On Thursday, after the ECB's stunning announcement that it would for the first time start monetizing corporate debt, we joked - or so we thought - that "within 6-9 months we expect to add a chart showing Europe's junk bond market which will be next on the monetization menu, followed shortly after by equities and kitchen sinks."
As it turns out, this wasn't a joke, and overnight JPM's Nikolaos Panigirtzoglou explained what to "expect" next from the ECB:
To the extent this week’s ECB decision marks a shift towards private sector asset purchases, the ammunition the ECB has expands hugely.
Assuming the ECB will be willing to navigate eventually into other private sector asset classes, the asset universe for QE purchases could expand to include uncovered bank bonds, bank loans and equities.
Will the ECB buy equities outright? Of course: after all the reason for all the "helicopter money" and cash ban talk is because central banks are now utterly desperate and have their backs against the wall. They will try anything, including what until just years ago was considered absolutely insanity: buying stocks outright.
Incidentally, the ECB is already buying stocks, only indirectly for now.
At the same time as the above "joke", we said something else which we thought was sarcasm: that corporations would take advantage of the ECB-guaranteed IG bid to issue debt and, having nothing else to do with the proceeds, use the funds to buyback their own stock, a rerun of what has been happening in the US for the past 4 years.
What happened:— zerohedge (@zerohedge) March 10, 2016
- ECB buys corporate bonds
- Corporations use proceeds to buy back stock
- Market rises
This too was not a "joke", and here is JPM again explaining that we were spot on:
The ECB’s corporate bond program will result to lower financing costs and more limited financial distress over time. This coupled with elevated Equity Risk Premia will increase the incentive for European companies to buy back their own shares. We thus see a higher chance that share buyback activity will improve in Europe from its current dormant phase.
Finally, we predicted that the most acute impact of the ECB's corporate QE action would be to impair an already painfully illiquid corporate bond market: "ECB purchases of company securities could serve to limit liquidity in a market where investors say it’s become harder to trade after banks cut their bond holdings to preserve capital in response to tougher rules."
And, lo and behold, JPM just confirmed this as well, estimating that the ECB can purchase at most €3.5 -€6 BN in bonds per month before it damages the market, and that in general "ECB corporate bond purchase program will be more difficult and more fragmented from an implementation perspective, than either the government bond or the covered bond purchase program":
Another implication of the ECB corporate bond purchase program is related to the liquidity of the European corporate bond market. Under what conditions will prospective ECB purchases be damaging for the liquidity of the European corporate bond market? How does this liquidity compare to the liquidity of other segments of fixed income markets such as government bonds, covered bonds and asset backed securities where the ECB has been purchasing bonds for a year now?
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The capacity of the ECB to purchase corporate bonds is also a function of the how the primary market responds to ECB buying. The primary market issuance is running at a rather slow pace of around €12bn a month currently. So again assuming ECB primary market purchases of 5%-10% of issuance, would add another €1bn per month of potential ECB buying. This capacity would naturally expand if the ECB program manages to bolster issuance going forward, e.g. if it manages to induce corporates to buy back their own equity.
Without an expansion of primary market capacity, the above analysis suggests that a feasible purchase pace by the ECB in order to avoid damaging the liquidity and the functioning of the European corporate bond market too much is between €3.5bn to €6bn per month.
Finally, another consideration for the ECB should be trade sizes and market depth. The Trax report provides data on average trade sizes across fixed income sectors, which can serve as proxy for market depth. The average trade size for IG Corporates has been €850k during 2015. This is a lot lower than that of Government bonds, at €7m, or covered bonds at €2m. This means that the ECB corporate bond purchase program will be more difficult and more fragmented from an implementation perspective, than either the government bond or the covered bond purchase program.
Said otherwise, in order not to break the already illiquid IG bond market, the ECB's intervention will hardly make a marginal price impact aside from the implicit backstop of these securities.
Finally, here is the final "joke" we made: "The only thing the ECB will never monetize, however, is gold - perhaps because it is the only asset class that does not need central bank support?"
In retrospect, this too is not a joke, and we find it very disturbing that we now live in a world in which the only asset class that has no explicit central bank support, is a "pet rock."