Here’s what Draghi has accomplished recently: the prices of euro-denominated corporate debt have soared. The average yield of investment-grade debt is on the verge of dropping below 1%. A good part of the €916-billion market for corporate euro debt is already below 1%, according to Bloomberg. Highly rated corporate debt with shorter maturities is trading at negative yields, where brainwashed investors engage in the absurdity of paying for the privilege of lending money to corporations.
Companies, including US companies, are scrambling to take advantage of this free money: They issued over €50 billion of euro-debt in May, the second-busiest month on record. On Monday, at least six investment-grade and junk-rated deals were announced. One of them was Air Liquide SA, which sold €3 billion in investment-grade debt. Four of the five parts of the deal priced with a yield below 1%!
They’re all getting ready for Wednesday.
June 8 is the propitious day everyone has been waiting for: the ECB – which is already buying government debt, covered bonds, and asset backed securities – begins buying euro-denominated corporate bonds. Maturities will range from six months to 30 years. It will buy these bonds either in the secondary market, where previously issued bonds are traded, or in the primary market, thus handing its freshly printed euros directly to the companies (“helicopter money” for corporations).
“The prospect of average yields below 1% is very scary,” Juan Esteban Valencia, a credit strategist at Societe Generale in Paris told Bloomberg. “Investors are being pushed outside their comfort zone to sectors like high-yield debt, where they may not have expertise.”
And where they won’t be paid for the risks they’re taking.
So junk bond yields have plunged as conservative investors are getting pushed into risky paper with a good chance of default, though the ECB won’t be buying junk bonds under the current program. According to the BofA Merrill Lynch Euro High Yield Index, the average junk-bond yield fell from over 6% earlier this year to 4.16% as of June 6.
But investors that jumped on the bandwagon belatedly might be in for a rough ride. That’s how it always happened before.
It’s how Draghi does business. A decision is made in secret to buy a certain type of asset or to lower interest rates. That decision is then communicated in secret meetings to hedge funds and certain other market participants so that they can buy into those positions and start pushing up prices. The ECB has gotten into hot water over this when it came out, but hey, that’s how the ECB operates.
Eventually, the decision is leaked in some form, still couched in vague words, and other players are buying into it, pushing up prices even further. Then the decision is officially voted on at the ECB meeting and announced in a press conference. At this point, the remaining players are buying into it and drive up prices even further. Prices peak around the time the decision is actually implemented, and then they drop, sometimes precipitously.
In the case of the ECB’s buying corporate bonds, that date is June 8.
After that date (perhaps just a few days later), the smart money that got the info during secret meetings will dump these assets to take profits. And the late entrants into the game, those that didn’t have enough insider info, get bloodied.
This happened when the ECB prepared for QE. European stocks skyrocketed to all-time highs during the period that began with the secret meetings. But in April 2015, shortly after QE took effect and the ECB started buying government bonds, stocks sagged. The German DAX, for example, remains 17% off that high to this day.
Same thing with covered bonds. In early 2014, prices started rising and yield spreads (in relationship to government bonds) began tightening as in-the-know investors began buying them, before anything was known to the rest of the world. Then well-placed rumors of an ECB buying program spread, and prices rose further. When the decision was announced in the fall of 2014, prices rose further. When the ECB actually started buying government bonds, prices peaked and yield spreads hit record lows of just above 20 basis points. Then those who’d benefited from the info provided during the secret meetings started dumping these covered bonds to take profits, and the entire trade unwound. Prices fell and the yield spread nearly tripled, before edging down recently, but remains at nearly 50 basis points.
Same thing with asset-backed securities. Those select few in-the-know investors got to position their trades early, watch them get inflated by the in-the-know buying pressure and the ECB’s machinery, and then, when the ECB actually started buying them, they dumped them. Those late to the party, got hit by the subsequent selloff.
It happens every time. That’s how the ECB operates.
This scenario is likely to play out starting sometime after Wednesday. Euro-denominated corporate bonds are likely near their peak, and companies are desperately trying to issue as much as they can at these peak prices. But over the next few weeks, the folks who got in early will dump them, and those investors now jumping on the bandwagon – often unwitting retail investors with global bond funds in their portfolios – get to eat the losses.
Draghi and his ilk excel in shuffling guaranteed profits to their cronies in this manner, all under the mantel of wanting to stimulate inflation. And if pension funds, life insurers, and other retirement arrangements that so depend on yield, impoverish retirees down the road, well, so be it. And if that impoverishment mauls demand because retirees – and there are lot of them in Europe – don’t have enough money to spend, well, so be it too. By then Draghi and his ilk will have moved on.
Contagion from the negative interest rate policies by the ECB and the Bank of Japan are spreading around the globe. Read… The NIRP Refugees Are Coming to America