16 May 2016
ECB’s credit purchase programme
With no policy change at the March European Central Bank (ECB) meeting, the market’s main focus was on the details surrounding the upcoming Corporate Sector Purchase Programme (CSPP). Overall the scope of the programme exceeded expectations with the investible universe based on the ECB’s criteria at €700-800 billion up from €400-500 billion estimated prior to the announcement.
Specifically the programme will include:
- Non-bank financial institutions, including insurance issuers
- Bonds issued by corporations incorporated in the euro area whose ultimate parent is not in the euro area are eligible once they meet the other relevant criteria. Thus several non-euro area corporates from the US, Switzerland and the UK are eligible
- Negative yielding corporate bonds
- Minimum rating of BBB-
- Maturity of between 6 months and 30 years
- Issue share limit size of 70%
- Bonds must be eligible for the Eurosystem’s collateral framework
The CSPP will commence in June and will be conducted by six national central banks and will use both the primary and secondary markets for purchases. The ECB has not given any guidance regarding the size of corporate purchases but market estimates are for approximately €3-5 billion per month.
European Investment Grade spreads have rallied since the announcement and we believe that this additional buyer of European credit will provide a strong technical support in the European market. Another beneficiary of the programme is US Investment Grade credit which has surprisingly rallied more than European credit since the announcement. The fact that non euro area parent companies are eligible securities will marginally reduce
USD issuance as Europe becomes a more viable market for these issuers.
Overall, we believe that the move by the ECB is positive for credit markets however the impact could be tempered by the low outright yields, high issuance levels, structural macro concerns AND the fact that markets may start to look through central bank policies which do not seem to create the desired economic growth.
The Australian dollar had been on an upward trend since the beginning of the year but this reversed in April prompted by the poor inflation print and took a further leg lower post the Reserve Bank of Australia’s (RBA) rate cut decision in May as illustrated below.
AUD USD currency
Source: Bloomberg, May 2016
The AUD rally in April was driven by a combination of events including strong domestic data, a bounce in commodity prices and a more dovish Fed.
That all changed with the dismal inflation print on April 27th when the headline CPI fell by 0.2% QoQ and the YoY figure printed at 1.3%. The RBA stepped in to tackle this low inflation number along with other domestic concerns by cutting rates to a new historical low of 1.75% at its May meeting. The Australian dollar reacted sharply with the AUDUSD exchange rate falling from 0.7720 to 0.7560 on the announcement.
Going forward, given the RBA is an inflation targeting central bank, we expect they are likely to respond with further easing, with a clear focus on the currency to impact this thinking. We would however expect some patience from the RBA given their communications around the demand side of the economy performing broadly as it should.
We expect the AUD to move lower as the central bank eases, but investors must always be vigilant for external global factors which may impact the currency.
Opportunities in credit markets
In the last 18 months, credit spreads have significantly widened. Whilst this has been a challenging period for credit investors, the outlook for credit markets is now much more attractive. We see three key factors which suggest that there is currently an opportunity in credit which we outline below:
Value on offer – Recent spread widening due to market volatility now means that credit investors are being better rewarded. As an example, 5 year Ford Motor Co and 10 year Bank of America corporate bonds issued in early 2015 were offering +80 bps and +120 bps yield above the risk-free rate. Currently they offer +140 bps and +160 bps respectively.
Historical high yield credit spreads
Source: Bloomberg, May 2016
Central banks remain highly supportive – The ECB has enacted more quantitative easing and cut rates into negative territory, the BOJ has also cut rates into negative territory and finally the Fed has backed away from any imminent successive rate hikes. We believe that central banks will continue to be actively involved in keeping markets and economies stable.
USD strength has been contained – The recent decline in the USD has provided some relief for the emerging market sector in particular, China as well as contributing to a rally in commodity prices. Without the suffocating impact of a strong USD on global economies, global credit markets are expected to perform well.
Whilst the current environment is accommodative for credit markets, investors should also be mindful of any changes in these supportive factors and be ready to act should volatility arise again.