By Marius Zaharia
The European Central Bank began buying Cypriot government bonds in July but failed to lower the country’s borrowing costs by much – a clue to what may happen if Greek bonds become eligible for the ECB’s monetary stimulus programme.
July was the first month in which the ECB bought Cypriot bonds, because the central bank’s rules say it needs to see a country is adhering to the terms of any bailout programme before buying any bonds.
But the much-anticipated launch of quantitative easing (QE) in Cyprus did not come with the expected bang in the market.
Yields on the benchmark seven-year Cypriot bond fell 30 basis points in July to about 3.7 per cent. And at least part of the move came after neighbouring Greece got bridge financing from its creditors to avoid an immediate default.
By comparison, yields on similarly dated bonds in Portugal, also sensitive to the Greek crisis, fell 50-60 bps in July.
The ECB bought €100 million of Cypriot bounds – a small sum, considering it plans to buy a total of €1 trillion of euro zone assets. But RBS calculates it represents 2.5 per cent of eligible Cypriot bonds, a bigger share than most countries. In France, for example, the ECB is buying about 1 per cent a month.
The main factor limiting the market impact, at least for now, is the bond ownership structure in markets classed by ratings agencies in the “highly speculative” junk bracket.
Many Cypriot bondholders are high-risk hedge funds or distressed debt specialists, who usually want to get in and out fast. They would be grateful for the ECB to enter the illiquid market as a new buyer and would gladly sell the bonds and book a quick profit.
In more advanced markets investors’ hands are stickier.
Banks, pension funds and insurers need bonds on their books for regulatory reasons. Other money managers have firm mandates to invest in European bonds. It is harder for the ECB to source the bonds, so it has to pay up for them, reducing their yield.
“Some of the early buyers there were looking … for the ECB to come in and that was going to be their exit point,” said Robert Tipp, chief investment strategist at Prudential Fixed Income, a Newark-based firm which holds Cypriot and Greek bonds.
“You’d have that phenomenon in Greece as well – when the market recovers, distressed buyers go out but the bonds are extremely low-rated and … it’s difficult to attract the next buyer group.”
But the structure of the Cypriot bond market may also mean that QE might have more impact later, after the fastest of the fast money leaves and it gets harder for the ECB to buy bonds.
“I’d be surprised if in another three months, assuming there’s no further blow-up in Greece – which is absolutely not impossible – the convergence (between Cypriot yields and other euro zone yields) would not go much further,” said Michael Michaelides, RBS rates analyst.
Michaelides recommends buying Greek bonds.
To become eligible for QE, Athens must conclude a deal for a third conditional bailout later this month. Even then, the ECB may hold off from buying until it deems there is credible implementation.
There are many bumps in the path to QE. So if it is actually enacted, chances are the bonds would have rallied beforehand as the market cheers Greece’s commitment to the deal. Those pre-QE moves might be significantly larger than the immediate post-QE ones, however, some analysts say.
And the history of Greece, where investor moods can see dramatic shifts from one day to another, bodes ill for any plans to wait until the fast money moves away and it becomes difficult for the ECB to source the bonds.
“The ownership (of the bonds) might make the difference,” said Gianluca Ziglio, executive director of fixed income research at Sunrise Brokers. (Reuters)
