Photo: AP/Riccardo De Luca
The next big European Central Bank (ECB) effort to lower interest rates may not happen in the sovereign bond or bank funding markets like many have been hoping for and expecting.Rather, they might happen in the market for non-financial corporate bonds.
That’s Goldman Sachs credit strategists Charles Himmelberg and Lofti Karoui’s read on the situation. In a note to clients, they write that since ECB president Mario Draghi is opposed in principle to unlimited support for sovereigns, it’s likely that “creative new policy instruments” are waiting in the wings to be deployed.
The ECB’s long-term refinancing operations (LTRO) in the first quarter of the year supported sovereigns by dousing liquidity on eurozone banks, which then took the cheap money and invested it in sovereign bonds, driving yields down.
A potential problem with another LTRO, as Citi has discussed, is that “domestic banks, already heavily laden with domestic sovereign debt, make room to buy primary issuance by selling in the secondary market.” In other words, it could actually send yields higher, which would of course be counterproductive.
According to Goldman, the next best option the ECB has now is to do the same thing for the non-financial private sector. In the note, they write:
The ECB could activate innovative policies that support the nonfinancial sector via direct purchases of corporate securities or possibly another LTRO modified in the direction of the Bank of England’s “funding for lending” scheme. Such policies would be consistent with a desire to support the private sector rather than encourage moral hazard by directly supporting sovereigns. Of course, like LTRO, but to a lesser degree, support for the nonfinancial private sector would flow back to the sovereigns via higher growth. But this is not the sort of sovereign support that runs a high risk of moral hazard.
President Draghi has not announced such policies, but in his remarks last week and again in yesterday’s press conference, he hinted that additional nonconventional measures are being considered. More importantly, we think, is the clear resistance – consistent with longstanding ECB policy – to providing any sort of unconditional support to sovereign markets.
Himmelberg and Karoui write, “we suspect the market is under-pricing the possibility.”