LONDON: Euro zone borrowing costs lurked around record lows on Thursday, with investors holding their bonds tight as the European Central Bank put the final touches to its trillion-euro asset-buying programme.
German two-year yields were minus 0.20 percent, in line with the ECB's deposit rate as markets were unsure whether the bond-buying scheme would include assets that yield less than the rate at which the ECB effectively funds itself. The main concern is the ECB's ability to meet its monthly target to buy 60 billion euros of assets, mostly government bonds.
Banks want the bonds as liquidity buffers as regulators are not asking lenders to set aside cash for government debt as they do for other assets perceived as riskier. Pension funds and insurers need the bonds to match their long-term liabilities.
"It will be quite difficult for the ECB to buy bonds," said Emile Cardon, market economist at Rabobank. German Bund yields were flat at 0.385 percent, exactly 10 basis points above their record lows. Spanish and Italian 10-year yields fell 2 bps each to 1.29 percent and 1.38 percent, respectively - both less than 10 bps above their troughs. "Everybody is aware of the scarcity problem," said Lauri Haelikkae, fixed income strategist at SEB. "The market seems confident that yields will fall further."
The likely sellers of bonds to the ECB would be asset managers that hold debt maturing in 5-10 years, those who have the flexibility to invest in other assets and outside low-yielding Europe as well as the hedge funds that have bought the bonds already anticipating they would sell to the ECB.
"It is quite true that some holders are not going to sell but as a global fund manager, when yields are negative I am a happy seller," said Christoph Kind, head of asset allocation at Frankfurt Trust.
Charles Diebel, head of macro strategy, fixed income at Aviva Investors told the Reuters Global Markets Forum community the Swiss National Bank, which has accumulated significant amounts of euro zone bonds in its failed attempt to keep the franc weak, could be eager to sell if the currency remained relatively stable.
"There is a clear consensus in the street that there will not be enough free float in most of the member state bond markets to satisfy the buying," Diebel said.
"But I am cautious on this. We know the SNB has a large amount of assets that it could start to let go if their currency remains broadly stable and likewise we are seeing some divestment of reserves by ACBs (Asian central banks)."
NEGATIVE YIELDS
Other uncertainties ahead of the ECB's meeting in Cyprus on Thursday include the start date of the programme and the freedom that national central banks have in choosing the bonds they buy.
If the German Bundesbank has any say over what it buys the expectation is that it would be reluctant to buy bonds with negative yields or long-term bonds that are riskier than short-dated ones.
The ECB only plans to cover 20 percent of the programme, with the rest being the responsibility of each country's central bank.
Frankfurt Trust's Kind expected the ECB to keep any details as vague as possible to give itself maximum flexibility.
Portuguese bonds are likely to benefit the most from the ECB's quantitative easing programme.
While Portugal's total debt is one of the highest in the bloc, having been bailed out by the International Monetary Fund and the European Union during the debt crisis, its stock of marketable bonds is relatively small.
The ECB is likely to scoop up between a fifth and a quarter of the Portuguese debt market.
Portuguese 10-year bond yields were little changed at 1.89 percent, having traded just below 18 percent three years ago.
Compounding the feeling that Greece is on the fringes of the euro zone, Greek debt is unlikely to be part of the ECB's programme at least until July.
The QE scheme is designed so that the ECB does not own more than a third of a country's debt market, which is already the case in Greece.
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