ECB, Italian Referandum and Bond Yields

Relief marked yesterday’s session as reports that the ECB stood ready to temporarily step up its purchases of BTPs in the wake of the Italian constitutional referendum. 10yr BTPs tightened by 14bp versus Bunds, outperforming SPGBs by up to 7bp. Note though, that Spain still has auctions scheduled for Thursday while this week’s Italian supply is out of the way. Temporary deviations from the capital key in the country split up of the ECB’s PSPP purchases is not uncommon. Monthly PSPP data shows that the ECB also skewed purchases to the periphery in June this year, when the Brexit vote led to spikes in EGB spreads. We calculate that this additional skew translated into some €0.5bn each for Italy and Spain above their average pace of monthly purchases. The lower weekly purchase figures released on Monday suggests the ECB might have made some room already. More crucially, this reaction function does indicate that the ECB is aware of the important support that QE lends to the periphery. As political uncertainties are unlikely to be resolved with the referendum, we believe that Draghi is unlikely to provide any reason to believe that the ECB is about to reduce its stimulus anytime soon. We stick to the view that an extension of €QE alongside technical adjustments to increase the pool of PSPP eligible assets will be announced at the ECB press conference next week. This should also be supported by yesterday’s German and Spanish inflation data, which do not point to an increase in underlying inflationary pressures in the Eurozone. Yesterday improved risk back drop has helped to push the 10yr Bund yield above 0.20% alongside ASW spreads tightening. The push higher was in part also a spill-over from better than anticipated US data. The next focus here is Friday’s labour market report with today’s ADP release providing a first taste. EGB Supply: Today Germany will tap the OBL 10/21 (€3bn), the penultimate German auction for 2016. The 5yr yield of -0.45% is still above ranges seen before mid-October, but sub depo yields should become PSPP eligible. While ASW levels might seem rich after increasing 10bp in November, the drivers of collateral scarcity remain in place.