BlackRock Warns on Euro QE as Pimco Bets Against Volatility

Bond investors have been too quick to bet the European Central Bank will buy sovereign debt, BlackRock Inc. said today, as Pacific Investment Management Co. looks to profit from the prospects of added stimulus.

While the ECB has set itself “an ambitious target” of increasing its balance sheet by about 1 trillion euros ($1.29 trillion), the low take-up of new cheap loans offered to banks to boost the economy is no guarantee of quantitative easing, said Owen Murfin, a money manager at BlackRock. A second tranche of targeted lending in December is likely to be larger, Murfin told a London press briefing.

“We are cautious on periphery sovereign bonds as we do feel we are pricing in too much of a probability of sovereign QE in Europe,” said Murfin, who works for the bonds team in London at the world’s biggest money manager, which oversees more than $4 trillion. “The TLTRO initial take-up was pretty poor last week. But I would argue that the market has been a little bit too fast in extrapolating toward any imminent need for quantitative easing and I would certainly caution against that.”

The ECB alloted 82.6 billion euros in loans on Sept. 18, falling short of the 150 billion-euro median estimate of analysts in a Bloomberg survey. Central bank President Mario Draghi also unveiled a plan this month to purchase asset-backed securities and covered bonds in his bid to boost the ECB’s balance sheet.

Reduced Risk

Pimco, which holds the world’s largest bond fund and has about $2 trillion under management, is betting a weakening euro-area economy makes QE more likely even while ECB policy has reduced the risk of another regional debt crisis.

“With the credibility of the ECB’s inflation target in doubt, Mr. Draghi has signaled that the ECB will act, if needed,” Andrew Balls, London-based deputy chief investment officer, wrote in a release on the company’s website today. A full-blown QE program “would be the most practical approach for the ECB,” Balls wrote.

The five-year, five-year forward inflation swap rate, a measure of inflation expectations in the euro area, declined to 1.92 percent on Sept. 19, the lowest in four years. The gauge was cited by Draghi last month as it slid below 2 percent, the central bank’s price-stability threshold.

Volatility Decline

Pimco expects to remain overweight on peripheral securities, focusing on Spain and Italy, Balls wrote. The company is also betting euro-area volatility will be suppressed as the ECB rolls out its stimulus measures, he added.

An overweight position is one in which an investor holds a bigger percentage of a security than is contained in the indexes used to monitor performance.

The sovereign bonds of the euro region’s most indebted nations have rallied since Draghi pledged at the height of the sovereign-debt crisis in 2012 to do “whatever it takes” to save the currency union. The yield on 10-year Spanish government bonds dropped to a record-low 2.039 percent on Sept. 8 after reaching 7.75 percent two years earlier. The rate was at 2.20 percent at 4:33 p.m. London time.

Spanish bonds have returned 13 percent this year through Aug. 29, set for the largest annual gain since 1996, according to Bank of America Merrill Lynch Indexes. Italian government debt has returned 12 percent since Dec. 31.

“We’ve had this continuous rally without any pullback” in the periphery, said BlackRock’s Murfin. “A lot of this is more on optimism around a very accommodative ECB rather than massive fundamental improvement. The periphery trade has rather run its course.”

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