from Zero Hedge:
On the verge of running out of bond to monetize, the ECB has engaged in something fed had expected: it is buying bonds from itself. But according to a troubling Reuters “trial balloon” that may be just the beginning: as Reuters writes, the “ECB may soon be forced to follow the Bank of Japan’s example and buy equities as part of any expanded stimulus programme.”
Over the past two years, we have repeatedly cautioned that the biggest challenge facing the ECB as it expands its bond monetization is the ability to find sellers of private securities, i.e., a shortage of monetizable bonds, both government and now corporate. Last March, even JPM warned that it doubts the Eurosystem can “meet its quantitative target without distorting market liquidity and price discovery.” That however has not stopped Mario Draghi from steadfastly continuing the ECB’s QE, even as the bond shortage has gotten more acute by the week. In fact, according to Jefferies analysts, the shortage is now so profound that the ECB is effectively buying back bonds from itself.
According to a note by Marchel Alexandrovich and David Owen, first flagged by the WSJ, courtesy of the circular nature of the Eurosystem, the central bank has masked what is essentially a backdoor monetization of its own securities.
How does Draghi achieve this? As the WSJ notes, the ECB’s QE program is implemented through several national central banks, like Germany’s Bundesbank and Spain’s Banco de Espana. National central banks buy bonds according to rules set by the ECB. The problem is that these constraints narrow the stock of debt the banks can buy from. These rules prevent the purchase of too much debt from any one country and stop central banks from buying debt with steeply negative yields. Portuguese and Irish debt, for instance, is now becoming scarce. But the national central banks also sell sovereign bonds. They sometimes reduce their holdings as a part of their reserve management activities, which aim to ensure that banks, state institutions and other organizations “manage their euro-denominated reserve assets comprehensively, efficiently, and in a safe, confidential and reliable environment,” according to the ECB’s website.
As a result, while the German Bundesbank bought €209 billion in sovereign bonds between March and July, it also sold off €43 billion of such debt, according to Jefferies. Those securities are then back on the market to be bought, potentially helping the central banks to work around the program’s restrictions.
The conclusion: “This suggests that one of the ways that QE has been implemented, especially in the countries where scarcity may be an issue, is that the (National Central Bank) is essentially buying bonds from itself; or more intriguingly, perhaps even from the other NCBs in the Eurosystem,”said Mr. Alexandrovich, one of the economists.
Circular nature of the ECB’s bond monetization notwithstanding, it merely confirms the underlying problem: there are simply not enough government bonds for the ECB to keep buying, effectively putting a hard limit on how long Draghi can continue his QE program.
There is, however, one loophole, one which the BOJ exploited recently when instead of expanding its bond purchases, it launched an even more aggressive equity buying spree, by doubling the amount of ETFs the central bank would buy.
That, according to Reuters, is precisely what will happen next, as it writes that the ECB may soon be forced to follow the Bank of Japan’s example and buy equities as part of any expanded stimulus programme. Reuters then recaps the familiar problem: “The European Central Bank could run out of eligible bonds for its 1.7 trillion euro bond-buying scheme, meaning alternative options are on the table should it decide to loosen policy further to lift growth and inflation across the bloc. Analysts say these could include large-scale share buying, a policy that the BOJ has already adopted after it started purchasing equity exchange traded funds (ETFs) for its own quantitative easing scheme six years ago.”
As Kuroda will readily admit, ETFs offer an easy way to directly monetize, and nationalize, the stock market:
“ETFs allow an investor to trade a range of assets, from a basket of stocks to government debt. ETFs, which offer a convenient way to purchase a broad basket of securities in a single transaction from an exchange, have risen in popularity with investors due to their simplicity and lower fees.”
However, the ECB faces significant hurdles in helping all 19 euro zone members equally without distorting a key market for investors. According to Reuters, buying ETFs in the 19-nation euro zone would be far from simple for the ECB, both practically and politically. “How do you buy an index which favours all countries within the euro zone? Obviously the ECB doesn’t want to be seen favouring one market above another,” said Commerzbank economist Peter Dixon.
The answer is, “you don’t“, so you do whatever Mario Draghi’s former employer, Goldman, advises him to do.
Putting Europe’s ETF market in context, investments in Europe-listed ETFs are worth just over $500 billion, compared with nearly $200 billion in Japan and more than $2 trillion in the United States, according to consultancy firm ETFGI.
And while, the European ETF market is bigger than Japan’s, such a scheme would have to benefit 19 member states, from heavyweight Germany to tiny Slovakia. If it buys an ETF that tracks a pan-European stock index such as the Euro STOXX 50 or MSCI’s EMU index , which are weighted in terms of market capitalisations, the ECB runs the risks of being seen to favour only the bloc’s biggest economies or sectors.
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