Enforced risk-taking

Thierry Million
Written by

12th April 2016

The European Central Bank (ECB) surprised the markets by announcing its decision to include non-banking corporate bonds issued by Eurozone companies in its asset purchase programme. According to initial estimates, the ECB could purchase €50 billion per year, out of a total market of €1,000bn eligible securities. As a logical result investment-grade CDS spreads tightened significantly, narrowing from over 0.92% to 0.72%. Investors anticipated that demand from the ECB would cause scarcity among corporate debt securities, while also hypothetically improving issuer creditworthiness due to lower financing costs. The ECB intends to focus its asset purchase programme on the most liquid issues in the secondary and primary markets, in order to fulfil its monthly quota. Based on an estimated €50bn of monthly transactions in non-banking investment-grade securities, the Eurosystem will account for some 10% of average traded volume. High-yield securities (rated below BBB-), which are not included in the ECB programme, nonetheless also rallied sharply, as spreads narrowed from 3.80% to 3.10%. The ECB is thus effectively standing in for, or is even evicting, investors, and encouraging portfolio rotation towards increasingly speculative assets, amid diminishing transaction liquidity. The resulting reduction in risk premiums, accompanied by lower volatility, increases the lure of security. Investors are thus being encouraged by powerful technical factors to adopt the riskiest strategies possible, although an unexpected downgrade in fundamentals is no longer remunerated, but remains a distinct possibility.

Expectation of ECB QE has driven Eurozone corporate bonds from valuations that were looking interesting, to levels that are arguably below ‘fair value’. The squeeze has meant that European investment grade industrial credit spreads have tightened from 160 basis points to below 120 basis points, which is back to mid-2015 levels. While ECB purchasing of corporate bonds is material, the sharp rally in Euro denominated credits will inevitably attract more supply, not only from European companies, but also from non-European companies who will take advantage of relatively cheap financing in the Euro credit markets. Indeed, just days after the ECB’s announcement, Anheuser-Busch issued €13.25bn in a single day, the largest sale ever of EUR-denominated corporate bonds, which will dwarf the size of the ECB’s monthly purchases. It therefore makes sense, in our view, to take advantage of the rally by lightening up on credit risk.

Source: All data Allianz Global Investors as at 08/04/2016

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