It is time to once again lift the lid on the engine of Quantitative Easing especially in the UK. As a I pointed out several weeks ago the ordinary version where sovereign bonds are purchased has reached its target of £435 billion ( to be precise £39 million below). However corporate bond purchases are continuing under this from the August 2016 MPC (Monetary Policy Committee ) Minutes.
the purchase of up to £10 billion of UK corporate bonds
This was to achieve the objectives shown below and the emphasis is mine.
Purchases of corporate bonds could provide somewhat more stimulus than the same amount of gilt purchases. In particular, given that corporate bonds are higher-yielding instruments than government bonds, investors selling corporate debt to the Bank could be more likely to invest the money received in other corporate assets than those selling gilts. In addition, by increasing demand in secondary markets, purchases by the Bank could reduce liquidity premia; and such purchases could stimulate issuance in sterling corporate bond markets.
Okay let me open with the generic issue of whether this is a better version of QE? This starts well if we look at the US Federal Reserve.
The FOMC directed the Desk to purchase $1.25 trillion of agency MBS ( Mortgage Backed Securities)……..The goal of the program was to provide support to mortgage and housing markets and to foster improved conditions in financial markets more generally.
Later it bought some more but here we see a case of a central bank buying assets from the market which was in distress which was a combination of housing and banking. We can see how this had a more direct impact than ordinary QE but applying that to the UK in 2016 has the problem of being years too late unless of course the Bank of England wanted to argue the UK economy was in distress whilst growing solidly in August 2016!
This is a clear change of course from Mark Carney as the previous Governor Baron King of Lothbury was not a fan and whilst the Bank of England had a plan for corporate bond QE in theory in practice it just kicked the ball around for a while and gave up. Why? Well as I have pointed out before the market is small because UK businesses are often international and issue in Euros and US Dollars so that the UK Pound market is reduced. This leads to the Bank of England finding itself having to purchase bonds from foreign companies and this week it is back offering to buy the bonds of the Danish shipping company Maersk. No doubt it and Danish taxpayers are happy about this but I do hope one day we will get a Working Paper explaining how this boosts the UK economy more than ordinary QE.
The technical view
There are some suggested examples in the Financial Times today from Zoso Davies of Barclays.
Initially, this seemed to work. August and September 2016 witnessed a flurry of new deals in the sterling corporate markets despite the uncertainty created by the UK’s vote to leave the EU. Since then, however, companies’ interest in borrowing in sterling has fallen to levels similar to those seen in 2013 and 2014.
As you can see once the “new toy” effect wore off things seem to have returned to something of a status quo. The “new toy” effect was exacerbated because the borrowing was so cheap.
Borrowers have also benefited from somewhat better terms on their bonds. After the initial announcement, sterling credit spreads (the additional yield risk borrowers must pay relative to the UK government to borrow in sterling) came down sharply.
If we look back we see that not only did the UK ten-year Gilt yield drop towards 0.5% but the spread above it corporate bond issuers had to pay fell, so there was a clear incentive to borrow. The catch is that if we recall the “lost decade(s)” experience of Japan the link between that and productivity activity tends to fail. One rather revealing fact is that the article does not mention real economy benefits at all instead we get this.
Our analysis, based on the limited data available for corporate bond markets, suggests that trading activity has not picked up across the sterling market as a whole, implying that the Bank of England has been crowding out other market participants. That said, the evidence is far from convincing in either direction.
The price effect did not last either.
Since then, however, the sterling market has hardly moved, indicating that most of the market impact came from the announcement rather than their execution. And that lack of movement has been a marked underperformance versus dollar and euro credit markets, to the extent that sterling has returned to being a relatively expensive bond market in which to raise financing.
Of course we have a tangled web here because one of the factors at play is the the 208 billion Euro corporate bond purchases of the ECB have allowed some companies to be paid to borrow, or if you prefer issue at negative yields. This is from Bloomberg in January.
Henkel AG’s two-year note issued at a negative yield
Also its activities make us again wonder who benefits? From Credit Market Daily.
A big theme in 2015-16 was the amount US domiciled corporates funded in the euro-denominated debt markets. As shown in the chart above, it was a record 26% of the total volume in 2015 and 22% in 2016. Low rates everywhere, but lower in Europe along with low spreads made it attractive for US corporates to borrow in euros (even when swapped back to dollars)
So the Bank of England is supporting European corporates and the ECB US ones? Time for Kylie.
I’m spinning around
Move out of my way
The article ends with some points that pose all sorts of moral hazards.
If sterling corporate bond issuance collapses and secondary market volumes plummet, it will be clear that the Bank’s newest tool has been propping up this small corner of the fixed-income universe over the past six months. Conversely, the more graceful the exit from corporate bond buying, the less clear it will be that the CBPS has been much more than a placebo for markets.
So if borrowers want to borrow cheaply just go on an issuers strike? Also what if the lower yields have sent other buyers away and crowded them out? That would have created quite a mess.
There are a lot of issues here. Lets us look at the real economy where are the arguments that it has benefited? Whereas on the other side of the coin we can see that subsidising larger companies both ossifies the economy and would help stop what is called “creative destruction”. Whilst the productivity problem began before this program started is it yet another brick in the wall for it via the routes just described? As the Bank Underground blog puts it.
Since 2008, aggregate productivity performance in the UK has been substantially worse than in the preceding eight years.
Also whilst the Federal Reserve purchases of MBSs seems to have been a relatively successful version of QE we have to add “so far”. This is in the gap between the word “stop” and “end” as whilst it stopped new purchases it maintains its holdings at US $1.75 trillion. How can it sell these and what if there are losses which could easily be large? Will the Bank of England end up in the same quicksand? Frankly I think it is already in it.
Yes equity markets are higher but the one area in the UK that has surged in response to this extra monetary easing has been unsecured rather than business credit.