Investors Shift to Longer Debt as ECB Avoids Scarcity Issue – Reuters

By John Geddie

LONDON (Reuters) – On Friday, investors showed a keen interest in longer-dated euro zone debt, anticipating that the European Central Bank (ECB) will shift its focus towards higher-yielding bonds due to a diminishing pool of eligible assets for its stimulus program.

Private estimates indicate that approximately one-third of euro zone government bonds, and over half of German debt, are not eligible for quantitative easing, as their yields fall below the ECB’s deposit rate—the minimum threshold set for its bond purchasing initiatives.

ECB President Mario Draghi stated on Thursday that procedural details would not hinder asset purchases and emphasized that the bank would reevaluate its policies after new economic forecasts are released in September.

Long-dated yields, which decrease as prices rise, showed a slight decline as data indicated that some economies within the bloc were beginning to feel the repercussions of the UK’s recent decision to exit the EU. In contrast, shorter yields experienced a rise.

Germany’s benchmark 30-year yield dropped 2 basis points to 0.51 percent, while two-year yields increased by 1 basis point to minus 0.61 percent.

"The central bank will focus on acquiring longer-dated bonds as these are among the few still eligible," stated Mizuho strategist Antoine Bouvet. "This trend is likely to persist at least until the September meeting, where new proposals are anticipated."

The rush for safe-haven investments following the UK’s unexpected decision to leave the EU in June heightened speculation regarding necessary adjustments to the ECB’s approach, although yields have retreated from record lows following the referendum.

When asked whether Brexit could further limit the ECB’s bond options, Bundesbank President Jens Weidmann suggested that the central bank might consider reviewing bond purchase conditions after its summer recess.

ZERO 30-YEAR YIELD?

Analysts surveyed by Reuters foresee potential changes, including the acquisition of bonds yielding below the deposit rate and an increase in the 33 percent cap on purchases of individual bonds.

There have also been discussions about more significant changes, such as a potential shift that would allow the ECB to buy bonds proportional to a country’s debt instead of its economy size. However, estimates indicate this might only extend the program’s lifespan by five to eight weeks, as some predict it could reach its limits in a matter of months.

Beyond the technical considerations, any perceived delays in monetary easing could suppress future inflation expectations. This scenario has traders considering "curve flattening" strategies, leading them to invest more heavily in long-dated bonds.

A crucial market indicator of long-term inflation expectations in the euro zone—the five-year, five-year forward rate—remains just above all-time lows at 1.33 percent, far short of the ECB’s nearly 2 percent inflation target.

Unless the ECB intervenes to address bond scarcity, analysts warn that pressures on long-dated bonds could push 30-year German yields toward zero percent.

Since the Brexit vote, those yields have fallen by 21 basis points, marking more significant declines than any other maturity.

"The overwhelming influence of the ECB could drive 30-year bond yields to zero," said Rabbani Wahhab, a senior fixed income portfolio manager at London and Capital.