With the latest ECB statement due out in just two days, traders are curious to see how Mario Draghi will escape from the trap in which the European central bank has found itself: on one hand, seeking to temper the recent dramatic rise in the Euro, on the other running out of QE eligible private-sector debt to monetize, especially in its largest captive market, Germany. While we don't know how Draghi will succeed (or fail) in this endeavor, overnight Deutsche Bank has released a useful analysis breaking down what share of bond markets the biggest central banks currently own.
In the analysis, DB puts the ECB CSPP holdings in the context of global QE by comparing what part of relevant markets is owned by major central banks. Then it provides a more granular update on the latest CSPP purchases, including the geographic breakdown of the current CSPP universe. Further, it focuses on the CSPP vs. PSPP dynamics, noting the conflicting signal between Q2 and the summer months. Finally, it addresses the question whether in selected jurisdictions CSPP purchases could be used to partly replace PSPP purchases if for one reason or the other the ECB cannot exit QE any time soon and scarcity becomes a hard, binding constraint in some government bond markets.
The answers are shown in the table below, which compares central bank QE holdings across asset classes with Deutsche Bank's estimates of the size of the corresponding markets. Using those estimates, the German lender calculates the fraction of each relevant universe in central bank ownership.
For the ECB alone, the latest number show that the Eurosystem holds €107bn of corporate bonds as part of its €2.1tn QE portfolio. Since the CSPP started, it has been 9.9% of the overall QE flow (9.6% before QE was trimmed by a quarter in April 2017 and 10.6% since then). However, because the other parts of QE started earlier, the CSPP currently represents only 5.2% of the QE stock
The next chart provides a visual representation of the same.
- The most extreme case is Japan where the BoJ owns nearly 45% of the JGB market. For the other major central banks engaged in QE, the percentage ownership of the government bond market is in the low 20s.
- In the ABS space, central bank ownership is nearly 20% in both the eurozone and US. Further, the ECB owns about 27% of the relevant covered bond market. As is well known, the BoJ also conducts purchases of equities as part of its QQE (Quantitative & Qualitative Easing) and we estimate that it effectively holds nearly 3% of the Japanese stock market.
- In the investment-grade bond space, in bank-based Japan, with a relatively less developed corporate bond market, the BoJ has amassed roughly 13.5% of the market. In the BoE case, the CBPS has brought its ownership of the UK IG corporate bond market to about 3.1%. And finally in the case of the ECB, the CSPP has brought its ownership of the eurozone IG corporate bond market to 5.1%. Unlike the BoE which has stopped the CBPS, the CSPP number is expected to grow as the programme continues for many more months.
Going back to the ECB, figure 3 shows quite clearly that the ECB ownership of the eurozone corporate bond market is low compared to the other bond markets. That invites the question whether the ECB could put greater weight on the CSPP if for one reason or the other it cannot exit the QE any time soon and starts to feel scarcity or liquidity constraints in the other asset purchase programmes. And less acutely, whether the relative weight on the CSPP could increase for a while as a gradual QE taper/trimming is implemented as early as next year. However, as Bank of America has noted repeatedly over the past few months, corporate bond liquidity is notably lower in Europe than in the government bond market and it is therefore not straightforward to assess which market offers relatively more room for a greater presence of the central bank. Finally, don't forget that Reuters trial balloon from last Septmeber, which may now seem like a distant memory, according to which the "ECB may be forced to buy stocks."
While the ECB's monetization of stocks is likely years away, the immediate question is what will the ECB cut first, or least. According to Deutsche, "the ECB might prefer to trim the CSPP less than the other programmes, at least initially." DB's strategist Michael Jezek explains why below:
- The CSPP started later than the PSPP (& CBPP & ABSPP) and the scarcity constraints seem lower, especially given robust net issuance of EUR IG corporate bonds. It should matter little that the ECB has made only about 15% of CSPP purchases in the primary market as shown in Figure 4. As long as net issuance is strong, the ECB can buy from private investors in the secondary who then go to buy in the primary. (The difference is that a greater emphasis on secondary purchases should have a stronger spread tightening effect, all else equal.)
- The CSPP offers a direct credit easing tool, which the central bank should see as preferable to the PSPP that relies on the substitution effect through which displaced government bond investors are pushed into corporate bonds. Admittedly, the countervailing incentive here is not to cut PSPP support for peripheral sovereigns too fast. But on balance, we would still expect some preference for the CSPP.
This is why so much attention has been paid to the relative pace of CSPP and PSPP purchases since QE was trimmed in April. Figure 5 summarises the QE dynamics since the CSPP began in July 2016, showing different components of the programme and also highlighting the evolution of the monthly CSPP/PSPP ratio over time. The key observations are as follows:
- August was the weakest QE month since the CSPP started and corporate bond purchases at €4.7bn were the second weakest ever, with only December having been weaker (€4bn).
- In Q2, the CSPP/PSPP ratio was well above the previous average, indicating the CSPP had been trimmed less than proportionately. However, this ratio was below the pre-trimming average in both July and August, possibly suggesting Q2 saw a bit of front-loading in preparation for relatively weaker corporate bond liquidity over the summer.
Thus, all eyes on relative CSPP and PSPP purchases in September when markets are back to full business
* * *
Finally, DB says that a client question was whether purchases of German corporate bonds could selectively replace Bund purchases if their scarcity becomes a hard, binding constraint. Its views are as follows:
- The distribution of corporate bonds across the eurozone does not mimic the distribution of government bonds or the ECB capital keys. In Figure 6, we show the value of bonds on the list of CSPP holdings by country (of risk & incorporation). While the ECB does not disclose how much of each individual bond on the list it holds, it aims to follow a benchmark based on outstanding eligible securities in each jurisdiction. Therefore, the chart should broadly reflect the allocation of ECB purchases across countries. Based on country of risk, most eligible bonds are French (29.5%), followed by German (25.1%), Italian (12.3%), Spanish (9.1%), Dutch (6.7%) and Belgian (4.5%).
- We do not think the ECB would deviate from the CSPP benchmark in order to replace PSPP purchases of Bunds (or singling out any other sovereign), if only because objections could be raised on the grounds of competition rules (favouritism towards some eurozone corporates at the expense of others).
- On average, the ECB/Eurosystem holds 14.3% of each issue it has bought from the eligible universe of over €750bn. (Thus, it should hold €31.6bn of French, €26.9bn of German, €13.2bn of Italian, €9.8bn of Spanish, €7.2bn of Dutch and €4.8bn of Belgian corporate bonds, among others.) However, while that implies that some €160bn of German corporate bonds still remain "available", their liquidity is nowhere near that of Bunds. While we think that the ECB could put some more weight on the CSPP proportionately across jurisdictions, we do not think the programme can be ramped up to replace a meaningful part of the PSPP without distorting corporate bond markets too much.