While we understand that following the biggest market rout in years, it was all up to the central bankers to do everything in their power to restore confidence in the market's upward trajectory in a time when there are only 2 POMOs left under the Fed's soon ending QE3 program, which explains not only last week's 2 QE4 hints by FOMC presidents but also yesterday's ECB "leak" via Reuters that the central bank is contemplating launching corporate bond buying as soon as December. A leak which sent the market soaring to its best day of 2014. And while we give the European central bankers an A for effort, we can't help but wonder if someone did a major mathematical error when calculating the "bazooka impact" of yesterday's leak.
The reason: the same one we have cautioned about ever since 2012; the same why as we also explained in August the ECB's ABS QE will be grossly sufficient: Europe simply does not have enough eligible, unencumbered collateral in the private sector which can be monetized by the central bank (the same issue that the Fed itself was forced to taper QE once its holdings of 10 Year equivalents hit 35% as we showed last year and the TBAC started warning about gross bond market illiquidity). This goes back to a different issue, namely that Europe historically has funded itself on a secured basis, where the loans are kept on bank balance sheets (and serve as deposit collateral) unlike the US, where the primary source of corporate debt is through unsecured borrowing directly from lenders. We have shown all this before:
Our summary from March 2012 was as follows:
What is immediately obvious here, is that unlike in the US, where these are less than 30% for corporates, in Europe, bank loans account for nearly a whopping 90% of total corporate funding! These are secured, LTV loans, made by banks, and not syndicated, which means they are kept on the banks' balance sheets. As a result the bulk of Europe's assets held by levered entities, are already encumbered through existing security arrangement in the debt market (recall that bond debt is for the most part unsecured, and is thus a junior piece to secured bank loans). It also explains why European banks have to scramble to find new assets which they can "pledge" to the ECB in exchange for some additional cash to plug this liquidity shortfall hole, or that.
And because we understand that few have actually done any math behind the ECB's leak, here it is:
According to Barclays, based on the iBoxx Euro Corporate Index, there is €495bn in par value of unsecured, senior non-financial debt outstanding from euro area issuers (Market Value €563bn).
In addition there is €271bn in par value of unsecured, senior financial debt from euro area issuers outstanding (Market Value €300bn). The rating and tenor breakdown of the outstanding universe of bonds is shown below.
According to Barclays the reason why nobody else appears to have done the math, is because the ECB itself screwed up the numbers:
We note that these numbers are significantly different from the numbers reported by the ECB. The central bank reports €1.4trn of marketable corporate bonds and €2.2trn of uncovered bank bonds as eligible collateral at its operations. However, this includes MTNs, CP and guaranteed bonds. Starting from the ECB’s collateral list, instead of a broad-based index, we estimate the stock of corporate bonds at €177bn of non-financials and €321bn of financial debt (excluding Landesbank). This is much smaller than the “headline” figure, but also materially different from our index-based estimate, on the non-financial side.
Barclays' conclusion on the stock of eligible monetizable corporate debt: "Overall, we estimate the upper-bounds of potential bonds that might be in “scope” for an ECB purchase programme at €560bn of non-financial and €320bn of financial bonds (taking the iBoxx and ECB derived estimates, respectively). This falls to €240bn and €220bn if BBB-rated bonds are excluded."
It doesn't get any better when one looks at recent trends in net issuance to determine which way the collateral will move in coming quarters and years:
net issuance from financials has been negative in the senior unsecured €-IG space for the past four years, while net issuance from non-financials has been positive. Ex. Subordinated transactions, the average monthly net flow over the past two years has been: +€5bn from non-financials; and -€10bn from non-financials
In chart format:
Ok, so there is roughly about €750 billion in eligible (non-fin and fin, even though the ECB will almost certainly just do the former) bonds that can be bought? Why is that a problem: can't the ECB just go out and buy them all in one massive BWIC in its holy quest to boost its balance sheet by €1 trillion (apparently the magic number that will get those record youth unemployed in Spain back in jobs).
Well no. Here is JPM with the missing link which has to do with market liquidity and how much the ECB would actually be able to buy without soaking up all bond market liquidity:
It is unlikely that the ECB would buy subordinated bonds as these are not even eligible as collateral in its refinancing operations. That leaves €750 billion of nonfinancial corporate bonds that the ECB may consider buying, around €500bn of which is issued by European corporates. Market turnover may currently be around 2.5% of outstanding (after correcting for double-counting in the turnover data) and the ECB may be able to purchase 10-20% of this turnover. In addition, the ECB could also go into the primary market, buying 10% of new deals (from a total gross issuance of almost €20 billion per month recently). Such considerations suggest that, as a rough guide, they could purchase around €50 billion over a one year period under current market conditions, and perhaps as high as €100 billion if purchases improve market conditions, raising turnover.
So... the entire mega ramp yesterday was over an ECB monetization leak that boils down to a whopping €50 billion ($60 per year) or a tiny $5 billion per month, which is $15 billion per quarter?
Keep in mind at its peak in 2013 the Fed monetized $85 billion per month, while the BOJ added another $75 billion or so in its QE. So as the Fed is about to completely pull out of the "flow injection" market (even as the BOJ still pushes on with its existing remit which as a result of soaring non-wage inflation will certainly not increase any time soon) it will be replaced by $10 billion or so in ABC/Covered bond purchases and another $5 billion per month in corporate bonds?
And this is the best Hail Mary pass that the central planners could come up with?
All of this is critical because as Citi explained over the weekend, in order to keep the market from crashing, central banks need to inject at least $200 billion per quarter:
For over a year now, central banks have quietly being reducing their support. As Figure 7 shows, much of this is down to the Fed, but the contraction in the ECB’s balance sheet has also been significant. Seen from this perspective, a negative reaction in markets was long overdue: very roughly, the charts suggest that zero stimulus would be consistent with 50bp widening in investment grade, or a little over a ten percent quarterly drop in equities. Put differently, it takes around $200bn per quarter just to keep markets from selling off.
In other words, the "mega-leak" from the ECB will hardly scratch the surface in terms of the required liquidity injections, and certainly will be insufficient if at some point in the coming year, the BOJ finds it too has run out of collateral and is forced to wind down its own QE.
So after actually doing the math we wonder: how long before the market realizes Draghi's latest bazooka was another water pistol, and how long until Reuters is forced to go with the nuclear leak - that the ECB is now considering monetizing ETFs and, gasp, stocks.
Because that, ladies and gentlemen, is the endgame here.