On the day Mario Draghi announced that the ECB would launch a historic corporate bond monetization program, the first of its kind, we said that we expect bond yields to tumble imminently as the market frontruns the ECB's open-market purchases of corporate bonds and soaks up all available supply in the market. Not even we expected what would happen next though.
As the WSJ writes, four years after ECB President Mario Draghi‘s famous “whatever it takes” speech sparked a decline in the cost of servicing sovereign debt in the Eurozone’s shattered periphery, the same is now seems to be happening for corporate bond issuers in those countries.
It references the Bank of America Merrill Lynch’s nonfinancial bond index for the Eurozone periphery which includes countries like Italy, Spain, Portugal and Ireland (which earlier today issued a 100 Year bond courtesy of the very same ECB), and which touched its lowest yield to maturity ever on Tuesday, at 0.76%.
Once again, Draghi has worked his verbal magic unleashing a buying spree before the ECB has bought even one single bond, all because other buyers are now completely price indiscriminate and fully aware they have the ECB's backstop.
Perhaps the recent record low yields are a warning: the previous record low yield for the index was 0.78%, which was reached just before the so called bund tantrum of Spring 2015, when credit across Europe sold off, and yields jumped.
However, back then, the buying impetus was driven by the ECB's sovereign QE program when, unlike now, there was no explicit backstop to corporate bond risk. There is now.
The WSJ also points out that yields on other classes of debt have also declined, but not to the levels recorded in the early months of last year.
Financial companies, whose bonds the ECB will not buy, are still a little way from their lows. In March last year, the yield to maturity of the Bank of America Merrill Lynch index for financial companies in the periphery fell to 1.12%, and it’s now at 1.35%.
The index for non-financial companies in the eurozone but outside the periphery also has a higher average yield than it did in April 2015.
This "arbitrage" will be fixed: once ravenous yield chasers run out out of peripheral bonds to buy and the market becomes dangerously illiquid - as we also warned will happen - buying activity will shift to corporate bonds in the core. At that point, once all yields are at record low yields, if not negative, the ECB will proceed to monetize financial bonds as well.
The WSJ's conclusion:
Since the ECB’s bond buying program is designed to spur lending by reducing the cost to corporations, record low yields are good news: for now, at least.
We disagree: what the chart above shows is yet another asset class that is now completely dislocated from its fundamentals, just like European sovereign bonds, which are trading not on their underlying merit but because the ECB has to buy them. The same is happening in the corporate financial space. And, once the corporate non-financial market ends up broken and there is no more supply, the ECB will be forced to expand its bond buying universe again, launching the monetization of junk bonds, convertibles and ultimately equities.
At that point, no news and no fundamentals news will matter any more, and the only driver of "markets" will be whether the ECB's credibility is intact, which in turn will make it a political issue as will the "valuation" of the markets.
And then, one day, when for whatever reason the ECB's mandate to monetize everything is taken away (whether as a result of German revulsion or the political collapse of the Eurozone) prices will once again find their fundamental "fair value." One thing that is certain: it will be far, far lower than where it is with the explicit backing of central banks to buy anything and everything.