Living up to expectations: QE and European corporate bonds
Felix Freund, investment director Fixed Interest at Standard Life Investments comments on the impact of Eurozone QE on European corporate bonds.
In January this year the ECB surprised markets with a larger than expected quantitative easing (QE) scheme known as the Public Sector Purchase Programme (PSPP). It has been six months since this announcement, and five since the ECB started buying. After the fanfare, what has been the impact on corporate bond markets?
At €60 billion a month, the programme is comparable to the US Federal Reserve’s QE programme both as a percentage of GDP and in relation to the size of the overall bond market. Perhaps more importantly, it is larger if compared to expected net issuance, as the US government was running a higher deficit at the time compared to the Eurozone today. While the Fed’s programme basically financed the additional growth of US government bonds issued to pay for the deficit, the ECB’s planned purchases of government bonds, asset backed securities, covered and agency bonds will outstrip expected net issuance by 250% in these segments.
This will have the added stimulatory effect of shrinking the total value of bonds outstanding in the market available to investors (see Chart 1), resulting in higher “crowding out” effects in European bonds markets than in the US. For many institutional investors in Europe one obvious consequence is a greater reallocation of assets into investment grade corporate bonds. Retail investors are also more likely to allocate towards higher yielding assets given the historical low yield on sovereign debt. Corporate bonds were not part of the programme initially but the ECB opened a backdoor in July by adding a few southern European governmentowned utilities and transportation companies to the eligible list for PSPP.
We think this is not necessarily the start of broad-based buying of corporate bonds but it sends a signal to the market that the ECB is ready to increase the scope of the programme if the original objectives are missed or if the debt crisis in Greece broadens into the rest of the Eurozone.
In theory the programme should have provided a strong support for European corporate bonds. However after the initial announcement effect, euro corporate bond markets have under-performed. We think this can be explained by three main factors. Firstly, investors had been anticipating sovereign QE since the second half of 2014 and positioned themselves accordingly in the run up to it. Secondly, Eurozone growth and inflation expectations have been revised upwards and are now aligned with the ECB’s projections, creating some concerns about overall bond valuations despite the ECB’s buying programme. Thirdly, non-Eurozone domiciled corporates and banks took advantage of the relative cheapness of the euro market and issued a record amount of new bonds leading to supply indigestion. Amongst other factors the impact of the Greek debt talks, the slowdown in China and expectations of tighter Fed policy have
all impacted European corporate bonds in recent weeks.