The ECB surprised the market with a further dose of quantitative easing last month. But the emphasis on balance sheet is proof that using interest rates as a mechanism is a busted flush as far as ECB supremo Mario Draghi is concerned.
Though he cut the deposit rate further, Draghi knows he needs the banks to be healthy to get through this and so offered more borrowing at zero rate, or lower, through the longer-term refinancing operations (TLTRO) to encourage them to lend. Draghi will also increase his bond-buying by a third, up to €80bn from €60bn and is targeting euro-denominated non-financial corporate bonds. So far, the details haven’t been shared, but PIMCO expects him to buy around €4bn in non-financial corporate bonds a month, placing the ECB is firmly in the realm of credit easing says Andrew Bosomworth, managing director and portfolio manager at PIMCO.
“Although we acknowledge the marginal efficacy of monetary policy is declining, we disagree with the view the ECB has run out of ammunition. There remains a large amount of assets outstanding that the ECB could theoretically purchase.
“And now that it has started with corporate bonds, blue-chip equities are not a far step away, if ever needed,” says Bosomworth, who is on Draghi’s side on the question of helicopter money.
He adds: “We think the ECB is a long way from contemplating forms of monetisation, and if history is any lesson, investors aren’t keen on monetisation either.”
However, the question remains as to where all these bonds will come from. Financials make up almost exactly one third of the euro investment grade universe (see chart above which shows what is left as portions of investment grade bonds are removed).After you exclude banks and you chip away at the other areas that won’t be covered by the policy, there is only €554bn left to play with.
It does nothing to help investors seeking yield and income, as areas eligible for the ECB’s programme will become more expensive and more illiquid. This is likely to focus minds on finding opportunities in peripheral government, investment grade corporate and high yield bonds and this will require careful credit analysis, says Bosomworth. “The Eurozone’s private sector is still deleveraging and banks need to dispose of their non-performing loans. For active investors, this constitutes an opportunity.”
