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ECB Starts Buying German, Italian Government Bonds Under QE Plan

Bloomberg, Mar 9, 2015

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The European Central Bank started buying government bonds under its expanded quantitative-easing plan designed to boost price growth in the region.

Central banks bought German and Italian debt, according to at least two people with knowledge of the transactions, who asked not to be identified because the information is private. They also purchased Belgian securities, one of the people said, and a separate person said French notes were being acquired.

Bonds rallied. The yield on Germany’s 10-year bunds fell five basis points, or 0.05 percentage point, to 0.35 percent at 10:30 a.m. London time, approaching the record-low 0.283 percent set on Feb. 26. Italy’s 10-year yield declined three basis points to 1.29 percent.

“The QE purchases are having the expected effect and the market is very positive,” said Michael Leister, a senior rates strategist at Commerzbank AG in Frankfurt. “In the core we’re seeing yields dropping sharply lower led by the ultra-long end so these are very much QE-style moves. Near-term it’s going to stay quite volatile because there are some sellers who did front-run these purchases and now are keen to sell.”

The ECB said in a Twitter post that it had started purchases along with national central banks. The Bundesbank was active in the market from 9:25 a.m. Frankfurt time, a spokesman said by phone.

Tighter Spreads

Anticipation of the 1.1 trillion-euro ($1.2 trillion) plan already fueled a debt-market rally that sent yields in the 19-nation currency bloc to all-time lows. ECB President Mario Draghi said in Cyprus last week that the stimulus will spur the euro area’s fastest economic growth in seven years and help return inflation to the ECB’s goal.

“The ECB may well have to bid bonds aggressively to procure them from their holders, in particular to avoid question marks around the credibility of its QE delivery,” Cagdas Aksu, an analyst at Barclays Plc in London, wrote in an e-mailed report. Yields on the safest euro-area bonds “will remain suppressed,” he wrote. “We also expect the core-periphery spreads of Italy and Spain versus Germany to grind tighter in this environment.”

Belgium’s 10-year yield tumbled six basis points to 0.57 percent and the rate on similar-maturity French debt dropped five basis points to 0.64 percent.

Scarcity Concern

Speculation over the impact of the quantitative easing program has dominated trading of euro-area bonds since it was announced in January. Some holders of government securities have indicated an unwillingness to sell, sparking concern that there will be a scarcity of available debt for the ECB to buy. There’s also a risk that flexibility and limited information on the plan stirs market volatility.

The ECB said last week that the purchases, which are to include public and private debt, will be conducted in the secondary market by national central banks via existing counterparties. That’s in contrast to the Federal Reserve’s approach, which involved a calendar telling dealers what it intended to acquire and when.

While the ECB has said that only securities due between a minimum two years and a maximum 30 years and 364 days at the time of purchase will be eligible, national central banks will have some wiggle room as they carry out purchases within their home markets, allowing them some choice between government and agency debt.

Purchases of bonds will be made roughly in proportion to the capital that each member central bank has contributed to the ECB, though that guideline doesn’t have to be strictly followed every month. There’s also flexibility on what maturity of bonds will be bought by the central banks to reach the target of 60 billion euros a month.

Cautionary Tale

Events in Japan in 2013 may offer a cautionary tale for dealers and central bankers alike. That nation’s government-debt market was rocked as its central bank expanded a quantitative easing program. After yields fell to record lows, they more than doubled in five weeks amid confusion by banks that were supposed to help facilitate trading of the securities, obliging the Bank of Japan to boost the number of operations it held each month to buy the debt.

Borrowing costs in the euro area have plunged on concern the plan may lead to a limited availability of fixed-income assets. The average yield to maturity on the region’s government debt reached 0.538 percent Feb. 26, the least since at least 1995, according to Bank of America Merrill Lynch indexes.

Balance Sheet

About 45 billion euros a month will probably be spent on sovereign debt, a central bank official said Jan. 22. That implies an intention to purchase 14 percent of euro-area government bonds outstanding by September 2016, or 18 percent of securities from Finland, Germany, Luxembourg and the Netherlands, the only nations with two or more AAA ratings from the three major credit-assessment companies.

To rekindle inflation in the euro area, Draghi has said the central bank intends to expand its balance sheet toward 3 trillion euros. Since October, when it announced details of plans to purchase covered bonds and asset-backed securities, the ECB’s balance sheet has grown from 2.05 trillion euros.

It took the Fed almost six years, and three rounds of quantitative easing, to boost its holdings to about 20 percent of U.S. Treasuries.

Buying Competition

Reduced government spending is likewise contributing to a global dearth of sovereign debt. Germany is due to curb the amount of conventional bonds outstanding by 8 billion euros this year. In Spain, where Prime Minister Mariano Rajoy’s People’s Party has implemented the deepest austerity measures in the nation’s democratic history, the net issuance target for 2015 is 55 billion euros, down from net sales of 97 billion euros in 2012.

With austerity measures and ECB buying, the euro-area sovereign-bond market will shrink by 259 billion euros in 2015, Morgan Stanley strategists, including London-based Neil McLeish, Anthony O’Brien and Serena Tang, forecast in a report in February.

Competition for purchases may come from banks requiring bonds to meet regulatory rules, pension funds that need to match their liabilities, passive investors who track debt indexes, and other central banks, which buy European securities as part of their balance-sheet management.

Negative Yields

Draghi added to demand for higher-yielding bonds last week, when he said securities won’t be purchased if their yields are below the ECB’s deposit rate of minus 0.2 percent.

Seventy-seven of the 346 securities in the Bloomberg Eurozone Sovereign Bond Index already have rates below zero, meaning buyers would get less back when the debt matures than they paid to buy them. Germany’s six-year yield was at minus 0.04 percent.

The ECB may have to cut its deposit rate further to ensure enough government bonds are eligible for purchase, according to Standard Bank Plc head of Group-of-10 strategy Steve Barrow.

Portuguese securities probably will fare best under the central bank’s program, according to a survey last week of the 37 banks that deal directly with Germany’s debt agency. Fourteen of the 20 financial institutions that responded on March 2-3 identified them as one of their top picks, saying they were attractive because they had the highest-yields of bonds included in the plan, and the nation’s debt market should be among the most saturated by ECB bids.

Whatever Necessary

The rally in bonds is a boon for the governments in the region because their borrowing costs should fall in international markets. Portugal took advantage of the upswing in demand to sell 30-year securities in January, the longest bond maturity since the country exited an international aid program. The nation’s debt agency has issued almost 60 percent of its 2015 target.

That’s a turnaround from 2011 to 2012, when concern the euro area would splinter under its debt load pushed yields to record highs and Draghi pledged to do whatever was needed to save the currency bloc.

Portugal’s 10-year yield was little changed at 1.75 percent, from a record 18.289 percent on Jan. 31, 2012.

The drop in yields has also helped to weaken the euro as it dimmed the allure of holding the currency and made it more attractive to borrow in the euro region in order to invest where yields are higher. Germany’s 10-year bunds yield about 188 basis points less than similar-maturity U.S. Treasuries, the widest yield discount since 1989, according to data compiled by Bloomberg.

Euro’s Slide

Only Brazil’s real and Denmark’s krone have fared worse versus the dollar this year than the euro among 17 major currencies tracked by Bloomberg. Even after a gain of 0.4 percent on Monday, it has weakened about 10 percent to $1.0891, reaching the lowest level since 2003. It touched the weakest level versus the British pound since 2007 on Friday and a record low against the Swiss franc in January.

The outlook for inflation is reviving as the lower yields and currency boost prospects for growth and exports. The five-year, five-year inflation swap, a market gauge of inflation expectations in the second half of the next decade, climbed to 1.7675 percent on Thursday, the highest this year, and up from a record-low closing rate of 1.48 percent in January. It was at 1.7265 percent on Monday.

The price of Germany’s 0.5 percent bund due in February 2025 rose 0.44, or 4.40 euros per 1,000-euro face amount, to 101.48.

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