There's a Potential Problem with the ECB's Plan to Buy Corporate Debt

A tiered system for a tiered eurozone.

European Central Bank President Mario Draghi Announces Interest Rate Decision

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Is this the chart that sparked a thousand monetary stimulus measures?

Source: BofAML

Analysts at Bank of America Merrill Lynch argue that despite years of low interest rates and asset purchases, the European Central Bank's monetary policy measures failed to produce a discernible effect on credit in recent months. With interest rates on government bonds drifting ever lower, spreads on investment-grade paper had actually gone up—a trend which could be attributed to continued concern over the impact of negative interest rates on eurozone banks.

With that in mind, the ECB on Thursday unleashed a tidal wave of stimulus measures including cuts in all three policy rates, targeted longer-term financing operations (TLTROs) to bolster banks and boost lending, as well as a surprising expansion of its asset purchase program to include European corporate bonds.

"Lower rates were simply pushing credit spreads wider," the BofAML analysts said. "We believe that the ECB has ... 'acknowledged' some of this market dysfunction, and extended a helping hand to credit through future asset purchases."

Though details of the ECB corporate bond buying program are so far sparse, there are enough facts to begin whittling it down to some broad categories of winners and losers. We know the central bank will be buying non-bank debt issued by investment-grade corporates with relatively stronger balance sheets, for instance.

But we don't know if they would focus on higher-quality names within the investment-grade universe or whether they'll be able to buy enough bonds to meet their new €80 billion purchase limit given the tendency of debt investors to buy and hold corporate debt. A previous ECB purchase program, of asset-backed securities, faced similar problems.

Still  BofAML sees €554 billion of debt ultimately eligible for ECB buying out of a European investment-grade universe that they put at €1.6 trillion. Of that €554 billion the vast majority has been issued by French and German credits, a fact which may disappoint some who were hoping for targeted stimulus of the eurozone's weaker nations.

Deutsche Bank AG Credit Analysts led by Nick Burns see similar figures, estimating around €418 billion of eurozone corporate debt could be eligible for ECB purchases, with the bulk of that coming from German and French issuers.

Source: Deutsche Bank

All of which serves to underscore the difficulty of implementing policy in a monetary union of disparate financial markets and nations. The ECB's bond buying program has so far sparked a full-blooded rally in European corporate debt markets, but there is a risk that it ends up further dividing the eurozone between weaker and stronger credits.

"This is one of the unfortunate elements of the euro area not having uniform financial markets throughout," Athanasios Orphanides, a former ECB council member and governor of the Central Bank of Cyprus, said in an interview with Bloomberg Television. "It's only the largest of the member states and very few of the smaller ones have deep corporate debt markets so they would benefit most from that."

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