Article / 16 March 2016 at 11:00 GMT

Weekly Update: Corporate bonds surge on ECB inclusion

Fixed Income trader / Saxo Bank
Denmark
  • Corporate bonds jump after ECB includes them in bond-buying programme
  • ECB included investment-grade rated non-financial corporate bonds
  • Distance to expansion into high-yield bonds or even equities does not seem large
  • HY corporate bonds have also rallied fiercely
  • New policy has led to liquidity shortfall and a spike in the primary market
  • Underlying demand for yielding assets strong as ever in euro-denominated bonds
  • Entry of world's biggest potential buyer will only enhance these trends

ECB headquarters in Frankfurt
ECB headquarters. When potentially the world's biggest buyer says it will expand its bond-buying to corporate debt, a frenzy ensues in the corporate bond market. Photo: iStock


By Michael Boye

Corporate bonds have rallied frantically after the European Central bank last week unveiled aggressive new stimulus measures, including expanding the bank's bond-buying programme to include corporate bonds issued by non-financial groups.

If anyone had been concerned about a repeat of a December dissapointment, they were certainly put to shame by last week's policy message from the ECB.

ECB president Mario Draghi firmly reminded the market that the bank's options (and willingness to deploy the neccesary measures) are indeed "limitless", when it announced the series of new measures, including cuts in all three benchmark rates, expanded quantitative easing and inclusion of investment-grade rated non-financial corporate bonds in the buying scheme.

Following some post-announcement jitters, markets -- especially corporate bonds -- have rallied on the news as investors began to grasp the magnitude of especially the latter part of the move, hich we believe should not be understated.

Keep in mind that barely a year ago markets were debating the then controversial decision to buy government debt. Now the ECB will indirectly lend money to private corporations, or doing the same thing it has been trying to get banks to do by dropping deposit rates into negative territory. This has proved rather unsuccessful so far, as banks have been busy adjusting to tougher regulations and capital requirements as well as re-inventing their business models. 

Whether the new policy will manage to achieve the stated end-goal of securing credit flow to the "real" economy, enhancing the so-called transmission mechanism, remains to be seen, and there is good reason to be sceptical. After all, how many small and medium-sized enterprises or new entrepreneurs will see their credit conditions improve just because the debt funding cost for large corporates, such as Nestlé, drops from 0.5% to 0.2% or even lower?

In terms of signal strength, however, the move is certainly off the charts, and the (slippery slope to some) distance to an expansion into high-yield bonds or even equities (the BoJ's Kuroda is setting the bar high) doesn't seem all that far. Consequently, high-yield corporate bonds have rallied fiercely as evidenced by the 190 basis points contraction in the Itraxx Xover index (credit spread of European HY corporate bonds) from a February 11 high of 490 bps to a dip below 300 bps earlier this week. 

Furthermore, what these numbers even fail to quantify is the sudden liquidity shortfall in the market when suddenly everyone turned a buyer and offers became few and rare. This development, along with the spike in primary market demand as well (see the 12-1 bid-to-cover ratio for Valeo and the 6-1 bid-to-cover for new UBS CoCos), reassures us that the underlying demand for yielding assets is as strong as ever in the euro-denominated corporate bond market. 

This will only be reinforced by the world's biggest potential buyer crowding out investors in the investment-grade space, prompting investors to hunt for yield in the high-yield and emerging market bond markets.



— Edited by John Acher


Michael Boye is a fixed income trader at Saxo Bank

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