M. M. Warburg: CSPP programme inflates prices

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Martin Hasse, fixed income analyst at M.M. Warburg, discusses the pitfalls of the CSPP programme.

  • Are you concerned about ‘crowding out’ effects of the ECB’s bond purchasing programme, and if so what are the downsides you see or expect, eg, mispricing of certain types of fixed income securities because of the impact on the demand side?

In our opinion, the ECB PSPP Programme has not yet led to a crowding out effect of sovereign bonds. The markets in core European sovereign bonds have such a large volume that neither the pricing nor the liquidity of these assets has been adversely affected. The low interest environment on the other hand, to which the PSPP Programme contributes, has driven many investors into less liquid segments of the European sovereign bond markets. In these markets, for example Lithuanian and Latvian as well other CEE countries, liquidity has decreased significantly.

The CSPP programme on the other hand does worry us a lot as the liquidity in investment grade corporate bond markets has deteriorated. Both, on primary and on secondary markets, it has become nearly impossible to trade larger sizes of debt. As a result of the crowding out effect, even bonds which would not be bought as part of the programme, for example high yield bonds, have lost their tradeability and liquidity. Due to these additional demand levels, business are able to artificially drive up prices when issuing corporate bonds, which in many cases means that newly issues bonds offer lower returns. This in turn means that investors are almost forced to limit subscriptions and hence risk not being taken into account when new bonds are being issued.

  • Which types of securities are you most concerned about being impacted – including possibly those above and beyond those the ECB has indicated it will purchase?

As stated above, believe that the purchasing programme has the most severe effects in smaller sovereign bond makrets and in all segments of the corporate bond market. The most affected are of course those corproate bonds which can be purchased by the ECB as part of its CSPP programme, but the effects are also tangible among high yield- and even subordinate bonds.

  • Do you feel you have to look further beyond traditional investment grade fixed income as a result of the ECB’s action, or were you looking further across the credit spectrum anyway as a result of the general ongoing squeeze on yields?

Even prior to the ECB purchasing programme, we have considered the entire fixed income spectrum in our investment universe. But due to the low interest environment and the growing risk of a rate hike we are increasingly looking towards alternative strategies such as cat bonds, convertibles and total return approaches.

  • What types of fixed income are you looking to do searches on in coming months?

Throughout the next months, we will increasingly look into assets which are set to benefit from a low interest environment, low default rates and moderate growth levels, this includes high yield bonds which, due to their relatively short duration and high coupon buffer offer an attractive risk return buffer. But emerging market debt,  both on the sovereign and corproate side also remains high on the agenda, we believe that there are still interesting investment opportunities to be found. We will also continue to consider total return approaches on the fixed income side.

This article is  part of the upcoming cover story on the impact of ECB bond purchases, published in the October issue of InvestmentEurope.