Early ECB Exit From Corporate Bonds Underpriced, JPMorgan SaysBy
Central bank could take ‘last-in, first-out’ approach to taper
Program launched in 2016 may have outlasted its purpose
Credit markets are underpricing the risk the European Central Bank pares purchases of corporate bonds before it starts a wider-scale taper, according to JPMorgan Chase & Co., which is telling clients to boost default protection on their holdings.
“It is time to start setting hedges,” according to strategists including Matthew Bailey in London, who said they see “several potential catalysts for material widening” of yield spreads and “risks balanced to the downside.”
The central bank is expected to begin tapering asset purchases, including corporate and government bonds, in January. With credit spreads at a post-crisis low, continued net corporate purchases are “arguably no longer necessary for market functioning,” JPMorgan said.
“We think that there is a small risk that corporate bond purchases could be stopped by as soon as the end of this year if the ECB follows a ‘last-in, first-out’ approach to winding down their asset purchase program,” according to the strategy team. “In our view, this risk is not priced into the market.”
Since the Corporate Sector Purchase Program started in June 2016, holdings of company bonds on the ECB balance sheet have swelled to more than 100 billion euros ($117 billion). The purchases have helped suppress borrowing costs to unprecedented levels.
Allaying concerns of a buildup in corporate leverage is another argument for ending the program early, according to JPMorgan. In addition, the bank would be creating “room” to buy sovereign bonds to support the periphery ahead of the Italian general election, the strategists said.