ECB: Debunking myths about QE technical changes – Deutsche Bank

Abhishek Singhania, Research Analyst at Deutsche Bank, suggests that there remains a lot of uncertainty and arguably some misconceptions about the impact of technical changes to the ECB QE programme in addressing the scarcity issue and the impact on curve and spreads.

Key Quotes

“We conclude that the ECB will be unable to address the scarcity issue by implementing any one single technical change. The ECB will have to combine a number of changes such as increasing the issue limit, removing the deposit facility rate constraint on purchases and flexibility around the capital keys to ensure smooth implementation of the QE programme.

There is a general belief that a shift from capital keys to market value weights for the PSPP purchases will alleviate the scarcity issue significantly by tilting purchases away from Germany to Italy.

However, we find that such a shift will reduce the monthly purchases of German central government debt from EUR 10.8bn a month to EUR 8.6bn a month and ease the scarcity issue by only two months. Given that such a change would also be politically contentious it is unlikely to be implemented.

A soft deviation from capital keys as is currently being implemented, if taken to its logical extreme, could imply that scarcity in individual markets becomes irrelevant. Instead, PSPP purchase can continue as long as there are any eligible outstanding PSPP securities irrespective of the country of issuance of such securities.

A soft deviation from capital keys taken to its logical extreme would, therefore, more significantly address the scarcity issue but would not be seen as a “soft” deviation. In practice, a limited form of soft capital key deviation is more likely.

Although EUR 142bn of German central government debt in the 2Y-31Y maturity bucket is currently trading below the DFR (after applying the 33% issue limit) we estimate that only EUR 63bn may be left for purchases with the remaining already purchased when these bonds were eligible. Therefore, removing this constraint in isolation would also not completely address the scarcity issue, easing concerns for only six months.

The removal of the yield floor constraint, if used in isolation, would reduce flattening pressure on the curve for a brief period. For the effect to be powerful the removal of the depo floor constrained would have to be combined with an increase in issue limits to enable greater purchases of these front-end bonds.”