European Bond Markets, Global Yields and ECB

According to a Reuters report, the ECB is looking into ways to lend out its bond holdings more easily. The market reaction to this report illustrated how much Bund valuations are distorted by collateral scarcity issues already, in particular at the short end which had reached all-time yield lows just before the release. The 2yr yield rose 6bp and lost 4bp versus OIS initially, but also 10yr Bunds temporarily rose by up to 8bp losing 3bp vs OIS. According to the article the discussed changes include reducing the lending fees, accepting new types of collateral and extending the duration of loans. They seem to be targeted more at solving market (il)liquidity- than collateral scarcity-issues directly. In the ideal case this will help mitigate the increased occurrence of “specialness”, but it may not prevent the further richening of general collateral as surplus liquidity increases. Key issues in the way of really tackling collateral scarcity are that lending against cash still remains unlikely as long as QE is ongoing, and furthermore the circumstance that the ECB, which could broaden the acceptance of other collateral against which it lends, only holds a small share of the total purchased assets. The main holder of Bunds is for instance still the Bundesbank which we assume would still only accept other German collateral in exchange. Anything else could be considered as softening of the capital key restriction (in particular if lending volumes are expected to increase). The market reaction was interesting in so far as we would have expected EGB spreads to tighten cet. par. with Bunds more affected also by collateral scarcity. But the bond sell-off was also driven by Gilts (+9bp in 10yr) and better US data. To the extent that this might keep expectations for a QE taper in the market, spread widening especially in Italy and France as observed yesterday appears plausible against the political risk backdrop. While the potential adjustments do not yet address the issue of a shrinking asset pool which the ECB can buy, we think it still has moderate potential to tighten ASW spreads. Much should depend on the additional measures to be decided by the ECB in December. We still believe that an “non-tapered” extension of QE looks likely, along with further adjustments to increase the pool of eligible assets like loosening the depo rate restriction.