Since 2014, the European debt market has had a clear protagonist: the European Central Bank (ECB), which has emerged as the main investor in bonds from the different public Treasuries in the eurozone. That year the ECB’s Asset Purchase Program (APP) began, which in the case of Spain has involved the acquisition by the issuing bank of 315,000 million debt. To this initiative, which already involved a clear intervention in this market, was added in March 2020 the Pandemic Emergency Purchase Program (PEPP) of covid-19 and in which the ECB invested 190,000 million in Spanish debt.
In total, the ECB has Spanish debt worth 500,000 million euros out of a total of 1.45 trillion (118% of GDP), according to the latest data from last March. Thus, the institution chaired by Christine Lagarde is the largest investor in Spanish bonds with approximately 30%, as is the case with other European countries. This fixed buyer for eight long years has allowed low interest rates on eurozone bonds, including the paradox of negative rates: you had to pay to invest.
Last April, Lagarde announced that as of July she would stop buying debt, but unlike the United States Federal Reserve (Fed), she will continue to purchase bond maturities until at least 2024. That is, not it buys new debt, but does not sell the one it already has. A very important nuance, as explained by Olivier Chemla, principal sovereign risk analyst for Spain at the rating agency Moody’s: “It is not going to go from white to black, it is a gradual turn and there will continue to be intervention,” he explains. David Cano, managing partner of Afi, points out that “it is undoubtedly a challenge for the ECB to stop buying bonds, but it would not be alarmist. The situation would be serious if the ECB sold bonds as the Fed has decided to do, but this is not the case”, he points out.
The transfer of debt in this decade has occurred from credit institutions (banks) to the ECB. Thus, in March 2012, the banks owned 35% of Spanish debt and currently hold just over 12%. Another singularity of the Spanish market is the strong presence of foreign investors who own 43% of Spanish debt, according to data from the Public Treasury. Analysts at Goldman
Sachs point to the investors who will take over from the ECB in the coming years: “We anticipate that the volumes purchased by the ECB in recent years will be replaced by a combination of private sector managers, bank treasury desks and financial institutions, as well as foreign exchange reserves of non-European countries”, they explain.
The intervention of the ECB during this long period has caused an anomalous situation in the markets and it is the peripheral countries such as Italy or Spain that may have the most problems when the purchases end in July. The evolution of inflation, economic growth, the public deficit, structural reforms, the use of European Next Generation funds or the weight of debt over GDP are, for Olivier Chemla, elements that Moody’s will take into account when to assess Spain’s rating. There will be more differentiation between some countries and others. In fact, the risk premium (difference between the return on the German 10-year bond and the Spanish one for the same term) has already risen: it is now 134 basis points compared to the 67.9 basis points with which it began this 2022. But last Thursday, after the ECB meeting, Lagarde showed her commitment to adjust all monetary policy instruments, including the creation of a new vehicle if necessary, to avoid the risk of financial fragmentation that would affect peripheral countries such as Italy or Spain. “Under stress conditions, flexibility will remain an element of monetary policy,” says the ECB. As the president of the ECB insisted at a press conference “we are committed to avoiding financial fragmentation that prevents the transmission of monetary policy. We will not tolerate financial fragmentation.”
He knows in depth all the sides of the coin.
Rafael Valera, CEO, partner and manager of Buy & Hold, points out that “the Spanish risk premium has been very contained by the ECB purchases and that the impact of its withdrawal has not yet been discounted. Therefore, it would not be an exaggeration to see a rise in the spread against Germany above 150 basis points”, he explains. And he adds: “Until now Spain and other countries in the eurozone have not had to worry about finding buyers for their emissions, but now they are going to have to start doing it.” A view that coincides with that of Goldman Sachs analysts: “Peripheral countries have had the greatest reduction in their risk premiums thanks to purchases by the ECB. As a consequence, we would anticipate a greater widening of credit spreads in these peripheral countries without this meaning that the investor base is not capable of absorbing the issuance volumes”.
In addition, there are other favorable elements for the debt that have been forged in recent years. “The Spanish Treasury has taken advantage of these years of ECB intervention to increase the average life of the debt, which now stands at eight years, compared to the six years it had in 2012”, explains the Moody’s analyst. This means that there is no tension about maturities —it will have to be renewed with new purchases— that will be extended over time.
It also benefits from a low cost of debt. Nadia Gharbi, economist for Europe at the manager Pictet WM, points out that data from the European Commission indicate that the average cost of debt in 2021 was 2.4% for Spain and 2% for Italy. “A sustained increase in bond yields to maturity would be needed for a higher interest burden to affect long-term debt sustainability. In addition, the GDP-weighted yield-to-maturity spread of the 10-year debt of the EU periphery countries, which has been at 1.59%, remains below the maximum of 2020 and close to the average of 1, 71% since 2014″, he explains. The Pictet expert also offers other data to expect a quiet 2022 for peripheral debts. “Both Spain and Italy will issue less debt this year. With fewer asset purchases, the ECB would cover 80% of the eurozone’s issuance this year (compared to 125% in 2020-2021) ”, she concludes.
The price of the bond
The Spanish 10-year bond began the year with a return of 0.576% and now stands at 2.98%, as a result of strong inflationary pressures and the expectation of increases in intervention rates at the ECB. This has caused strong losses in the price of bonds that have had to adapt to the new profitability. The cessation of purchases by the ECB as of July does not seem decisive for expecting new increases in profitability, which, according to them, will depend more on the progress of inflation. At Goldman Sachs they forecast that the rest of the year will continue to be very volatile for yields on a global scale and, especially, for the European framework. “There is a possibility that bond rates continue their upward trend, but this will depend on the evolution of inflation, as well as the impacts suffered by the commodity markets,” they explain. Rafael Valera indicates that “we will see more rises from the current levels because the market is discounting fairly sustained inflation in the medium term, which has given rise to real interest rates as negative as ever before”.
However, David Cano is more cautious about new increases. “We are not going to the 2007-2008 cycle because there are current account surpluses, and the current situation of the banking system is solid in the face of that crisis,” he concludes.
Exclusive content for subscribers
read without limits