The latest Barclays Capital’s AAA Investor research looks at the ECB’s recent foray into the sovereign bond market.
The bank’s analysts conclude that compared to the ECB’s entry into the covered bond market, the move this time has been much more aggressive.
As they noted on Wednesday (our emphasis):
Within the scope of its government bond purchase scheme, the Eurosystem appears to operate more aggressively than within the scope of its covered bond purchase programme. Whereas covered bond purchases did not start until two months after the programme was announced, government bond purchases literally started the morning after the measures had been announced, and the €16.5bn purchased in only three days corresponded to what had been spent on the covered bond market in three months.
The problem, though, is that the buying doesn’t seem to be pulling up related assets such as supra-national and agency debt with it. For instance, the analysts write:
Still, spill-over effects on neighbouring asset classes remain moderate for the time being, signalling that investors are returning to the market rather hesitantly, as government bonds have become too expensive for some. With the pricing of government bonds thus being overshadowed by the Eurosystem’s purchases, current swap spread levels of covered bonds and agency debt might instead reflect a more realistic image of the reality on the debt market.
Apparently nowhere is the discorrelation more severe than in the pricing of swaps of Spain’s main supra-national agency the Instituto Credito Oficiale (ICO) versus Spanish government bonds.
As the analysts note:
In the case of Spain, as illustrated above, the correlation between the swap spreads of government debt, agency debt and covered bonds has declined markedly in May. This comes after a very high correlation confirmed the relatively symmetrical swap spread development (the cheapening move in the run-up to the announcement of the €750mn rescue package) in April. Interestingly, the mounting swap spread divergence (as measured by the drop in the correlation coefficient) is most pronounced in the case of Spanish development bank ICO (versus bonos) and in the case of Cédulas Territoriales (which, paradoxically, are backed by loans granted to the Spanish public sector). Despite also falling sharply, the correlation between the swap spread development of Multi-Cédulas and bonos (at 0.8) remained relatively sound, indicating that swap spreads of Multi-Cédulas have reacted more sensitively (ie, richened somewhat stronger) than those of their peers.
And, whereas the analysts would usually have seen such a discorrelation as an opportunity to invest in SSA debt — because SSA debt traditionally follows the performance of government bonds — this time round they’re not quite as hopeful.
In fact, they are expecting the very opposite effect — since the SSA market is now probably a much better indicator of real investor appetite for government debt:
In the medium term, swap spread levels of sovereign bonds, agency debt and covered bonds will likely converge again. Still, we caution that this might not be attributed to a richening of covered bonds – but could, ceteris paribus, result from a cheapening move of government debt.
Oh dear.
No wonder the ECB has been so aggressive.
Related links
Eeek, ICO is getting riskier -FT Alphaville
Riding on a sovereign guarantee in Spain - FT Alphaville
Spain’s ICO distortion – FT Alphaville