Corporate Bonds to Benefit from European QE

Terry Flanagan

David Zahn, head of European fixed income at Franklin Templeton Fixed Income Group said investors are likely to head into corporate bounds as a result of the European Central Bank’s quantitative easing program.

This month Mario Draghi, president of the ECB announced plans to purchase at least €1 trillion, or €60bn a month, of government, agency and supernational bonds domiciled in the eurozone with maturities ranging from two to 30 years, until at least September 2016.

Zahn said in a note that while €1 trillion was larger than many people expected, it is still modest plan in comparison to QE in the US or the UK. He added: “The plan demonstrates that the ECB not only talks, it also acts, which is important for market psychology.”

Zahn said QE should have a modest impact on the ECB’s goals of weakening the euro exchange rate and stimulating growth by making it easier for businesses and consumers to borrow.

“The plan also should provide an accommodative backdrop for countries that are implementing necessary structural reforms, which are critical to the long-term recovery of the eurozone,” Zahn added.

Although corporate bonds not part of the ECB’s plan, Zahn expects corporate debt to do well on the back of QE.

“I think there will likely be a moving out on the risk spectrum as the ECB buys government bonds, and investors then have to find something else to own to get yield,” he added. “I think it’s likely that investors will head into corporates, and I think that may lead corporate spreads to continue to decline.”

Russ Koesterich, chief investment strategist for BlackRock, said in a blog that the size of the QE package, the open-ended nature of the commitment and the willingness to purchase longer dated bonds were all positive surprises for investors.

Koesterich said: “By itself, QE is unlikely to spur European growth, but it should go a long way in mitigating the risk of deflation and supporting European equities, particularly in peripheral countries, where stocks are already up sharply year-to-date.”

However he warned that the anti-austerity left wing Syriza party winning the Greek election will lead to a prolonged period of heightened tension as the country tries to renegotiate its debt.

“Monetary conditions and less stretched valuations are acting as tailwinds for international stock markets, even after accounting for European politics,” added Koesterich. “This improvement in the relative performance of international stocks is evident and starting to impact investor behavior in the US, driving fund flow to non-US markets.”

Blackrock has moved from overweight to neutral in residential mortgage-backed securities as interest rate volatility has increased this year. Koesterich said: “Instead, we would continue to emphasize US high yield bonds and longer-dated municipals, as we believe both still offer some relative value within fixed income.”

Rob Waldner chief strategist and head of the multi-sector team for Invesco Fixed Income, said in a note that Syriza’s victory raises the prospect of Greece’s exit, or Grexit, from the eurozone even though the party and the majority of Greece favors staying in the eurozone.

Invesco says Greece will have to soften its negotiating terms if it wants to keep the euro.

“The ECB is in control of Greece’s banking system and this is the major pressure point – it can make Greek collateral ineligible at the ECB and threaten to cut off additional funding mechanisms such as Emergency Liquidity Assistance – see the 2012 financial crisis in Cyprus or former ECB President Jean-Claude Trichet’s letters to Ireland for examples of this tactic,” added Waldner. “We also believe that while fiscal surpluses make default easier for Greece, the viability of the Greek banking system is dependent upon ECB support.”

Robert Doll, senior portfolio manager, and chief equity strategist at Nuveen Asset Management, said in his latest weekly commentary that the ECB’s QE program will be moderately effective in helping to stave off deflation and boost growth, although the eurozone needs significant structural reforms.

“The new program should be a positive, and the weaker euro, the fall in oil prices and some healing in the banking sector should also help the eurozone.” added Doll. “Looking ahead, we believe eurozone growth is more likely to surprise to the upside than the downside.”

Doll said that over the next twelve months, Nuveen has a constructive view toward risk assets and that equities will end this year higher than where they began.

“US economic growth is improving, corporate earnings should be decent (outside of commodity-related sectors) and the fiscal drag is fading,” said Doll. “The Fed is likely to raise rates, but will do so carefully and modestly. Outside of the US, reflationary support in Europe and Japan should help global growth.”

Featured image via iStock

Related articles

  1. Deutsche Borse-LSE Merger in Focus

    Instinet Fox River Quant Solution will initially be rolled out in the Americas.

  2. Algos, Post-Trade Top FCM Concerns

    Instinet's Anushree Laturkar says investing in research and analysis is key to improving client outcomes.

  3. The new platform launched via a partnership with BestEx Research.

  4. It is the first liquidity-seeking algorithm on Atlas, the equities trading platform introduced in 2019.

  5. Algorithms in Focus

    Strategy Studio allows brokers to create their own execution platforms.