Beware the Bund squeeze or will the real ECB please stand up? – RBC CM

Peter Schaffrik, Chief European Macro Strategist at RBC Capital Markets, suggests that the UK’s vote to exit the EU has made Bunds even richer and has exacerbated a problem that has been around for quite some time: Increasing demand for the euro area’s ultimate safe haven but dwindling supply.

Key Quotes

“Against this backdrop, the ECB’s QE involvement – particularly under its current rules – runs into severe difficulties. We estimate that all ECB Bund purchases have to be concentrated in an ever smaller part of the market representing now less than EUR 300bn. Over the medium term, the risks are that the ECB will run out of Bunds to buy – somewhere in H2 2017 according to our estimates.

The long end of the Bund curve is under severe risk of experiencing a squeeze. We recommend staying long particularly 30y Bunds which we estimate will test the 0% yield level soon. We stress that a proper squeeze in the euro area’s ultimate benchmark would be very disruptive and might lead to many unintended consequences.

The richness of the European benchmark is also likely to drive flows into other safe havens such as US Treasuries, Gilts and even markets further afield such as Canada or Australia. This requires global investors’ attention to focus on the Bund market and the ECB – even more than usually the case.

We expect that the ECB will have to address this topic in the upcoming meeting on 21-July. There are multiple options available – none of them easy. We reckon that abandoning the deposit rate floor and increasing the issuer limits will be on the cards. We stress, further, that we continue to believe changing the buying metrics away from the capital key towards a volume weighted measure appears the measure with the most bang for the buck.

Market reaction to changes are manifold and dependent on which concrete measure will be taken. Taking away the deposit floor would, for instance, constitute a 5y-30y steepener while a change in the capital key argues for significantly tighter spreads with the European fixed income markets.”