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Easy now: A covered bond blog

23 January 2015
Richard Kemmish

Professional ECB commentators have been having a field day this year going on and on about the probability of ECB quantative easing in the form of buying government bonds.

Professional ECB commentators have been having a field day this year going on and on about the probability of ECB quantative easing in the form of buying government bonds. But they do seem to be fixated with the, ‘will they?’/’won’t they?’ part of the debate and not saying a whole lot about ‘what happens if?’ Maybe that’s up to the rest of us, maybe that is too heavily dependent on the details (or modalities as they like to call it for some reason) of the programme. So, a few thoughts from my side. 

The impact of a good hefty government bond buying programme on the covered bond market, for me, boils down to three things: what happens to the covered bond buying programme, whether QE  works and – that old covered bond debate – whether covered bonds are correlated more to govvies or swap spreads. 

The second covered bond purchase programme just seemed to whither away when it became obvious that it was irrelevant. I’m not sure that it was ever officially cancelled, it just stopped happening. 

Would the same apply to the third programme if the ECB started buying government bonds instead?  The rhetoric at the launch of the covered bond purchase programme focussed on the role the instrument could play in channelling funds to the ‘real economy’. Was this true? Or was it a way of playing down the detail that it was de facto quantative easing? If the former, there must be a case to continue with it. The inclusion of securitisations in the programme (even if it hasn’t been particularly successful so far) would suggest that this is the case. If it was just a mask for QE then we can expect the programme to go the way of the second one. 

Secondly, will QE be successful? No idea. But if it does generate growth it would argue for spread compression between different jurisdictions. To the extent that it does work it might also argue for a steeper yield curve than the ridiculously low long term rates currently priced in. In other words: good news for credit, bad news for rates. 

Which leads me to the final factor: what will the impact be on government bond rates and therefore relative value of covered bonds. Long before the crisis covered bond analysts used to talk about the correlation of covered bonds to either swap rates (as a proxy for credits) or Bunds (as a proxy for rates). Pfandbrief had roughly a .5 correlation to both (in other words, if bund/swap spreads widened by 2 basis points, the pfandbrief would widen 1 basis points relative to bunds but narrow by 1 relative to swaps). Other products were more heavily correlated to swaps, up to cedulas whose spreads over bunds moved almost entirely in step with movements in swap rates to bunds. 

Will this relationship reassert itself when markets normalise? Or will huge buying of government bonds distort the relationship of govvies to every other security?  

Sorry, more questions than answers. But as QE via government bonds looks increasingly likely its time to start asking them.

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