ECB Fast Exhausting German Bonds for QE Buying as Yields Tumbleby
German issuer limits likely hit as early as 1-2 months: UBS
More than 60% of nation’s debt yields below eligibility limit
The European Central Bank’s bond-buying program will be scrounging for German debt within months, according to two of the region’s banks.
The securities that yield less than the ECB’s minus 0.4 deposit rate have grown to more than 60 percent, based on a $1.13 trillion Bloomberg German bond index. That means they’re ineligible for the purchases. Analysts from UBS Group AG and SEB AB are estimating the central bank may run out of German targets within six months, and as soon as August, unless the rules are broadened.
Reaching the precipice would affect a broad range of investors, because a decision by the ECB to open up new groups of bonds for its quantitative-easing program may support their prices even more, helping extend this year’s rally. It’s also significant because German debt is Europe’s benchmark, and it must be bought in a greater proportion than securities from the other euro nations included in the QE program, under current rules.
Euro-area debt has earned more than 5 percent this year, and yields were driven to record lows across the region in recent weeks by investors seeking the safest assets after the U.K. voted on June 23 to break away from the European Union. That sparked market turmoil and renewed concern about the outlook of the global growth.
Interest rates already were depressed by the central bank’s 80 billion euros ($89 billion) of monthly asset purchases. The 1.7 trillion-euro program, due to run until at least March 2017, has also eaten into the pool of sovereign debt available to private investors.
“Based on current yield levels we estimate that the ECB could hit the issuer limit for all German debt within the next 6 months,” said Nishay Patel, a London-based fixed-income strategist at UBS. The earliest time could be “around one to two months.”
Germany’s 10-year government-bond yield touched its lowest-ever level of minus 0.205 percent on July 6. About 84 percent of the nation’s government bonds, including those that come due in as long as 10 years, have yields below zero. That means investors who buy them now and hold them to maturity earn less than what they paid for them.
Economists slashed their German 10-year bund yield forecasts in a Bloomberg survey after the Brexit vote. They saw rates at zero percent by the end pf the year, compared with 0.5 percent in a previous survey conducted in June before the referendum.
“They can only keep the current show on the road for a couple of months, and the reason is all the self-imposed limits,” said Peter Schaffrik, head of European rates strategy at Royal Bank of Canada, referring to the ECB’s stimulus plan.
In an interview with Markus Karlsson and Anna Edwards on Bloomberg Radio, London-based Schaffrik said the bond scarcity issue was a “much more medium-term problem than a short-term” one and the central bank will have to tweak some of the rules in future meetings to avoid reaching “a situation where they are forced to effectively taper.”
When asked last month about whether the purchasing program was facing roadblocks, ECB President Mario Draghi said that policy makers saw “ample liquidity.” He said the program “continues to proceed smoothly” and has enough “flexibility” to deal with any limits that might come up.
Cutting the deposit rate solely for increasing the amount of eligible bonds is unlikely, UBS’s Patel said.
The other more plausible option is removing the deposit-floor rule, which would enable the ECB to buy bonds with yields less than minus 0.4 percent. This “would dramatically increase” the pool of German bonds and “purchases of German bonds could run for another 11 months or so,” Patel said.
Increasing the share of bonds the ECB can buy from a single debt issue, which currently stands at 33 percent, is another way the central bank alleviate the bond scarcity issue.
Considering all the QE program’s restrictions, from not buying below the deposit rate, or more than 33 percent of a country’s debt, plus the curbs on shorter on maturities, there are about 75 billion euros of German bonds still accessible to the ECB, according to Marius Daheim, a senior rates strategist at SEB AB in Frankfurt. That suggests the stock may be exhausted by November this year, at the current pace of monthly purchases, he said.
Scarcity in debt from Germany is further exacerbated by rules requiring the amount of bonds purchased to be relative to the size of the economy, based on the so-called capital key. That means even as Germany has a lower amount of outstanding debt compared with Italy, for example, the Bundesbank -- which carries out most QE German-bond purchases for the ECB -- currently must buy a greater amount than the Bank of Italy, because its economy is larger.
Doing away with the capital key is politically sensitive and is thus “highly unlikely,” UBS strategists wrote.
The ECB’s Governing Council will meet in Frankfurt on Thursday when it will announce its monetary policy decision followed by Draghi holding a press conference. SEB’s Daheim says it’s unlikely the institution will make major tweaks to its program this month and will likely wait until September when it will also present growth and inflation projections.
“Our view is that they are still in implementation mode,” Daheim said. Given that the central bank has recently started its purchase of corporate debt and launched its Targeted Longer-Term Refinancing Operation he said it “is too early for the ECB to judge whether these tools are going to provide sufficient stimulus to get growth and inflation to where the ECB wants to have it.”