From Suki Mann, FI strategist at UBS (bold statements from us):
« Corporate bond market capitulation: Is it coming?
We believe that if the ECB announces any kind of corporate bond buying this week, investors could well embark on a fairly aggressive grabfest ahead of the actual commencement of the programme.
Already bereft of supply, decent yield, spreads unchanged into the macro-headwinds; and, plenty of pent-up demand for paper as cash keeps rolling-in to the asset class, we think that the actual announcement could see a lurch tighter in spreads. That is, QE is not in the current price. Some think it is, we don’t.
How much can spreads tighten? The answer ultimately depends on the modalities of the program (size, duration, mix). »
« The covered bond purchase programme (“CBPP3”) launched last year by the ECB can shed some light here. The bulk of spread tightening occurred between the announcement date of the program and the actual start of covered bond purchases by the ECB. In that time period, spreads tightened by just over 10bp (20% of the starting spread at the time the programme was announced) as depicted in Figure 1. Using that 20% move as a baseline estimate for IG corporates, we could see as much as 20-25bp of spread tightening from current levels of B+111bp.
However, we would make the observation that the corporate bond market is akin to the last bastion of the fixed income asset class after sovereigns and covereds at the top. So, while sovereign and covered bond holders can switch out of these asset classes into higher yielding corporates, no such technical switch exists for participants in the corporate bond market (into another fixed income asset class). It raises the question of how they will reinvest their cash if the ECB buys their bonds. So we think that there will be a final crowding out effect and investors will add more to their HY exposures. The main conclusion we would draw here is that corporate bondholders won’t necessarily sell that obligingly.The ECB will have to offer a significant premium to buy corporate bonds in large size and that could mean spreads tighten more than 20-25bp.
On the other hand, if the QE decision does not include corporate bonds – perhaps because they see fit that the corporate bond market is not broken and a further manipulation of yields/spreads/liquidity lower/worse will only exacerbate the current frustrations in it – then we think that there will be no sell-off in spread markets. And for exactly the same reasons stated above (demand etc). At best IG corporate credit doesn’t move, at worst (given where valuations are) it crunches tighter. Currently, we’re at 1.28% for the iBoxx index yield and we still look for 1% on QE, or the 1.15% area otherwise by year-end. »