, concerns that eligible bonds will become scarce are resurfacing.
“Some suggest a depo rate cut may ease the scarcity, with the amount of quantitative easing-eligible bonds above the rate increasing, but we suspect the opposite may be the case,” said Christoph Rieger, Commerzbank’s head of fixed-income strategy in Frankfurt. “As long as rate cuts linger, a large share of German paper will continue trading below any new depo rate. ”