Rates Daily: United We Stand

Today's Eurogroup meeting has a chance to keep the risk-on mood going. We hope they don't waste it. The ECB's latest asset purchase data details the efforts taken to stem the market turmoil, which going forward will be aggregated in a single PEPP figure. Keep an eye on Euribor too, as it's emulating Libor.

Optimism to continue for now...

The tone so far his week in global markets has been upbeat and rates were not immune. As is often the case, the sharpest move has been registered in USD rates. A flattening of the infection and fatalities curves in the hardest hit European countries as well as in some part of the US has been a key element in shoring up sentiment. Another one has been open discussion of Austria, Italy, and Germany's exit from confinement measures, although the latter declined to give a timeframe. In this context, it is easy to overlook news flow that contradicts this narrative, such as the imposition of stricter controls in Japan.

Provided the Eurogroup plays its part today (see below), the risk-on mood should continue today. Growing hopes of a second stimulus package from the US, and the Fed's financing of loans to small businesses should also contribute. Granted there are plenty of reasons to treat the above news with a hint of caution, most notably because the coming months might still be characterised by on and off periods of confinement and more lasting damage to the economy. For a more detailed discussion of the various economic scenarios ahead, see our April economic update. In the coming session however, we see rates skewed upwards.

..if the Eurogroup plays ball

The Eurogroup today has the potential to spoil the party early if it fails to deliver sufficient progress on a joint European response to the economic slump. Expectations have been guided towards a package of loans from the EU (to support national employment schemes), the European Investment Bank (to provide guarantees to corporate loans), and the European Stability Mechanism ( loans to states to be used for health and economic stimulus measures). The amounts remain to be hammered down but a few hundred billions of euros in total capacity would be enough to buoy sentiment.

No measure should be judged in isolation but the latter would be most significant as it opens the door to more ECB sovereign bond purchases. In the long run, we argue that these measures will not change the debt profile of beneficiary countries dramatically, therefore the reasons for diverging borrowing rates between member states remains. A rare display of unity and the prospect of ECB support should add to improving sentiment in the short term, and the prospect additional borrowing should help EUR yields higher.

ECB QE data: A rare glimpse of intervention at work...

Over the course of March, the ECB’s asset holding increased by €66.6bn. The newly operational Pandemic Emergency Purchase Programme (PEPP) accounted for €15.4bn of the net purchases, even though it only reported two days of settled trades in that month.

Purchases under the previously existing Asset Purchase Programme (APP) accounted for €51.1bn. This was well above the implied pace of €33.3bn after the €120bn 'envelope' for additional purchases until year-end was introduced in addition to the regular €20bn per month. This suggests that the ECB used its existing flexibility to intervene in markets even before the PEPP became operational. The weekly data supports the idea that Public Sector Purchase Programme (PSPP) in particular being used to counter the spread widening that was observed in Italian bond markets. Coming from an average of just above €3bn earlier in the year, PSPP net purchases were ramped up to €20bn in the final week of March before dropping off to €8bn last week, when PEPP become operational. PEPP reported €30.2bn in its first full week, spanning March and April. 

ECB, ING

...and probably the last in this detail

As a result, the PSPP accounted for 73% of the net buying within the APP versus 64% in the prior four months, ie an increase counter to the announcement by the ECB that the added envelope would be focused at the private sector purchases. Another telltale sign of increased intervention to counter the observed widening of spreads is that Italy accounted for 35% of the PSPP net purchases in March, mostly at the expense of Germany. This is above the 16% average over the prior four months and also well above the share as implied by the ECB capital key subscription, although larger redemptions in the past have also led to larger deviations.

Going forward it will be harder to pinpoint the ECB’s market intervention. For the PEPP, the central bank will only report aggregate volumes and no break down into asses classes, not to mention country breakdowns. We suspect that the APP will return to a pattern more resembling those of earlier months, though with the stated tilt toward the private sector, while the ECB’s new flexibility and creativity will be concealed behind a single PEPP headline figure.

And watch Euribor; it's doing a bit of a Libor

Meanwhile, pressure on Euribor has also built. It has not been as marked as seen for Libor, but is reflective of the same types of pressure as seen on Libor in recent weeks. Why the difference? Libor has a lending bias i.e. at what level could banks fund, and that typically is gleaned from where banks print commercial paper. It does not have to be, but typically this is as good as anything else to hang Libor on. So, as CP rates rise, so does Libor. Euribor has more of a deposit based underpinning, and reformed Euribor employs a myriad of phased moving parts against which to benchmark Euribor.

But, despite all of that, there still must be some link back to implied funding rates. There can be a “bid/offer”, but it cannot get too stretched. That’s why Euribor has been pulled higher – it’s been pulled up by the implied elevation in banks funding costs (and this in turn partly reflects and the risk for elevation in default rates).

In contrast with the fall in US market IRS rates in the past month, EUR rates have in fact risen by some 20bp. This reflects some episodes of liquidation of core rates for pure liquidity purposes, but also the fact that Euribor is in effect a weighted compilation of money circumstances in each eurozone market including Italy, where rates have seen a material rise. This plus banking stresses affects where Euribor is pitched.

Today's other events: A continuing bond supply deluge

The EU finance ministers' video conference discussing the Coronavirus response will grab the headline attention. But member states' efforts to fund their own emergency plans are also well underway. Several bond mandates were announced yesterday: Ireland mandated banks for the sale of a new 7Y bond, Slovenia mandated a new 10Y bonds and reopenings of 3Y and 25Y bonds while Cyprus a new 7Y and new 30Y bond.

Regular auction scheduled for today are Austrian bond taps (€1.04bn) and German inflation-linked bond taps (€0.5bn).