Asset managers have criticised the European Central Bank’s (ECB) decision to purchase covered bonds and asset-backed securities as too small to make a major impact on the economy.
Large European asset managers like Schroders and M&G Investments have called for more coordinated and supportive regulation, saying the ECB will need to do more as the eurozone economy remains weak and the monetary bloc risks falling into deflation.
Mario Draghi, president of the ECB, confirmed a programme to purchase covered bonds and asset-backed securities (ABS), in a press conference in Naples, Italy, yesterday.
The ECB plans to buy covered bonds from mid-October and ABS from the fourth quarter of this year. As much as €1 trillion in assets could be purchased, with the wider aim of increasing the ECB’s balance sheet to the levels seen in 2012.
Draghi also confirmed that interest rates would remain unchanged and reiterated the aim of maintaining inflation rates at around 2%.
He says that the new purchasing programmes would last for at least two years, and have “a sizeable impact” on the ECB balance sheet.
“The new measures will support specific market segments that play a key role in the financing of the economy,” he adds. “They will thereby further enhance the functioning of the monetary policy transmission mechanism, facilitate credit provision to the broad economy and generate positive spillovers to other markets.”
Azad Zangana, European economist at Schroders, says that Draghi’s speech was a disappointment to investors, as the president failed to offer specific details about the plans.
“Investors had hoped that the ECB would step-up stimulus plans after the recent weakness in both growth and inflation data, either by announcing a very large amount of purchases, or the addition of sovereign debt purchases,” he says.
“However, Draghi merely confirmed previously announced measures, but without revealing the scale of the programme.” In the past, Draghi had signalled that he would like the ECB’s balance sheet to return to the peak seen in 2012, which Zangana says would imply an additional €1.1 trillion.
“However, he played down the notion of returning to past peaks – a sign that the governing council either did not support the notion, or that it understands that it may not be possible.”
Zangana says the main problem that the ECB faces is that the group of assets being targeted is “too small to make a major impact on the economy”.
“We believe the ECB is aware of this problem, which is why it has not set a purchase target. As a result, European equities and bonds are trading lower (in price), while the euro has appreciated slightly.”
He says that although purchases of private assets may begin in the near future, policy makers are likely to want more time to assess the impact of all of the measures recently announced. He adds, however, that Draghi did emphasise that the governing council would unanimously support further unconventional measures if needed.
Zangana concludes: “The clear message is that monetary policy in Europe will remain loose for a very long time, which contrasts with the US and UK, where markets expect interest rates to rise next year.”
Patrick Janssen, ABS portfolio manager for M&G Investments, also sees a need for “more coordinated and supportive regulation”, if the ECB’s purchasing plans are to be a success.
He says: “Given Solvency II makes it extremely challenging for insurance companies to buy ABS, the burden really falls on other investors, chiefly pension funds. It was notable and surprising that there was a marked lack of emphasis in Draghi’s press conference on this vital matter.”
Janssen says that the ECB must address this regulatory issue if it intends to give the ABS market a sufficient boost to encourage more new issuance and bank lending over the long term.
He adds: “We believe there needs to be more action on the rules that impede large segments of the market from allocating significant amounts of capital. Until that happens, today’s action is unlikely to have a lasting effect on new ABS issuance.”
Janssen says that spreads are tightening across the ABS market, with the biggest movement in peripherals.
“Senior Spanish residential mortgage-backed securities (RMBS) have come in some 30 to 40 basis points and now trade inside UK non-conforming bonds, which, being outside the eurozone, are not in the ECB’s scope. In fact, even weaker Spanish RMBS are on a level with UK non-conforming. There is a similar story in Italian and Portuguese bonds.”
He also highlights that the inclusion of Greece in the programme had an immediate effect on Greek ABS, with eligible bonds moving up by one to two points.
Paul Brian, leader, fixed income at Newton Investment Management, also says that the limited information from the ECB is “disappointing the markets”.
He comments: “We believe they will need to do more as the economy requires further stimulus, whether this comes in the form of direct quantiatative easing into government bonds is still open to debate due to prior German resistance to the idea. At the very least, it opens up the chances of less fiscal restraint, which ultimately could prove beneficial.”
Brian says he expects bond yields to continue to trend lower and spreads to eventually narrow.
“The current ‘risk off’ phase is more widespread than just Europe and is producing a period of weakness for corporate and emerging market bonds. This phase is unlikely to be reversed by yesterday’s lacklustre showing by the ECB.”
In response to Draghi’s speech, Darren Ruane, head of fixed interest at Investec Wealth and Investment, focuses on the wider picture. He says: “The overall macroeconomic backdrop remains weak, with anaemic credit growth. Geopolitical concerns have also weighed on consumer and business confidence.
“The ECB continues to look at a broad measure of inflation expectations and short and medium term inflation expectations remain low, including the five year inflation swap pricing in medium term inflation of just over 2%.”
©2014 funds europe
