Mario Draghi might need Janet Yellen to bail him out in the bond market.
Ever since the European Central Bank president’s 1.1 trillion-euro ($1.2 trillion) asset-purchase program kicked off last month, he and his colleagues have been beating back suggestions there won’t be enough sovereign debt to buy.
Critics maintain that European governments are slowing issuance at the same time as investors hoard the securities because of the lack of attractive alternatives in a low-inflation world, or because they’re required to do so by post-crisis regulations. In some countries, yields have fallen so far that certain bonds have become ineligible for the program.
That has the ECB looking for potential sellers abroad, where foreign banks and investors own almost half the euro-region’s outstanding bonds.
“International banks and asset managers are the most likely sellers of their euro-area government bond holdings,” ECB Executive Board member Benoit Coeure said in a March speech. “And these investors are generally felt to have more flexible mandates.”
Just how much those investors are willing to sell to the ECB may ultimately be determined more by Federal Reserve Chair Yellen than by Draghi, according to Michael Schubert, an economist at Commerzbank AG in Frankfurt.
That’s because their readiness to sell euro-denominated bonds will depend on the appeal of other investments, such as U.S. Treasuries, whose value will be partly dictated by how fast the Fed raises interest rates.
“U.S. Treasury yields are set to rise more strongly, rendering them more attractive, the more Fed hikes exceed current market expectations,” Schubert said in a report this month. “If, however, the Fed hikes fall below market expectations, the lack of investment alternatives would make it more difficult for the ECB to source enough bonds for its purchase program.”
The Federal Open Market Committee concludes a two-day meeting on Wednesday at which it is forecast to leave rates on hold for now.
The good news for Draghi is that Commerzbank sees the Fed increasing borrowing costs more sharply than the market does. The German bank predicts the Fed will raise its benchmark rate to 2.25 percent by the end of next year from near zero today. By contrast, eurodollar futures are pricing in about 96 basis points of hikes, according to Royal Bank of Scotland Group Plc.
“U.S. Treasury yields are therefore likely to rise, which would boost investors’ willingness to sell their euro bonds,” said Schubert.