With Draghi On Deck, ECB Mulls Steps To Solve "Non-Existent" Bond Scarcity Problem

Tyler Durden's picture

It’s nearly that time again.

On the heels of December’s “big disappointment” wherein Mario Draghi cut the depo rate by a “measly” 10 bps and extended PSPP by an underwhelming six months, the ECB meets again next week, and this time around, expectations are low.

Despite the fact that markets have descended into outright turmoil, the ECB “is very unlikely to change its QE dynamics or cut the deposit rate at the upcoming meeting,” Barlcays says. “The earliest QE tweak opportunity for the ECB is the March meeting, if at all.”

So assuming Draghi doesn’t immediately push the panic button now that sub-$30 crude is virtually guaranteed to keep the Eurozone mired in deflation, we’ll write next week off when it comes to further cuts to the depot rate of a further extension/expansion of QE.

That said, we doubt we’ve seen the end of ECB easing especially given what’s currently unfolding in markets across the globe and considering the trajectory for commodity prices. The question now is what options the ECB has considering the fact that each incremental bond purchase brings the central bank ever closer to the endgame wherein Draghi begins to bump up against the issue cap for German bunds and, depending on how long the program is ultimately extended, for Spanish and French bonds as well. That goes double in the event the ECB expands the pace of monthly purchases (i.e. if Draghi both extends and expands the program).

Here’s a table from Barclays which outlines two hypothetical scenarios. The first assumes PSPP is extended for another six months beyond March 2017. The second assumes a €20 billion expansion in the monthly pace of purchases and no extension of the program’s duration.

As you can see, in either case the ECB hits the threshold (33%) for bunds, implying that expanding and extending the program simply isn’t possible unless the EBC drops the capital key allocation.

“We think flexibility in potentially moving away from the capital ratio has a more credible chance because it would not have to happen immediately. It will likely be pitched as: if and when we hit the 33% limit in Germany, we might look into allocating the excess in German purchases to other EGBs, still according to ECB key capital rules of the remaining issuers,” Barlcays says, adding that dropping the issue cap would risk running into the CAC problem.

As for buying more covered bonds, SSAs and ABS, Barclays says the game is about up in those markets. “Liquidity has significantly worsened in asset classes such as covered bonds, agencies, supras and ABS since the launch of the asset purchase programme,” the bank notes. “As a result, the ECB might run out of bonds to buy or just find it difficult to place bonds in these universes in order to achieve its monthly target purchase amount (likely up to €20bn out of €60bn).”

In another sign that purchase eligible assets are indeed becoming scarce, Bloomberg notes that although ECB officials “say monthly purchases of about 1 percent of the bonds outstanding haven’t constricted the market, sales of ‘off-the-run’ securities by some of the region’s biggest issuers argue to the contrary.” Here’s more:

France’s AFT, which boosted the proportion of sales of such non-benchmark securities to 33 percent last year, the most since 2011, said reopenings of the less-traded debt help “preserve liquidity along the entire curve.” Germany plans to sell more of an off-the-run July 2044 security this year, the Finance Agency said last month.


“The longer QE goes on, the more that the distortion impact can be visible, and you can tackle that through these off-the-run issuance,” said David Schnautz, a director of rates strategy at Commerzbank AG, which acts as a primary dealer in both France and Germany.


Existing benchmark bonds become off the run once they’re replaced by a new similar security in sufficient size. Issuing more of the older bonds, which tend to be less frequently traded and, in today’s environment, tend to carry a higher coupon, helps expand the universe of securities available to national central banks, who carry out QE.


“If you can only buy 33 percent of the benchmark bonds, you won’t hit your monthly purchase target over an extended time period,” Commerzbank’s Schnautz said.

In other words, scarcity and liquidity are indeed problems, no matter what the Governing Council says. 

What all of the above suggests is that if the ECB intends to both expand and extend PSPP while maintaining the issue cap and retaining the depo floor constraint, eventually Draghi will need to find more bonds to buy and he's not going to get to where he wants to be by snapping up a few sub-sovereigns or coaxing out off-the-run issuance in dribs and drabs.

And so, unless the ECB intends to find itself in a situation where it is forced by PSPP's many constraints to continually disappoint the market in an environment where low commodity prices are likely to cause inflation to continually undershoot the central bank's target, it's just as likely as not that the ECB will move into IG corporates next and from there, it's full-Kuroda-ahead into stocks.

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ebworthen's picture

"Whatever it takes."

Death Star Bonds?

Soul Glow's picture

Mired in deflation after the world's central banks have printed hundreds of trillions of dollars to buy bonds.  Yeah I'd say the Death Star approaches.

PersonalResponsibility's picture

Gov. prints money, gov. buys all stock, gov. owns the country/world eventually.  Am I missing something?  Seriously

MrNosey's picture
MrNosey (not verified) ebworthen Jan 16, 2016 8:13 PM

There will be no real recovery what so ever!

The elite will soon run and hide in the bunkers paid for with citizens taxes, after engineering a full economic collapse as well as starting WW3, plus they will make sure that there are enough Jihadi's in the West to start a race war.

That should be enough to cover up the failed fiat ponzi scheme and take care of the 'excessive' population......


cwsuisse's picture

Pictures from a madhouse!

Mini-Me's picture

If their goal was price inflation, they could just digitally deposit euros into everyone's account.  They would eventually destroy the currency, but they're doing that now.  Might as well go full retard.

PontifexMaximus's picture

Or issue banknotes with a limited validity stamp printed.

Soul Glow's picture

The crazy thing is there are economists who appove of these measures.

FedFunnyMoney's picture

Welcome to the currency war.

Enjoy your stay.

R.R.Raskolnikov's picture

I expect not much going to happen because  the ECB has to deal with the influence excerted by other countries. Germany and the Netherlands are against. I assume that more are against, but I am not informed about that. In the weekend edition of financial news paper something was dedicated of stopping with this program. I will read it tomorrow.

R.R.Raskolnikov's picture

I have read the article in that financial news paper refering to in my post above. They stated that there is growing oposition for the program.

PontifexMaximus's picture

Extend the eligibility!

JamaicaJim's picture

Mario Goldmann needs to jump in a luke warm filled bathtub holding a plugged in toaster.


Farmer Joe in Brooklyn's picture

Tyler took my "go full-Kuroda" line...!!

I don't know how a central bank can justify buying stocks.  That is DIRECTLY putting taxpayer money into the pockets of (largely wealthy) equity holders. 

This is not going to end well... unfortunately, this slow motion trainwreck is taking many years longer than anyone here would have guessed.  The crash, when it finally comes, is going to be epic..!!

Tick tock, tick tock....

Soul Glow's picture

So let's say, Draghi comes out with a "We're going to do whatever it takes" rhetoric, the euro will slip a few cents to the dollar, the Yen will go down in terms, stocks will get the slightest bounce, and they will say everything is still under control and if you don't believe them you are peddling fiction.  

This will last a week or two and then the market will realise it is running on hopium spoons, unicorn puke, and pixie dust, at which point the stock market reverses and one of the greatest crashes ever happen.

It's hard to play kick the can in the dark, and it's nearly nightfall.

TheDanimal's picture

 So about that full Kuroda thing...Isn't Janet Yellen currently doing that with her friends at Citadel?  I bet the ECB has some sort of plunge protection team too.

Luckhasit's picture

Super Mario baby, what's really good. He just following the script as expected since he helped write it.

Yen Cross's picture

  I think he's limited.. The ECB balance sheet is really loaded. If you expand bond issuance, that's a new can worms.

  I know those pin heads[EMU] want to expand their monetary base, but they're confined by lack of GDP.

  Do you guys/gals remember how the ECB would sterilize any outflows<><>, almost instantly.