• Last night, the ECB held an emergency meeting in response to COVID-19 and the financial market fragmentation, which was led in particular by Italian and Greek yields.
  • ECB went all in with a Pandemic Emergency Purchase Programme (PEPP) with an overall envelope of EUR750bn, to be done in all asset classes under the APP. The EUR750bn will be implemented until end 2020 in a flexible manner. The EUR750bn comes on top of the normal APP and the EUR120bn envelope decided last week.
  • ECB stands ready to adjust the self-imposed (ISIN) limits. Non-financial commercial paper is included in the PEPP.
  • We believe this will act as a circuit breaker in fixed income markets and lead to extremely sharp spread tightening and decline in credit risk.

New PEPP programme

With the current credit widening and particularly Italian surge in yields in recent days, a forceful response from the ECB to act as a circuit breaker was needed. Yesterday, we changed our call to include a step up its QE, ISIN limits, and even more deviation from the capital key with a total envelope of at least EUR500bn, see ECB Research – Action needed urgently. This happened last night.

The ECB launched a new purchase programme to contain the severe repercussions of the spread of COVID-19 spread and the malfunctioning of markets in recent days – most notably in Italy and Greece. The PEPP envelope is very large but also has a sufficiently bold level of EUR750bn purchases by the end of the year and will be conducted in all asset classes under the APP. Furthermore, the PEPP will be implemented in a ‘flexible manner’, which allows purchases to focus on the most distressed parts at the current time. Part of the strong signal is also that Greece will be included in the PEPP, which so far hasn’t been part of the APP. It is a very strong signal to send that it includes non-investment grade bonds in its purchases.

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On the more technical side, but importantly, the ISIN limits, which are deemed to be broken on the back of the increased purchases, will be reassessed to the ‘extent necessary to make its action proportionate to the risks that we face’.

The ECB decided to ‘expand the range of eligible assets under the corporate sector purchase programme (CSPP) to non-financial commercial paper, making all commercial paper of sufficient credit quality eligible for purchase under CSPP’. Similar to the Fed’s and BoE’s decision, this is welcomed in a distressed market in this turmoil. Also, the ECB eased ‘the collateral standards by adjusting the main risk parameters of the collateral framework’.

The reassurance that markets needed

After the recent miscommunication and turmoil in financial markets, we believe the package will serve as a clear reassurance to markets that the ECB will be there to buy more than EUR1tr by the end of the year on a net basis on top of the reinvestments from the current programmes. (PEPP of EUR750bn, net APP of EUR20bn/month and additional EUR120bn envelope equates to approximately EUR1,06tr by the end of the year or EUR111.6bn/ month). This is significantly higher than the highest purchase rate of the APP in 2016 of EUR80bn/month. The ECB clearly indicates a readiness to do more and increase the size of the purchase programmes and adjust the composition.

Market implications

With the strong and bold package from the ECB, we expect a strong rally in risk sentiment – and most primarily in the fixed income space. Naturally, as Italy and Greece have been under severe pressure, this is where we expect to see the best performance near term. Looking ahead, with the package of almost EUR110bn / month, we expect the ECB to contain the credit risk element that was introduced. That said, the increased demand from the ECB is also needed to address the increased supply of bonds on the back of COVID-19 funding from member countries. We still do not have the funding implications; however, with governments spending on average up to 2% of GDP, the significant package is very welcoming.

Lessons for the future

While there are no doubts the recent communicative turmoil would like to have been avoided in the ECB (most recently Holzmann’s comments yesterday morning), our takeaway is that in regards to the limits that have been restricting them for some time, or about to restrict them (ISIN limits, eligibility in PSPP, etc) and are self-imposed, the ECB has clarified that ‘there are no limits to our commitment to the euro’.

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