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ECB Monetary Policy

The ECB’s Monetary Policy Is Now Creating a Rush Into Derivatives

While actual macroeconomic and corporate fundamentals do still exert influence on financial asset prices from time to time, the far bigger driver of performance over the past several years is central bank policy. To understand just how destructive this is, recall what we learned in last month’s post, Japan’s Bond Market is One Gigantic Joke – “No One Judges Corporate Credit Risks Seriously Anymore”:

“Tokyo: Fixed Income investors in Japan are increasingly assessing bonds based on their likelihood of being bought by the central bank, rather than the creditworthiness of the issuers.

Still, the fund manager desperately wanted to get hold of the bond because he bets that debt issued by Mitsui and other trading houses will be picked up by the Bank of Japan in its bond purchase program.Even if an investor buys a bond with a subzero yield, the investor could sell it to the central bank for a higher price, the thinking goes.

It goes to show that no one judges corporate credit risks seriously anymore,” said Katsuyuki Tokushima at the NLI Research Institute.”

From Bloomberg: A rush for credit exposure in Europe is manifesting in the swaps market because investors are struggling to find enough bonds to satisfy their demand.

The European Central Bank’s plan to purchase corporate bonds is fueling demand for securities in anticipation of a rally when the purchases start. Investment-grade bond funds in euros had inflows each week since the ECB said on March 10 that it would expand measures to stimulate the economy. That’s already suppressed yields and made it harder to obtain the notes, making credit derivatives more attractive.

“There’s a dearth of bonds investors can get their hands on,” said Mitch Reznick, the London-based co-head of credit at Hermes Investment Management, which oversees $33 billion. “In this liquidity vacuum, managers can use credit-default swaps as a proxy for the bonds that they can’t obtain in order to get longer in credit.

This behavior is a lot of things, but “investing” is not one of them.

“The quickest way to go long credit is by selling contracts tied to indexes in large size,” said Roman Gaiser, who oversees 3.5 billion euros ($4 billion) of assets as the Geneva-based head of high yield at Pictet Asset Management SA. “That’s easier than buying lots of individual bonds. It’s a quick way of getting exposure to credit.”

If investors are merely looking to front run central banks, you could make an argument that QE can strengthen a currency, at least in the short run, as global fund managers move into the QE producing nation’s currency in order to front run central bank purchases.

So in the short-term, will further QE weaken a nation’s currency or strengthen it? It’s an important question to ask in this increasingly twisted world of global finance.


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