LIQUIDITY IN EURO AREA BOND MARKETS AND THE MARKET IMPACT OF THE END OF NET PURCHASES OF THE APP - ECB BMCG, 12th February 2019
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LIQUIDITY IN EURO AREA BOND MARKETS AND THE MARKET IMPACT OF THE END OF NET PURCHASES OF THE APP ECB BMCG, 12th February 2019 Oliver Eichmann (DWS) For Professional Clients (MiFID Directive 2014/65/EU Annex II) only.
LIQUIDITY IN EURO AREA BOND MARKETS AND THE MARKET
IMPACT OF THE END OF NET PURCHASES OF THE APP
Euro Covered Bonds - Market Structure Developments
COVERED BOND INVESTOR BASE AND ESCB’S MARKET SHARE NET NEW ISSUE DEVELOPMENTS & INFLUENCE OF THE ESCB
Amount of ECB eligible bonds in million €. % of ECB eligible bonds outstanding in billion €
800,000 60%
700,000
50% 200
600,000
40% 145 153
500,000 143
150 130 137 135
400,000 30% 128
113
300,000 102
20%
200,000 100 87
100,000
10%
50
0 0% 50 33
Jan 15
Jun 15
Jan 17
Jun 17
Jun 18
Sep 14
Dec 15
Aug 16
Nov 16
Sep 17
Dec 17
Sep 18
Dec 18
Oct 15
Oct 16
Mar 15
Mar 16
Mar 17
Mar 18
6 11
2
0
Private investors CBPP1
CBPP2 CBPP3
CBPP 1-3 share (RHS) -17
-26
-50
Source: Credit Agricole, as of January 2019
-72
-100
_ Covered Bond market structure has changed since the -97
start of CBPPs. -115
-150
_ The ESCB has become the dominant buyer. The investor 2015 2016 2017 2018 2019e
base in this market segment changed over time
_ With a market share of around 40% and the persistent Redemptions Gross issuance Net issuance Net issuance after QE
presence of central banks in these markets the bargaining
power of sellers relative to buyers has significantly
changed Source: Credit Agricole, as of January 2019
Oliver Eichmann (DWS), February 2019 2LIQUIDITY IN EURO AREA BOND MARKETS AND THE MARKET
IMPACT OF THE END OF NET PURCHASES OF THE APP
Euro Covered Bonds – Transaction Costs in a Changed Market Structure
LIQUIDITY COST INDICATOR® - DECLINING TRANSACTION COSTS BID-ASK SPREADS FOR 5 YEAR COVERED BONDS
LCS in %* Spread in % of par value
1.000 0.1600
0.900
0.800
0.700 0.1400
0.600
0.500
0.1200
0.400
0.300
0.200
0.1000
0.100
0.000
Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17 Sep-18 0.0800
LCS Euro Covered
LCS=(Ask price –Bid price)/ Bid-price
Source: Barclays Bank, as of January 2019
0.0600
_ Transaction cost measures such as Bid-Ask spreads and
liquidity cost scores signal no deterioration in the overall
0.0400
liquidity situation, rather the opposite
_ The length and size for the CBPP programs suggest that
0.0200
the covered bond market has become a „sellers market“
_ Anecdotal evidence suggests that while the overall
0.0000
liquidity premiums have been reduced it became more Oct-14 Oct-15 Oct-16 Oct-17 Oct-18
difficult for potential investors to source bonds (at least
without increasing market prices significantly) FR 5Y DE 5Y IT 5Y NL 5Y ES 5Y
Source Credit Agricole, as of January 2019
Oliver Eichmann (DWS), February 2019 3LIQUIDITY IN EURO AREA BOND MARKETS AND THE MARKET
IMPACT OF THE END OF NET PURCHASES OF THE APP
Euro Covered Bonds – Trading Volume in a Changed Market Structure
TRADING VOLUME VERSUS OUTSTANDING DECLINED OVER TIME BOOK TO ISSUE SIZE FELL DESPITE ESCB BUYING
0.50%
0.45% 2.8
0.40%
0.35% 2.6
0.30%
0.25%
0.20% 2.4
0.15%
0.10% 2.2
0.05%
0.00%
2.0
Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
€ benchmark trading volume as reported to Trax, in % of nominal
1.8
Source: Commerzbank, TRAX as of January 2019
1.6
_ Volume based measures such as trading volume and book/
issue size suggest a reduction in liquidity 1.4
_ This measure could also point to a „crowding-out“ of „typical“
covered bond investors that left the market as a result of a 1.2
less attractive risk-return profile
1.0
_ Evidence of strategic decisions by institutional investors to
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Jan-18
Jan-19
Sep-13
May-13
Sep-14
May-14
Sep-15
May-15
Sep-16
May-16
Sep-17
May-17
Sep-18
May-18
reduce covered bond holdings significantly should be taken
into account when ending the CBBP program
Book/ Issue Size Book/ Issue Size (12 months rolling)
_ Studies provide evidence of negative effects on market
Source: Credit Agricole, as of January 2019
functioning by reducing the amount for tradable securities in
the context of Fed’s purchases of MBS **. ** Kandrac, J. & Schlusche, B. „Flow Effects of Large-Scale Asset Purchases“, Economic
Letters, 2013
Forecasts are not a reliable indicator of future returns. Forecasts are based on assumptions, estimates, views and hypothetical models or
Oliver Eichmann (DWS), February 2019 4
analyses, which might prove inaccurate or incorrectLIQUIDITY IN EURO AREA BOND MARKETS AND THE MARKET
IMPACT OF THE END OF NET PURCHASES OF THE APP
Corporate Bonds – Liquidity & Spread Developments
BID-ASK SPREAD EURO-CORPORATE BOND MARKET FLOW MOMENTUM TURNED NEGATIVE IN 2018
Spreads in bps vs. government bondsFlows in% of retail funds assets under management
in % of par value
1.60 185.0 0.5
1.40 % aum (10wk avg, rhs) spread (lhs) 0.4
1.20 165.0
0.3
1.00 0.2
145.0
0.80
0.1
0.60
125.0 0.0
0.40
(0.1)
0.20
Bid-Ask-Spread Euro HG Bid-Ask-Spread Euro HY 105.0
0.00 (0.2)
2013-01-31
2013-04-05
2013-06-10
2013-08-09
2013-10-11
2013-12-12
2014-02-18
2014-04-23
2014-06-26
2014-08-28
2014-10-29
2015-01-05
2015-03-06
2015-05-12
2015-07-14
2015-09-15
2015-11-16
2016-01-21
2016-03-23
2016-05-27
2016-07-29
2016-09-30
2016-12-01
2017-02-06
2017-04-07
2017-06-14
2017-08-15
2017-10-17
2017-12-18
2018-02-21
2018-04-26
2018-06-29
2018-08-31
2018-11-01
(0.3)
85.0
(0.4)
65.0 (0.5)
Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Grey shaded area – ECB Corp Sector Purchase Program, net purchases ended
December 31st 2018, Source: Market Access, 01.2019 Source: DWS Investment, Bank of America, as of January 2019
_ Transaction cost indicators do not signal a material shift LIQUIDITY COST SCORE® – EUR IG & EUR HY
in corporate credit liquidity 2.000
_ Spread widening in Q4 2018: Did spread widening trigger EUR IG Credit EUR HY
1.500
outflows? Anecdotal evidence suggest that secondary
market depth in Euro IG was rather low during this phase 1.000
with generous pick-ups in spreads of new issues versus
outstanding bonds 0.500
_ Re-balancing of fixed-income portfolios toward higher 0.000
yielding assets might trigger outflows in a more volatile May-10 May-11 May-12 May-13 May-14 May-15 May-16 May-17 May-18
environment Source: Barclays Bank PLC, as of January 2019
Forecasts are not a reliable indicator of future returns. Forecasts are based on assumptions, estimates, views and hypothetical models or
Oliver Eichmann (DWS), February 2019 5
analyses, which might prove inaccurate or incorrectLIQUIDITY IN EURO AREA BOND MARKETS AND THE MARKET
IMPACT OF THE END OF NET PURCHASES OF THE APP
Price Based Measures – Liquidity Premiums & QE – Empirical Findings
US-TIPS & INFLATION SWAP MARKET* (2010/2011) EURO-PERIPHERY SOVEREIGN DEBT MARKET (2010)***
_ Study on the Fed’s second QE program (November 2010 _ Study on the effects of the ECB’s purchases of peripheral
to June 2011) for Treasury inflation protected securities sovereign European debt through its Securities Markets
(TIPS) and inflation swap contracts Program
_ Study results suggest that TIPS purchases temporarily _ Bonds relative liquidity premiums are measured by
reduced liquidity premiums in the market for TIPS comparing prices for sovereign bonds and CDS written on
those bonds
_ “Event study analysis demonstrates the purchases
persistently depressed the liquidity-premium measure by _ “We find that an official purchase of 1% of sovereign
an average of about 10 basis points for the duration of the bonds outstanding lowers liquidity premium by 32-40 bps
QE program”. This is a reduction of the liquidity premiums on impact, 13-17 bps of which is lasting”
of almost 50% from pre QE2 levels
_ If this finding can be transferred to the Public Sector
_ Explanation: QE reduces price frictions in less liquid Purchase Program it would imply that even after the end
markets as the persistent presence of central banks of net new purchases the liquidity premiums would be
increases bargaining power of sellers relative to buyers – persistently lower compared to the status quo ante,
this lowers liquidity premiums especially as reinvestments continue and the stock of
_ Liquidity premium effects dissipated towards the end of purchases is unchanged
QE2 purchases. Does this imply that the end of the net
asset purchases by the ESCB will lead to a similar rise in
the liquidity premium of the relevant markets?
*Christensen J.H.E.& Gilian, J.M. „Does Quantitative Easing Affect Market Liquidity?“, *** De Pooter, M., Martin, Robert, F.M., Pruitt, S., „The Liquidity Effects of Official Bond
San Francisco Fed, September 2018 Market Intervention“, Journal of Financial and Quantitative Analysis, February 2018
Forecasts are not a reliable indicator of future returns. Forecasts are based on assumptions, estimates, views and hypothetical models or
Oliver Eichmann (DWS), February 2019 6
analyses, which might prove inaccurate or incorrectLIQUIDITY IN EURO AREA BOND MARKETS AND THE MARKET
IMPACT OF THE END OF NET PURCHASES OF THE APP
Focussing on Tails Events – Liquidity in Market Stress Phases
SPIKE IN BTP BID-ASK SPREAD END OF MAY 2018
18
_ Flow momentum in “riskier” parts of fixed-income is Bid-ask spread
16
positive since several years
14
_ This is probably partly due to negative risk-free rates and 12
central bank forward guidance (portfolio rebalancing 10
channel) 8
_ Additionally the ESCB is an increasingly dominant market 6
participant in several market segments under the asset 4
purchase programs 2
0
_ A less experienced and more homogeneous investor Jan-11 Jan-13 Jan-15 Jan-17 Jan-19
base might follow a similar behavior which could
potentially amplify a “sell-off” in times of market stress Source: Citigroup, as of January 2019
(“Herding”)
STRONG FLOW MOMENTUM INTO FIXED INCOME ETF
_ Reduced dealers balance sheet and a higher proportion 140%
of e-trading might increase illiquidity in times of market 120% EM
stress further 100%
Global HY
Global HG ex-EM
_ Example: “sell-off” in BTPs on the 29th / 30th of May 2018, 80%
especially shorter-dated bonds. Was the “sell-off”
60%
amplified by the fact that buying shorter-dated BTPs has
40%
been a “crowded-trade”?
20%
_ According to Tradeweb the ticket non-quote rate for the
0%
entire Tradeweb market for Italian government bonds was
-20%
47% (30th May 2018) 14 15 16 17 18 19
Source: Citigroup, as of January 2019
Forecasts are not a reliable indicator of future returns. Forecasts are based on assumptions, estimates, views and hypothetical models or
Oliver Eichmann (DWS), February 2019 7
analyses, which might prove inaccurate or incorrectLIQUIDITY IN EURO AREA BOND MARKETS AND THE MARKET
IMPACT OF THE END OF NET PURCHASES OF THE APP
Topics to Discuss
_ What is a proper measure of market liquidity especially in times of market stress?
_ Will the change in market structure as a result of central bank purchases increase the risk of liquidity-shortfalls once the
ESCB stops asset purchases (e.g. Euro covered bond market)?
_ If central bank asset purchase programs help to lower the liquidity premiums in the respective markets? Does this mean
the end of central bank purchases will revert this completely? Or is there a persistent effect due to changes in the market
structure and investor behavior?
_ Is there a change in the investor base in several market segments e.g. Euro corporate bonds as a result of the low yield
environment and the ECB‘s forward guidance? If so, does this increase the risk of pro-cyclical behavior especially in
times of stress?
_ How do participants see the electronic trading in the context of liquidity?
Forecasts are not a reliable indicator of future returns. Forecasts are based on assumptions, estimates, views and hypothetical models or
Oliver Eichmann (DWS), February 2019 8
analyses, which might prove inaccurate or incorrectIMPORTANT INFORMATION Germany This marketing communication is intended for professional clients only. DWS is the brand name under which DWS Group GmbH & Co. KGaA and its subsidiaries operate their business activities. Clients will be provided DWS products or services by one or more legal entities that will be identified to clients pursuant to the contracts, agreements, offering materials or other documentation relevant to such products or services. The information contained in this document does not constitute investment advice. All statements of opinion reflect the current assessment of DWS Investment GmbH and are subject to change without notice. Forecasts are not a reliable indicator of future performance. Forecasts are based on assumptions, estimates, opinions and hypothetical performance analysis, therefore actual results may vary, perhaps materially, from the results contained here. Past performance, [actual or simulated], is not a reliable indication of future performance. The information contained in this document does not constitute a financial analysis but qualifies as marketing communication. This marketing communication is neither subject to all legal provisions ensuring the impartiality of financial analysis nor to any prohibition on trading prior to the publication of financial analyses. This document and the information contained herein may only be distributed and published in jurisdictions in which such distribution and publication is permissible in accordance with applicable law in those jurisdictions. Direct or indirect distribution of this document is prohibited in the USA as well as to or for the account of US persons and persons residing in the USA. DWS Investment GmbH as of 1/18/19 Oliver Eichmann (DWS), February 2019 9
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