Europe's QE Starting Point Faces Risk as ECB Talk Turns to Taper

  • Covered bonds may be first market for slowdown in asset buying
  • ECB holds 25% of market after beginning QE two years ago

The risk of Mario Draghi turning “first in” to “first out” is stirring Europe’s covered-bond market.

The European Central Bank holds almost 25 percent of the region’s covered bonds after starting purchases about two years ago as the first step in stimulus efforts. Attention is now swinging to how and when the central bank will cool its asset-buying program, which has snowballed into a 1.7 trillion-euro ($1.8 trillion) shopping spree including sovereign and corporate debt. Policy makers will discuss the topic next week in Frankfurt.

“The ECB started with covereds so maybe they’ll start tapering there too,” said Oliver Hueckel, UniCredit SpA’s Munich-based head of financial-bond trading, who will speak on a panel at the AFME/vdp Covered Bonds Market Conference in Berlin on Friday. “Everyone is waiting for Dec. 8 to see if they’ll give more advice about what will happen next.”

The ECB has acquired 202 billion euros of covered notes, which are guaranteed by the issuer and backed by a pool of assets. The possibility that the ECB will change its purchase program was the biggest concern among 50 European covered-bond investors in Societe Generale SA survey published last month. Investors are worried how tapering will be communicated, and whether it will be an abrupt or gradual process.

Tapering Pathway

While President Draghi has ruled out a sudden stop to ECB purchases, it’s not yet clear whether the program will be extended beyond March or if the pace will be curtailed. Some policy makers have said they want stimulus measures to be withdrawn as soon as possible.

Covered bonds are traditionally less volatile than other types of debt, which may help them ride out ECB tapering. The 860 billion-euro market may also shrink for a fourth year in 2017, with Landesbank Hessen-Thueringen analyst Sabrina Miehs forecasting 110 billion euros of new notes and 120 billion euros of redemptions

“Probably it’s a time to be cautious and reserved,” said Miehs, who will also appear at the AFME conference. “But there will also be periods where investors take the opportunity to go back into certain markets.” She cited bonds issued in periphery European nations, such as Portugal, as an example.

Euro covered bonds suffered in a global fixed-income rout last month after Donald Trump’s surprise election stoked expectations for higher inflation and interest rates in the U.S. The average extra yield investors demand to hold the notes compared with benchmark rates rose about 15 basis points in November to 61 basis points, according to Bloomberg Barclays index data.

The sell-off may gain pace if the ECB signals any moves toward easing stimulus, said Juergen Mueller, a fund manager at Bayern Invest, which holds about 7 billion euros of covered bonds.

“The biggest risk is that the biggest investor will make changes to its behavior,” said Mueller, who will be on a panel at the AFME conference. “Tapering discussions are on the table for 2017.”

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