As bond markets brace for an end to ECB stimulus, reinvesting funds from maturing bonds the bank holds could prevent the kind of “taper tantrum” that sent yields soaring in 2013 after the US Federal Reserve signaled an end to its bond-buying scheme. The cash the European Central Bank receives when the bonds it holds are repaid or redeemed is set to pick up next year and accelerate in 2019, according to bank estimates.
Dutch bank ABN AMRO calculates that over the next three years, reinvestments of maturing bonds including regional, sovereign and supranational debt could reach up to 640 billion euros ($756 billion). That cash going back into bond markets is important because it’s likely to coincide with a scaling back of the ECB’s 2.3 trillion euro asset-purchase scheme – widely expected to begin in early 2018 – and limit a rise in government borrowing costs.
So far, reinvestment flows have been overshadowed by a focus on a tapering but are expected to grow in importance. “We will still have a great level of monetary policy accommodation through 2018 in Europe, no matter what the ECB decides in September,” said Vincent Juvyns, global market strategist at J.P Morgan Asset Management, referring to an upcoming meeting. The ECB began buying government bonds in March 2015 to lift economic growth and inflation and set a minimum maturity of two years, lowered to one year in January. Those purchases make up the bulk of the ECB’s asset purchase scheme.
It redeploys the money it receives from maturing bonds back into the market and these reinvestments are in addition to monthly bond buys. The ECB does not give precise details on reinvestments but has said these would be done in a “flexible” way and run for “as long as necessary.” Estimating reinvestments is difficult as the ECB provides limited information about asset buys, leaving markets guessing about upcoming volumes and resulting in differing estimates.
The ECB declined to comment on the volume of reinvestments in the coming years. Since bonds bought by the central bank first started maturing in March, reinvestment flows have been small. Societe Generale calculates reinvestments averaged just 1.23 billion euros per month between March and June. It expects reinvestments to average 8.2 billion euros over the first half of 2018.
SocGen rates strategist Ciaran O’Hagan expects the ECB to cut asset buys by a third to 40 billion euros a month from January, indicating that reinvestments would then equal about a quarter of net purchases. ECB tapering is viewed as a major market event. Comments by ECB chief Mario Draghi in June, seen as paving the way for a scaling back of stimulus, pushed German bond yields to 18-month highs while the euro jumped to its strongest in over a year.
In 2013, global markets took fright at the Fed’s first hint that it might unwind its monetary stimulus in what became known as the taper tantrum. Navigating a path out of extraordinary monetary stimulus without disrupting markets is one of the ECB’s biggest challenges. “A clear risk to the ECB’s taper is that the ECB could exit the programme too hastily and that it would unwarrantedly tighten financial conditions or, even worse, it could create a taper tantrum,” said ABN AMRO senior rates strategist Kim Liu.
“However, the increasing reinvestment flows will help the ECB. They are significant and mean that the ECB will still be a dominant buyer in the euro zone bond market for the years to come.” Analysts expect bond yields to head up as the ECB tapers but say it is hard to gauge how much reinvestments could cap yields, which will also be influenced by the inflation outlook.
Just how long the ECB will continue to reinvest proceeds from maturing bonds is not defined. The Fed finished tapering in 2014 but will only start cutting its bond holdings this year. Germany is expected to receive the largest reinvestment flows, followed by Italy and France.
That’s because these countries have higher shares in the capital key – where the ECB buys a country’s bonds in line with the size of its economy. Redemptions in Germany, the bloc’s biggest economy, are likely to be skewed towards the latter half of 2018, according to ING. ING calculates that average monthly bond reinvestments next year could be around 11.5 billion euros. It also estimates monthly redemptions in Germany at 3.3 billion euros, compared with 2.9 billion euros in Italy and 1.9 billion euros in France. The ECB is not required to immediately reinvest redemptions, so it could smooth the purchases over several months. That could be beneficial for Italy, where markets face potential volatility heading into elections in 2018. “They (the ECB) will still be buying, just at a lower amount on a monthly basis…Ultimately the taper won’t have as much of an impact as they would have outright,” said Marianne Winkelman, director of global bond, EM and FX trading at Loomis, Sayles and Company.Dhara Ranasinghe, "Cash going back into market is important," Reuters. 2017-08-29.
Keywords: Economics , Monetary policy , Management , ECB , Germany , France