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From the sublime to the ridiculous

05 September 2014
Richard Kemmish


The first covered bond purchase programme was instrumental to the recovery, not just of the covered bond market but the much broader funding of the banking system. The second programme was I suppose a nice gesture but, frankly, meh. The third, please no.

For me the announcement of the first purchase programme was a death of Kennedy moment. Everyone remembers where they were when they heard about it. It’s well documented but I think there are two important aspects that get overlooked. Firstly, that it was emphatically not QE. All of the money that the ECB put into the market they subsequently took out of the market elsewhere. No new money.
 
The other aspect is more interpretational, and more nuanced. Whereas some commentators (including some covered bond researchers. The quislings!) said that this was the ECB coming to the rescue of the covered bond market,  the reality was that the ECB was coming to the rescue of the banking system. They just chose to channel that help through the covered bond market as the most robust channel available to them. 

The second purchase programme was frankly unnecessary. Spreads in the covered bond market were already rallying, as they were more generally, in fact both senior unsecured and covered started to exhibit consistent spread moves (on a beta adjusted basis). Perhaps it provided a fillip to the spread rally in covereds, but only at the expense of a consistent senior:covered ratio. Or to put it in terms that central bankers hate, it generated a distortion of the price mechanism.

The fact that they gave up on the second programme half way through was testament to the pointlessness of the exercise. Within a year I was (perhaps facetiously) calling for a covered bond sale programme to restore a balanced two way market.

So what to make of the yesterday’s announcement?

It differs from what went before in three main ways.

Firstly, this is QE. Although the details haven’t been published yet it seems impossible that the ECB will be able to sterilise this amount of buying. They even gave up trying to sterilise the SMP programme a couple of months ago. My contention that CBPP 1 was about helping banks, not about helping the covered bond market may be debateable. But no debate here. This is about helping the economy, even with the potential for adverse effects on the covered bond market.

Secondly, it is a combined ABS and covered bond purchase programme. This could be interpreted as a sign of the rehabilitation of the ABS market or of the unwillingness of the covered bond market to embrace the important new asset class – SMEs. I wonder though if by referring to ABS the ECB was really allowing itself to buy covered bonds that don’t fit into their regular definition of covered bonds.

Third: size. €500bn is just ridiculous in the context of either market’s issuance or outstandings. The ECB aren’t fools, so how are they thinking of spending the money? I suspect that the real objective will be to term out some of the vast quantity of covered bonds and ABS that are already on their books in the form of repo collateral.
 
We’ll have to wait until October to find out more.

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