ECB’s bond-buying scheme creates some bout of scarcity on the market, but not necessarily resulting in lower yields. From their temporary lows after the Brexit shock, yields on European government bonds have rebounded in a material way. In the case of 10-year German Bunds, the increase was from -0.2% to +0.3%, while their French counterpart moved from 0.1% to 0.9%.
According to Markus Allenspach, Head Fixed Income Research at Julius Baer, at first glance, the bond yield increase seems to be in line with the improving economic outlook and the decision of the European Central Bank of early December to reduce the amount of monthly purchases from the current rate of EUR 80 billion to EUR 60 billion from April. “What is disturbing, however, is the reported scar-city of bonds, which normally results in a price increase, not a decline. Prices of bonds move inversely to yields”, he points.
The scarcity of government bonds is most obvious on the money market, where most trades among banks are done on a collateralised basis. According to data collected by Bloomberg, the fees to borrow German and French government bonds have widened materially in recent weeks, with fees in year-end trading up to 6%. From the point of view of a trader, this is a very stark sign of scar-city of government bonds. It should be kept in mind that the ECB is only lending out EUR 50 billion of the bonds it has in its portfolio against cash, while a big part of the bonds “rests in its vaults”.
How can prices of bonds decline – the yields increase – when there is a scarcity of bonds on the market for security lending and borrowing as mentioned above? A rising number of strategists – and seemingly also investors – see the scarcity of bonds as a sign that the ECB must scale back its purchases sooner or later. We all remember ECB President Draghi saying that the ECB has sufficient material at hand to continue its purchases as long as need-ed. Obviously, the market has a different view on this. As said by Markus Allenspach:
We share the critical view of the bond market that the massive purchases of the ECB will increasingly be questioned. Accordingly, prices of bonds eligible for ECB purchases will remain subject to massive volatility: government bonds and investment-grade bonds of non-financial issuers in EUR.
