Invesco Hoards Bonds as ECB Lures Frankfurt Trust to Sell

When the European Central Bank came calling, the visit was unwelcome for some investors who own euro-area sovereign bonds. They chose to hold on for more gains.

Their reluctance to sell was vindicated by the securities extending a rally on Tuesday. The gains pushed Italian and Spanish 10-year yields to record lows. They drove German five-year rates further below zero. And they preserved the allure of German 10-year bonds -- even at a yield of just 0.21 percent on Wednesday versus about 2.11 percent in U.S. Treasuries with a similar maturity, the biggest spread since 1989. Some money managers are bullish on debt across the euro area.

“We are not selling, and many others probably won’t either,” said Mark Nash, London-based senior money manager at Invesco Ltd., which manages about $786 billion. “Why sell when your government bonds will rise in price as they become a scarce asset?” Government “deficits are being cut and that will reduce issuance. Yields are low and may get lower.”

With the ECB’s member banks said to be buying German debt even with negative yields in carrying out the quantitative-easing program, rates on the nation’s five-year securities fell to a record minus 0.125 percent Tuesday. German 10-year and 30-year yields also touched the lowest ever.

QE Challenges

The yield premium investors demand for Germany’s 30-year bunds compared with two-year notes shrank to 92.6 basis points Tuesday, the least since September 2008 on a closing basis, and down from about 234 basis points a year ago.

The ECB and national central banks have set out to pump 1.1 trillion euros ($1.2 trillion) into the economy to rekindle growth by acquiring public and private debt through September 2016. Challenges include finding enough eligible securities and willing sellers while maintaining bond-market liquidity.

The ECB bought 3.2 billion euros of public sector bonds when the program started on Monday, ECB Executive Board member Benoit Coeure said in a text for his speech in Frankfurt on Tuesday. He said there wasn’t a shortage of securities to buy.

“While the effective supply of eligible securities is undoubtedly lower than the total amount outstanding, I do believe that it will still be substantially higher than the amounts we intend to purchase,” he said. “If this is the case, there will be a price at which we can buy the quantities needed to meet our monthly targets. In other words, we may face a scarcity of bonds, but we won’t face a shortage.”

14-Month Rally

Euro-area government bonds are extending a 17 percent rally in the past 14 months, fueled by speculation that buying 60 billion euros a month of securities will create a scarcity of the fixed-income assets. Austerity measures such as social spending cuts adopted since the start of the sovereign debt crisis in 2009 have also contributed to price increases. The average yield to maturity on the euro area’s government debt fell to 0.4696 percent on Tuesday, the least since at least 1995, according to Bank of America Merrill Lynch indexes.

Central banks, of course, did find sellers.

Christoph Kind, head of asset allocation at Frankfurt Trust, which manages about $20 billion, said he sold German bonds because the yields are not attractive.

“It doesn’t make sense to hold bonds with negative yields for fund managers,” said Christoph Kind, head of asset allocation at Frankfurt Trust, which manages about $20 billion. “It’s a good idea to sell if you are not forced to hold.”

Certain money managers that track bond indexes and some pension funds must hold fixed-income securities, regardless of the yield. Kind’s sales weren’t to the ECB, though it’s possible they could end up in ECB hands, he said.

Best Prices

To execute the plan, central banks across the euro area are seeking the best prices from at least three dealers, according to the ECB. They buy through existing counterparties.

Fabrizio Fiorini, chief investment officer at Aletti Gestielle SGR SpA in Milan, said he won’t be selling his Italian bonds until the extra yield that investors get for holding the nation’s 10-year bonds instead of German bonds drops to his target of 80 basis points, or 0.8 percentage point.

“No one is in a hurry to serve the Bank of Italy,” he said. “I think this can support the euro-zone market for two months, but after that we will see more sellers.”

That yield difference, or spread, was at 97 basis points, down from 575 basis points in November 2011, when the possibility of monetary union disintegrating caused a surge in borrowing costs across the region. The spread is still more than double the average of 35 basis points between the euro’s debut in 1999 and October 2009, when Greece sparked the currency’s biggest crisis.

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