End of ECB stimulus to leave demand ‘void’ in corporate bond market

The end of the European Central Bank’s huge bond-buying regime will leave a “void” of demand in the bloc’s corporate debt market, investors warn, as they brace themselves for interest rate rises and more volatility.

Under its corporate bond-purchasing programme, the ECB owned €341bn of companies’ debt at the end of May — having ratcheted up its holdings by almost €140bn since the early days of the coronavirus pandemic in March 2020.

“The ECB became not just the buyer of last resort but the buyer of first resort,” said Barnaby Martin, head of European credit strategy at Bank of America. “The sheer volume they were buying was enormous.”

But now, the central bank plans to halt the vast scheme early in the third quarter of this year, before raising interest rates in a bid to cool surging inflation.

The prospect of such funding being withdrawn marks a “seminal” moment that will leave a “void” of demand, Martin said. This will lead to greater dispersion of spreads — the perceived riskiness of different kinds of bonds relative to each other — and, in turn, to companies seeking less financing, according to investors.

“The biggest question the bond market is asking is who is the marginal buyer of debt from July onwards,” Martin said.

James Vokins, head of Aviva Investors’ investment grade credit team, added that the withdrawal of support would be “unpleasant” but the market had to “transition away from having a backstop”.

Despite speculation that the ECB will still support the debt markets of weaker eurozone countries in times of stress, credit traders have started offloading their holdings ahead of the impending stimulus withdrawal. Investors have also been spooked by persistently high inflation and expectations of higher interest rates, which damp the appeal of fixed-income paying securities.

The riskiest European corporate bonds and higher-grade bonds have fallen around 9 per cent in 2022 on a total return basis, according to Ice Data Services indices.

“[The end of stimulus] will be manageable for a core domestic investment grade company with plenty of demand from domestic investors,” Vokins said, referring to companies with high-grade credit ratings.

The ECB’s asset purchasing programme lowered volatility in prices and pushed down yields for higher-grade debt, with little dispersion between companies and sectors. This encouraged investors seeking yield to buy riskier instruments like subordinated debt to find returns, Vokins said.

“Those secondary benefactors of quantitative easing that have come to market are unlikely to find a home for the time being,” he said.

Greater volatility will encourage a more active bond investment strategy, Martin said: “All QE will be over very, very early in July. After a matter of weeks you’ve got a credit market that will better reflect risks.”

“For an active manager, they’ve got to drill down into the budding risks. If they can identify and isolate them, they can position accordingly,” Martin added.

Despite the less supportive environment, there are few expectations of immediate defaults, said Tatjana Greil Castro, co-head of public markets at Muzinich & Co. “[Many] companies secured funding last year and have enough cash for 18 months. When they run out of liquidity, the market is anticipating higher rates of default.”