In last week’s article I mentioned that at the European Central Bank (ECB) meeting held on December 3, the ECB maintained its Quantitative Easing (QE) programme at €60 billion per month but extended it by a further six months, from September 2016 to March 2017.
The QE programme, also referred to as the Public Sector Purchase Programme (PSPP), was initially announced to the market by the ECB on January 22, 2015. The programme commenced on March 9.
It is worth recalling that the QE programme is a form of money printing through a process by which national central banks inject cash into an economy by buying government bonds from banks and other holders of such securities including retail investors. The aim of the QE programme is to ultimately instigate the commercial banks to increase lending to households and businesses, weaken the currency (in this case the euro) and increase exports which should collectively lead to a rise in inflation.
As explained in my article on March 12, 2015, the ‘QE desk’ at the Central Bank of Malta was entrusted with conducting the PSPP in Malta which entails an acquisition of circa €36 million in Malta Government Stocks (MGS) per month.
Following the announcement earlier this month that the ECB extended the QE programme by a further six months until March 2017, it would be interesting to analyse how the QE desk at the Central Bank of Malta has fared in achieving its objective during the first nine months of the QE programme.
Trades conducted with the ‘QE desk’ are not done via the regular market but through the Over-The-Counter (OTC) market. Moreover, the OTC trades in the ‘QE window’ are not visible on the website of the MSE. Instead, the ECB publishes the aggregate purchases of securities across the eurozone on a weekly basis. Moreover, on a monthly basis, it provides the breakdown of trades across the different countries within the eurozone. The data published by the ECB as such also includes the information on the amount of Malta Government Stocks purchased by the ‘QE desk’ at the Central Bank of Malta on a monthly basis.
After a very slow start in March with only €5 million worth of MGS acquired, the QE programme in Malta gathered momentum in the following three months and peaked at €85 million in May – way above the monthly target of €36 million.
Having said that, the amount of MGS purchased by the QE desk suffered in the subsequent months – especially during the past two months. The recent data published by the ECB shows that only €2 million worth of MGS was acquired by the ‘QE desk’ in Malta during the month of November. In fact, although between April and June the monthly purchases exceeded the allocations by a significant degree, the total amount of QE purchases conducted to date amounting to €275 million is circa €49 million below the amount that ought to have been acquired so far.
So why did the purchases increase so much in the initial four months and why have these subsided in such a significant way in the following five months? There are various factors which may have contributed to this.
As a start, the high activity between April and June is possibly a direct result of the initial surge in MGS prices during the month of April with a subsequent correction in May and June. This is indeed evident from the Rizzo Farrugia MGS index showing significant volatility between March and June 2015.
As explained over the past few months, movements in MGS prices reflect changes in the benchmark German bund yield as well as the yields in the peripheral eurozone countries with similar credit ratings to Malta.
€275m QE purchases to date are circa €49m below the amount that ought to have been acquired so far
The 10-year German bund yield had slid from 0.546 per cent at the start of the year to a mere 0.05 per cent on April 17 and this was reflected in a corresponding rally across the eurozone’s sovereign bond prices including those in Malta. However, following the decline in yields to almost zero for the 10-year maturity by mid-April 2015, yields suddenly rebounded to 0.8 per cent in early May leading to a sharp downward correction in bond prices.
Market conditions were more subdued during the summer months but the bond market remained particularly volatile from one week to the next, reflecting mixed economic data across the eurozone as well as statements by the ECB and other major central banks.
The influence of communications by the major central banks across financial markets was widely evident earlier this month when yields unexpectedly jumped from 0.47 per cent on December 3 to 0.68 per cent after the ECB announcement – one of the biggest one-day moves in a long time.
Despite this volatility from one period to the next, market conditions were generally much calmer during the summer months and despite the reduction in the minimum amount per QE trade to €50,000 nominal, few investors participated in the QE window.
Possibly, the major reason for the decline in QE trades over the past five months is the lack of alternative investment opportunities. As indicated in an article published earlier this year, 35 per cent of all MGS’s are held by individuals with a further 32 per cent by credit institutions (banks). Both these categories of investors are clearly not being offered suitable alternative investments.
From a retail perspective, the amount of corporate bond issuance in 2015 was far less than originally anticipated and this surely led to a lack of participation by retail investors in the ‘QE window’ despite the sizeable capital gains across all MGS. Moreover, whenever a new bond was issued, the extent of over-subscription left many investors disappointed with the level of their allotments.
Likewise, the continued inflow in deposits at credit institutions coupled with much weaker growth in the loan book contributed to heightened levels of liquidity across the main banking institutions.
Given the negative deposit rates at the ECB, banks therefore tended to hold on to their MGS holdings in order to achieve an acceptable return on equity for shareholders.
In view of the difficulty for the Central Bank of Malta to date to source willing sellers in the QE window, it is debatable how they will manage to achieve the monthly target in subsequent months, especially given the six-month extension until March 2017.
The ECB has also reiterated on various occasions and again at its meeting earlier this month that the QE programme may be extended further if inflation fails to approach their target of two per cent by then. The latest forecasts indicate an inflation rate of only one per cent in 2016 and 1.6 per cent in 2017.
Should the ECB decide to increase the amount of monthly purchases across the eurozone, the Central Bank of Malta would be left in a quandary given the present difficulties to abide by the current level of the PSPP, let alone an additional amount. Although at the December meeting, the ECB broadened the list of eligible securities to include regional and local government bonds, this is not applicable in Malta’s case since no such instruments are issued and tradeable on the Malta Stock Exchange.
The Central Bank would therefore need to come up with other initiatives to instigate holders of MGS to dispose of their securities.
From a retail investor perspective, until such time as the evident sizeable pot of liquidity finds its way into suitable and attractive corporate bonds and new equities offering sustainable dividends, it is unlikely that such investors will participate again to a large extent in the ‘QE window’ unless bond prices are on a clear downward trend, jeopardising the strong capital gains across most MGS.
Edward Rizzo is a director at Rizzo, Farrugia & Co (Stockbrokers) Ltd.
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