ECB Dare Not Blink First as It Stares Down Bond Market Yields: Euro Credit
“The ECB’s bond purchase program has been a very effective deterrent to panic selling, and as long as they don’t blink now, they can have this problem of speculative shorting licked in weeks rather than months,” said Luca Jellinek, the London-based head of European rate strategy at Credit Agricole Corporate & Investment Bank.
The ECB snapped a five-month hiatus to buy 22 billion euros ($31.7 billion) of government bonds in the week through Aug. 12, and has bought more securities since. That helped push 10-year Spanish and Italian yields below 5 percent after they surged to euro-era records the previous week amid concern contagion from the debt crisis had infected both countries.
The success mirrors the initial benefit of the ECB’s first program of buying Greek bonds in May 2010. Policy makers must avoid what came after that: a reluctance to extend the program with further purchases saw Greek 10-year yields reverse declines and soar by more than 10 percentage points.
Staying in Play
“They don’t need to do massive amounts every week, but they do need to remain in the market to help stabilize the situation,” said Olaf Penninga, who helps manage 140 billion euros at Robeco Group in Rotterdam. “They could probably get away with a few billion a week if asset markets remain relatively stable, but they would have to do considerably more if political tensions arise, like internal disagreement within the ECB or opposition to the buying from Germany.”
Ten-year Greek yields initially dropped as much as 468 basis points after the central bank began 16.5 billion euros of Greek bond purchases last year. Some 14 months later, the yield had soared as high as 18.39 percent.
The ECB has overcome internal opposition among its board members to more bond purchases as bond market moves suggested the region’s debt crisis was spreading to economies considered too big to rescue by investors.
Italy has the euro-region’s largest outstanding debts at 2.1 trillion euros, including principal and interest payments, according to Bloomberg data. That compares with 838 billion euros for Spain, the fourth-biggest burden in the region.
Italy’s 10-year borrowing cost was at 4.90 percent as of 10:46 a.m. in London, after surging to a euro-era record 6.40 percent on Aug. 5. Similar-maturity Spanish debt yields 4.91 percent, after touching 6.46 percent on Aug. 2, the most since the introduction of the shared currency in 1999.
European leaders are struggling to find a solution to the debt crisis, after a July 21 accord to bolster the region’s rescue fund failed to calm markets. German Chancellor Angela Merkel and French President Nicolas Sarkozy rejected an expansion of the 440 billion-euro rescue fund on Aug. 16 and rebuffed calls for a common euro-area bond, saying greater economic integration was needed first.
The two largest euro-area economies will instead push for tougher fiscal debt limits and the establishment of a “euro council” as part of a planned “economic government” for the region, Sarkozy said after the two-hour Aug. 16 meeting with Merkel in Paris. Germany and France still share an “absolute determination” to defend the euro, said Sarkozy.
‘Only Viable Stopgap’
Dutch Finance Minister Jan Kees de Jager backed the opposition to a common euro-area bond, telling his nation’s parliament that while jointly issued debt was interesting “conceptually,” it would not solve the region’s debt woes.
“In the absence of a sustainable policy solution, ECB buying is the only viable stopgap,” said Padhraic Garvey, the head of developed-debt market strategy at ING Groep NV in Amsterdam. “The ECB does not know it yet, but it will find that it cannot step away from its bond buying.”
Purchases may need to be as big as “something approaching forthcoming supply,” according to Credit Agricole’s Jellinek.
Italy needs to refinance an average of about 7.5 billion euros per week in maturing principal and interest payments for the remainder of this year, according to calculations by Bloomberg News. That’s more than double the weekly average of 3.4 billion euros for Spain.
“They certainly would need to consider being more active around big supply events,” said Jellinek. “They obviously can’t participate at the auctions, but they can help stabilize things by buying bonds before any coming sales.”
The ECB may have spent around 12 billion euros in the second week of bond purchases, according to Harvinder Sian, an interest-rate strategist at Royal Bank of Scotland Plc in London.
Concerns about the creditworthiness of euro-area members spread to France last week, with speculation it may lose its AAA debt rating hammering shares in the nation’s banks and sending the risk premium on its government bonds to a euro-era record. France’s top rating was affirmed by Standard & Poor’s, Moody’s Investors Service and Fitch Ratings on Aug. 10.
Unprecedented bailouts for Greece, Ireland and Portugal have already cost 365 billion euros in emergency funding from the European Union, the International Monetary Fund and ECB. That comes as growth in the region slows. The EU statistics office said Aug. 16 that gross domestic product rose 0.2 percent in the second quarter, the least since the region emerged from recession in late 2009.
Questions of Safety
“A lot of institutional investors are beginning to question whether Spanish and Italian bonds are stable enough to be included in their bond portfolios, which are meant to be among the safest, most stable investments,” said Robeco’s Penninga. “New investors need to be attracted to take up the slack. You are only going to attract them with higher yields. Either way, the ECB still needs to be in the background to prevent a return to the recent market turmoil.”
With Merkel and Sarkozy ruling out either an immediate enlargement of the European Financial Stability Facility or the sale of Euro bonds, further debt purchases by the ECB may be the only defense for Italy and Spain.
“They need to convince the market that if you go short, the guy on the other side is the ECB and they don’t lose money, you do,” Jellinek said. “If they really want to win this they can, because there’s no one big enough to take them on.”