European Bond Market Rally Continues

The European Central Bank surprised investors last week with announcement that it will start buying corporate bonds. It certainly is an unprecedented central-bank stimulus measure what leaves more questions than answers at this point in time.

Source: Wall Street Journal

The European Central Bank’s announcement that it will start buying corporate bonds continued to boost credit markets, even as some investors ask how his program will work and whether it will fuel a credit bubble.

European credit markets rose sharply after the ECB surprised investors last week with the announcement. The cost of insuring against a default on European investment-grade debt fell to levels unseen since August as credit rallied across the board.

But many investors remain cautious as they scramble to assess the implications of this almost unprecedented central-bank stimulus measure with few details to go on.

Investors worry the central bank may become a giant buyer that will fuel a bubble in European credit and hit secondary-market liquidity. For the ECB, the plan could bring complications, forcing it to pick winners and losers in companies and sectors.

“This really is a game-changer,” said Philippe Berthelot, head of credit at Natixis Asset Management.

But “it’s not necessarily a win-win” situation for the bond market, he said.

The ECB said that it will start buying the investment-grade, euro-denominated debt of nonfinancial eurozone companies toward the end of the first half of the year. It has ruled out buying bank debt.

ECB President Mario Draghi said buying corporate bonds would help further ease financing conditions in the eurozone economy. That could make it cheaper for companies to borrow money to invest.

Corporate bonds will be included in the ECB’s broader asset-purchase program, which mainly focuses on government debt and, on Thursday, was expanded from 60 billion euros ($67 billion) to 80 billion euros a month.

The ECB’s other forays into buying private-sector assets have had mixed results. In 2014 the ECB launched a program to buy asset-backed securities, which bundle loans and mortgages into new debt.

But the bank has been slow in buying bonds for reasons that remain unclear, pointing to the potential headache for a central bank as a large-scale buyer of private-sector assets. By March 4, the ECB had bought only 19 billion euros of this debt.

Nicolas Trindade, a portfolio manager at AXA Investment Managers, said that the ECB program could encourage investors to buy bonds just on the assumption their prices will keep rising, without paying attention to the creditworthiness of individual companies.

Investors also worry that the ECB could end up holding large portions of the market and harm liquidity, meaning it is harder for others to buy and sell debt without unduly moving prices. Some investors point to the recent decline in liquidity in the market for covered bonds, a type of secured bank debt, which the ECB started to buy in late 2014.

For the moment, bond investors are looking on the bright side.

The annual cost of buying default protection on $10 million of European high-grade debt for five years using credit-default swaps, or CDS, fell to $68,000 Friday, according to Markit, around $25,000 lower than before the ECB’s announcement.