Italian auction highlights hunger for ECB action
LONDON (MarketWatch) -- Expectations the European Central Bank will soon move to resume purchases of troubled government bonds ensured smooth sailing at a closely watched auction of Italian government debt on Thursday, underlining the importance of policy announcements following the central bank's meeting next week, analysts said.
ECB President Mario Draghi earlier this month outlined a proposal that would see the central bank purchase government bonds in the secondary market, while the region's rescue fund would make purchases in the primary market. A distressed government would have to first apply to the rescue fund for help, however, and agree to abide by policy conditions.
Speculation has mounted surrounding the ECB's likely approach, including whether the ECB would attempt to set explicit caps or ranges for yields or yield spreads within the euro zone. The ECB Governing Council meets on Sept. 6.
"The good auction reflects that there are expectations that the ECB will come up with some sort of solution. It probably won't be anything that finishes the crisis, but something that is a step in the right direction," said Jesper Berg, senior vice president at Nykredit's regulatory affairs and ratings division in Copenhagen.
The Italian Treasury sold its maximum targeted 6.5 billion euros ($8.15 billion) in 5- and 10-year conventional bonds, known as BTPs, and sold close the to the maximum amount in the five-year floating-rate note known as a CCTeu. Yields on the 10-year bond fell to 5.82% from 5.96% at a previous auction, while borrowing costs on the 5-year paper dropped to 4.73% from 5.29%. Demand also rose for both maturities.
Since Draghi's Aug. 2 news conference, Spanish and Italian government debt has rallied, particularly at the short end of the yield curve, where the ECB chief said central-bank purchases would be focused. Equities have also rallied.
Thursday's solid demand for Italian paper should, however, not be interpreted as a long-term improvement in the country's debt situation, said Berg, a former head of division for the ECB's Monetary Policy Directorate. Neither should it give the ECB less incentive to intervene in the bond market.
"If [ECB President Mario] Draghi doesn't deliver anything at the press conference next week, interest rates will rise again. Even if he delivers a little bit, the question is if it will be enough to reflect what expectations are," he said.
The ECB announced earlier this week that Draghi and other members of the bank's executive board would the Kansas City Federal Reserve Bank's annual gathering of global central bankers in Jackson Hole, Wyo. That boosted speculation the ECB is aiming to present a more detailed plan next week.
"I would not expect him to say that they'll ensure yields below a certain level. I expect him, on a good day, to say that they will under certain conditions sign a program to intervene in the short end of the market," Berg said.
Such a move would not directly affect the longer-dated bonds, such as 10-year paper, although it could still relieve some of the pressure, said Nick Stamenkovic, macro strategist at RIA Capital Markets in Edinburgh.
"The 10-years are more influenced by the fiscal matrix in the countries. Investors in those bonds have to be more concerned that Spain and Italy are on the right track," he said. "It's just a matter of time before Spain asks for a sovereign bailout and Italy's growth rate is extremely slow."
Stamenkovic further pointed to the yields at Thursday's auction, which were "still relatively high" at 5.82% for 10-year bonds, with little interest from foreign buyers.
"Domestic buyers are quite happy to buy at over 5%," he said. "But the overseas investors showing reluctance means an ECB intervention is crucial and expectations for that has driven the rally," he said. "They can't just announce proposals now, they have to act. Otherwise the rally will end and rates rise sharply."
The next test of confidence in the sovereign bond in on next week, when Spain seeks to raise money.
"The Spanish auction will probably go smoothly, but maybe not as well because their fiscal problems get more attention in the markets," Stamenkovic said.