ECB, Corporate Bonds, And Credibility

The euro’s rallied shortly after the ECB announced numerous monetary measures that in their totality were more than expected. Many saw this as proof that monetary policy had lost its effectiveness, and central banks have lost credibility.   

Recall summer of 2012. The market anticipated another round of asset purchases by the Federal Reserve. The euro rallied from about $1.2050 in late July to $1.30 on September 13 when Bernanke announced the open-ended QE3. The euro peaked two days later near $1.3175. By earlier October it was back to $1.28 and by mid-November had fallen to $1.2660.   

There are plenty of other examples are the market’s anticipatory function that has generated a “buy the rumor sell the fact” type of response to monetary policy. It is not correct to argue that this means monetary policy is ineffective. 

One of the innovations the ECB announced earlier this month was that it would buy investment grade bonds of non-financial corporations. The precise details are still not available, but the market’s reaction suggests institutions and investors respect this decision. Look at what has happened to corporate bonds since the announcement.  

First, in the week following the ECB meeting, European corporates brought four bln euros of new supply to the market. This was a third of the amount that had been issued year-to-date. Despite the supply, the premiums corporates pay over the sovereigns narrowed.   

Second, there was a multiplier effect. Bonds that the ECB would not buy, like those below investment grade, also rallied and saw new supply. The ECB is not going to buy bank bonds, but bank bonds rallied. Investor demand was such that the contingent convertible bond market (cocos) re-opened with new supply. One bank reportedly received $8 bln of orders for a $1.5 bln offering. 

Will this boost inflation?  Fat chance. Does it mean that it is a failure? Hardly.