These 'Anomalous' Spreads Show How the ECB's Been Distorting Bond MarketsBy
Individual bond moves imply ECB-driven dysfunction, says Citi
Liquidity ‘not flowing smoothly,’ potential for wider spreads
Buyer beware. Beneath the placid surface of euro credit markets dysfunction prevails, with a slew of corporate bonds trading without rhyme or reason.
The culprit: the European Central Bank’s asset-purchase program, which has distorted the relative value of debt issued by a number of European companies -- and set up a potential trap for investors as the central bank scales down its monthly purchases.
Thus charges Joseph Faith, credit analyst at Citigroup Inc., who strikes a more bearish note than a number of his peers on the ECB’s presence in, and impact on, the market, citing a little-noticed disruption in spreads when looking at individual bond stories.
“An analysis of bonds the ECB has bought shows several individual instances of anomalous spread moves,” the strategist writes in a report this week. “These dislocations highlight a cost that is becoming increasingly apparent, with a breakdown in the notion of relative value, as liquidity fails to flow smoothly between market segments.”
The ECB announced last year that it would extend its asset-purchase program to investment-grade corporate bonds with the aim of reducing borrowing costs and stimulating the wider euro-zone economy. Since then risk premiums demanded by investors to lend to companies have reduced, while falling bid-offer spreads -- the difference in the price an investor is willing to pay for a security and the level at which a market-maker is willing to sell -- paint a flattering picture of liquidity conditions.
But that’s not the full story: the spread-distorting and liquidity-sapping presence of the Corporate Sector Purchase Programme (CSPP), as the ECB program is known, is evident in the movements of some specific bonds, according to Citi.
Take euro-denominated debt issued by telecoms operator Orange SA, for example. The spread on its bonds due in February 2027 tightened considerably in March without a credit-specific driver. Meanwhile, its similar-duration benchmarks widened, while its November 2028 note barely budged.
What’s more, the February 2027 obligation has considerably outperformed a similar-maturity peer issued by competitor Deutsche Telekom AG. And yet, Orange’s outperformance against its peer doesn’t ring true in the credit-default swap market, which can offer investors a form of insurance against default.
Typically, strong performance in the cash bond is mirrored in derivatives tied to it, as investors express a bullish position on a company’s credit fundamentals. This notable divergence suggests the ECB has distorted market pricing, notes Faith.
A similar story can be seen in debt raised by Pernod Ricard SA, the French producer of wine and spirits. Its May 2026 bond has significantly outperformed its shorter-dated counterparts, even as its credit default swaps flatlined.
Citi’s Faith points to another example of seemingly strange spread moves of late: the notable outperformance of a new bond eligible for ECB buying. Without naming the issuer, he notes that investors have been flocking to the fresher security despite the fact that the bond offered a lower premium relative to the unspecified company’s older notes. Those older bonds actually sold off in the same period, the strategist notes.
“Liquidity is not flowing smoothly from one place to another,” Faith concludes. “This resonates with the commonly voiced sentiment that it’s often not worth analyzing fundamentals because market technicals are dominating anyway.”
To be sure, seemingly odd moves in bond spreads can be a feature of the credit landscape even during normal economic conditions, and there’s no smoking gun linking recent examples with the ECB. But the manner and the timing of the spread moves -- plus the fact two-thirds of the market is ineligible for central-bank buying -- lend credence to Citi’s thesis..
The suggestion means investors may need to tread more carefully in the coming months as the central bank scales down is bond-buying program. The ECB currently owns 75.4 billion ($79.6 billion) of corporate bonds, but is reducing monthly purchases of public and private debt this month to 60 billion euros from a previous pace of 80 billion euros.
That may help to normalize incongruous bond spreads, but a push by investors to price in a waning monetary backstop creates a bearish outlook for investment-grade bond spreads in the latter half of the year, according to Citi.
“A move away from ‘peak easing’ is liable to cause some ructions as the ECB heads towards the exit,” Faith concludes, suggesting investors downgrade their exposure to credits whose recent price increases looks suspect.
Citi is not alone in its recommendation. Credit differentiation should dominate asset-allocation strategies in the coming months, according to Bank of America Corp. analysts. They advised investors last month to lighten up on CSPP-eligible names, citing the prospect of rising premiums as ECB liquidity wanes.
The counterpoint comes from Suki Mann, founder of bond-market analysis and data firm CreditMarketDaily.com, who reckons the ECB is poised to pull off a “seamless transition” by downsizing its “manipulative” purchase program just as economic conditions improve.
“The impact of fewer purchases might be offset by the growth dynamic leading to tighter spreads,” said Mann, a former head of credit strategy at UBS Group AG.