The ECB’s Ever-Expanding Shopping List
Bank Considering Buying Corporate Bonds But Efficacy Is Questionable
By Richard Barley
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It’s still all about the central Banks.
That much is clear from the reaction to a report Tuesday that the European Central Bank could decide as soon as December to buy corporate bonds. In short order, the euro fell half a cent against the dollar, stocks and southern European government bond prices jumped and the cost to insure investment-grade corporate debt fell. The ECB said no decisions had been taken.
The ECB has been careful not to rule out further stimulus measures beyond those already announced, such as purchases of covered bank bonds and asset-backed securities. But the market believes the ECB will have trouble lifting its balance sheet back to the size it was in 2012—implying an expansion of €650 billion-€1 trillion—by targeting these instruments. Buying eurozone-government bonds is clearly a last-resort option, such a move being politically controversial and practically difficult.
Buying corporate bonds could give the ECB a big market to aim at: there are €710 billion of securities in the Markit iBoxx nonfinancial senior corporate bond index, and issuance is plentiful. And such a move, while radical, isn’t beyond the pale: the Bank of England and the Bank of Japan have both bought corporate debt.
But there are clearly risks. First, the ECB already has its hands full. It only started buying covered bonds on Monday and will be handing out fresh loans to banks in December. To throw corporate bonds into the mix so quickly might show a lack of faith in the existing options, a bad signal to send.
Second, there is the question of what the ECB would hope to achieve with such purchases, beyond a short-term boost to market sentiment. The iBoxx nonfinancial index currently yields just 1.44%, down from 2.41% at the end of 2013.
And investment-grade companies have no trouble at all raising money—the bigger issue is whether they are willing to spend it. The ECB could make a difference by buying high-yield bonds, which could boost access to markets for smaller companies. But that is likely a step too far: the ECB has already been stung by criticism that asset-backed bond purchases will load its balance sheet with “junk.”
Third, even with a large market, it isn’t clear the ECB could expand its balance sheet quickly. Investors may not be willing to sell, as they would face a reinvestment headache. Indeed, that is one reason for the relative resilience of Europe’s corporate bond market in the current turmoil.
J.P. Morgan Chase & Co. economists suggest purchases could reach €50 billion over one year, extending to €100 billion if market turnover rises. In the context of a €2-trillion-plus balance sheet, that is relatively small.
Despite this, such actions, even if small, could ultimately crowd investors into riskier assets such as stocks. The aim would be to lift prices elsewhere, sparking some confidence that leads to renewed investing and lending. But that may be less effective in Europe than in the U.S., as the continent relies on the banking system to provide financing more than capital markets.
Still, the ECB is facing a clamor for market action that is only getting louder and economic data that is getting worse. Absent unified thinking and action on Europe’s fiscal front, the central bank may have little choice but to stay at the center of the action.
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