Since the spring of 2015, the ECB has been purchasing assets within the framework of its frequently-adjusted asset purchasing programme that has meanwhile reached a volume of nearly 1,772 billion euros. Since this month, the monthly purchasing volume has been tapered from 80 to 60 billion euros. The ECB has stated that the purchases will continue until the end of December 2017 at least, with an extension not only possible but also very likely.
Given the growing problems on the capital market as a result of the asset purchasing programme, the central bank would be advised to start preparations for the exit sooner rather than later. A number of market segments are showing signs of liquidity bottlenecks and market distortions. With its persistently high demand, the ECB has put markets in a state of dependence which will be difficult to end without creating withdrawal symptoms.
This is evident from a look at the longer bond maturities: in some cases their bid-offer spreads tripled or quadrupled over the past year in response to the high demand and relatively short supply. The volatility of the bid-offer spreads was also unusually high, a further sign of a market mechanism that is no longer functioning correctly. As regards short-dated Bunds, the fight for collateral has become so harsh that it has driven the two-year treasury yield close to minus 1%, far off from the reasonable level of minus 0.4%.
The yield premiums of EMU sovereign bonds versus Bunds have of late been increasingly decoupled from the fundamental development (economic trend, rating). The structural departure from the purchasing programme’s quotas for Irish, Finnish and Portuguese bonds is also indicative of the distortion as there is a shortage of liquidity and obviously no price can be determined. The market price no longer seems risk-adequate, with the ECB’s readiness to buy dominating the influence of the fundamental factors. Typical market mechanisms such as rising EMU spreads on the back of falling interest rates are also no longer as pronounced as before, indicating that what we have here is a buyer’s market. This will make the exit all the more difficult: when it becomes clear that yields are rising amid a solid economic development and revival of inflationary momentum, investors can be expected to shorten their durations which in turn will intensify the yield increase in the long-dated segment. And that’s exactly what the ECB wants to avoid. But when the current buyer’s market turns into a seller’s market, it is doubtful whether the central bank, as the only remaining buyer and a reduced purchasing volume, will have sufficient strength to prevent speads from widening on a large scale. In France, it is already proving impossible to smooth down the marked rise in risk premiums. Investors‘ belief in the market’s ability to function independently could be shaken.
The interest rates for the periphery countries are still very low, and a limited increase can be shouldered for a period of time. After that, the only thing left will be to tackle the reform measures that were shelved during the long phase of cheap money.