These Bonds Should Make ECB Hawks Apoplectic With Rage
(Bloomberg Gadfly) -- This is tapering?
With the economic recovery well under way in Europe the European Central Bank has cut its government bond purchases by two-thirds. Fair enough. However, it is not reining in its involvement in company debt. The securities now comprise about 20 percent of monthly purchases, up from 7 percent at the start of the program in mid-2016. The total amount could top 200 billion euros ($244 billion) before quantitative easing ends.
If it had any self-knowledge the ECB should be aware of the problems it's creating. The fact that, by its purchases, it has soaked up all the liquidity in the secondary market and has had to turn to the primary market should be a warning sign.
The central bank's growing involvement in company borrowing should be causing ructions among the hawks on the Governing Council, who seem alive to the dangers of being late in withdrawing stimulus. Yet their silence is deafening.
Through QE the ECB has invested in over 230 individual companies, and with an average maturity of 5.6 years it's impossible to see them as being exposed only in the short term. Performance has been decent -- spreads have tightened on about three-quarters of its holdings. The odd misstep, such as having to liquidate Steinhoff Europe AG or German fertilizer maker K+S AG bonds when they fell below investment grade, can be overlooked.
The knock-on effect of such largess is that corporate bond spreads have had a seemingly unending streak of achieving record lows. Support for credit markets in times of strife is one thing. But driving outsized performance isn't just storing up trouble for an individual company or investor for the future, it's a reckless refusal to allow financial discipline to inform the decision making of actors in the financial system.
S&P Global Ratings's upgrade of ArcelorMittal is a case in point. The rating rose to BBB- on Feb 1, which made its bonds eligible for ECB purchases. Its latest euro-denominated deal, issued Nov. 28, has since tightened 40 basis points, significantly outperforming the iTraxx crossover CDS index.
Though the company is still a long way from being a solid investment-grade credit, the fact that the ECB is allowed to buy it, has no other steel exposure, and could perhaps do with the extra yield suggests it's a likely candidate to finding its way into its portfolio. It's hard to see why an industrial company operating mostly in emerging markets should receive European state aid. But if a South African mattress conglomerate can make it into its holdings, so could ArcelorMittal.
The surge of demand for additional tier one bank capital is another particularly worrying phenomenon. Investors face a total loss if the issuing bank's capital ratios fall below regulatory requirements. Raiffeisen Bank International was able in January to issue an AT1 perpetual bond at 4.5 percent, having issued a similar 6.125 percent AT1 security in June. Though there was a one-notch credit-rating upgrade, that can hardly justify such an enormous improvement. And 4.5 percent can never be enough compensation for the risk of getting completely wiped out.
That is the effect the ECB's corporate bond program is having -- funds that are on the hook to provide a certain return to their clients are driven to ever-risky securities because the central bank has crowded them out. While that is surely the point of an official program of credit easing, and perhaps a benefit when measures are introduced during a period of crisis, the bank is now continuing support for the market when economies are flourishing and a range of borrowers can tap open markets.
In the meantime, officials are injecting massive doses of nitroglycerin into debt markets that will seep into the cracks of corporate finance. When the ECB clarifies its forward guidance at its next meeting on March 8, it should be calling time on its corporate bond experiment.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Marcus Ashworth is a Bloomberg Gadfly columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.
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