Back in April of 2015, we warned that the biggest risk facing the ECB is running out of eligible securities which the central bank can monetize. Draghi's recent launch of the CSPP, in which the ECB has been buying not only investment grade but also junk bonds, is an indirect confirmation of that. A direct one comes courtesy of a Bloomberg calculation according to which following a seventh straight week of gains in German bunds, the yields on securities of all maturities has plunged to unprecedented lows, which has left about $801 billion of debt out of the statutory reach of the European Central Bank.
As noted earlier, there is now $13 trillion of global negative-yielding debt. That compares with $11 trillion before the Brexit vote. The surge in sovereign debt since Britain’s vote to exit the European Union last month has pushed yields on about 70% of the securities in the $1.1-trillion Bloomberg Germany Sovereign Bond Index below the ECB’s -0.4% deposit rate, making them ineligible for the institution’s quantitative-easing program. For the euro area as a whole, the total rises to almost $2 trillion.
As Bloomberg adds, following a rush for safety and a scramble for capital appreciation ahead of more ECB debt purchases, the yield on German 10-year bunds to a record-low, and those on securities due in up to 15 years below zero, even though - paradoxically - the rush to buy these bonds has made them no longer eligible for direct ECB purchases as they now have a yield lower than the ECB's deposit rate threshold.
Or rather, they are ineligible for the time being.
As a result, the rally has boosted the same concerns we warned about for the first time in the summer of 2014, namely that the ECB’s Public Sector Purchase Programme could run into scarcity problems well before its completion date of March 2017, prompting speculation policy makers may tweak their plan.
ECB's QE began in March 2015 and was initially due to run until September 2016, before being extended by six months earlier this year. Apart from the deposit-rate floor, there are limits on how much the central banks may own of each bond, and each nation’s overall debt, while purchases must also be carried out in line with the ECB’s capital key, which is roughly in proportion to the relative size of each euro-area economy. That means Germany must back up the biggest proportion of purchases, even as the stock of eligible securities gets ever smaller.
The ECB's implicit admission of an apriori failure came in March of this year when the ECB had no choice but to expand its bond buying program to corporates, unleashing an unprecedented central bank intervention in corporate securities, in the process directly manipulating the corporate bond market.
Central-bank officials acknowledged the concerns that its asset-purchase program could face implementation challenges over time, an account of the June 2 Governing Council meeting published on Thursday showed. Officials next set policy on July 21.
Meanwhile, the frontrunning of the ECB continues: German bunds have returned 6.9 percent since the start of the year, according to Bloomberg World Bond Indexes. That’s beaten a 5.2 percent gain in Spanish bonds, and 3.6 percent return in Italy’s - two nations likely to be among the biggest beneficiaries of any move to loosen QE rules.
That said, it is only a matter of time before the ECB moves the goalposts again. Recall just a week ago Bloomberg reported that the European central bank was about to fold:
- ECB SAID TO WEIGH LOOSER QE RULES AS BREXIT DEPLETES ASSET POOL
- ECB OPTIONS SAID TO INCLUDE MOVING AWAY FROM QE CAPITAL KEY
- ECB SAID TO BE CONCERNED ABOUT SHRINKING POOL OF ELIGIBLE DEBT
A Reuters report refuted this news the day after, but the trial balloon for the market reasponse was already in place. We expect that during the next ECB meeting Draghi will announce changes to existing ECB policy and do away with the deposit rate floor entirely, or in combination with the elimination of the ECB's capital key.
After all, the ECB will not rest before it is the proud owner of all European sovereign and corporate debt.