The ECB yesterday (Thursday) unveiled a larger than expected sovereign QE programme, with market participants speculating CBPP3 buying will ease, albeit only slightly, and the relative value of covereds versus govvies further improve, priming the market for new supply.

Following a meeting of the European Central Bank governing council yesterday, president Mario Draghi announced a programme targeting bonds issued by EU governments, agencies and public institutions that will, from this March until at least September 2016, purchase Eu60bn of assets per month, “encompassing the existing purchase programmes for asset-backed securities (ABS) and covered bonds”.

In the following Q&A session, Draghi said it would be difficult to provide a precise estimate of how the target will be divided between public and private assets.

“First of all the size of the market for ABS is relatively small, although we think it will expand in the coming months,” he said, “and the covered bond programme has done quite well, much better than the other programme, but also we don’t know what the market size will be next year.

“What you could look at is basically the past behaviour as an inference for the future behaviour of our purchases.”

Market participants noted the ECB’s intentions for CBPP3 remain vague, but some suggested buying would continue at close to its current rate.

“Given that ABSPP has only played a minor role so far, we take this as an indication that the current run-rate of CBPP3 will continue, at least in the near term,” said Sverre Holbek, senior analyst at Danske Bank.

Other analysts said the scale of sovereign bond buying would ease the pressure on CBPP3, but suggested purchasing volumes would be reduced only slightly.

“We don’t think that the amount of covered bonds being purchased under CBPP3 will be reduced substantially but we expect the ECB to slightly reduce the daily purchase volume,” said Michael Spies, covered bond and SSA strategist at Citi, calculating that the contribution of the new purchasing programmes would leave CBPP3 and ABSPP to provide Eu10.8bn towards the monthly Eu60bn target.

“With Eu350mn of weekly ABS purchases, this would leave Eu2.36bn of weekly covered bond purchases, slightly lower than the average recorded since the start of CBPP3,” he said.

Meanwhile, analysts at ABN Amro calculated the ECB will continue to buy around Eu5bn-Eu10bn of covered bonds per month, down from Eu10bn-Eu14bn.

“Therefore, the ECB will most likely become a less dominant player in the covered bond market, which would be in line with recent observations,” said Joost Beaumont, senior fixed income strategist at ABN Amro.

Analysts and syndicate bankers added that a large QE programme working alongside a still active CBPP3 should cause government bonds to outperform covered bonds.

Danske’s Holbek said that should CBPP3’s purchase volumes not fall significantly, the programme would continue to support Eurozone covered bonds, which could tighten further versus swaps as relative value improves.

“While we expect the launch of sovereign QE to cause covered bonds to underperform on a relative basis, much has already been priced in,” he said. “This should limit the potential underperformance.”

A covered bond trader said that most prominent in covered bond flows yesterday afternoon was buying of higher beta names. However, he noted that while a Caixa Geral de Depósitos Eu1bn seven year benchmark launched at 64bp over mid-swaps on Monday was a basis point or two tighter alongside credits such as Monte dei Paschi di Sienna, they were still underperforming peripheral government bonds by 5bp-10bp.

“We expect the QE effect to be positive for our market as investors are crowded out of the most liquid and highly rated assets into the next best thing and the initial underperformance will tilt the RV scales back into favour of covereds,” said the trader.

Citi’s Spies said that the trend would vary between core and peripheral segments, with covered bonds looking more attractive in some.

“This should sooner be the case for core and semi-core segments, particularly France,” he said. “For peripheral segments, we think that covered bond underperformance might last a bit longer as current levels are still relatively rich, with several government bonds trading cheaper than covered bonds. That’s particularly the case for the Italian market.”

A syndicate banker meanwhile noted that longer maturities could prove attractive.

“As you would expect, peripheral covereds and sovereigns have rallied and the important thing here is that what Draghi is trying to achieve is to flatten the curve, or flatten rates across maturities,” he added. “So you’re seeing quite a decent curve flattening already in German govvies, in swaps and in the peripherals sovereign space as well.

“The good thing about that is that it’s going to be positive for covereds in the sense that flattening the curve even more will entice investors to push further, so they don’t get crowded out even more. Everyone is going to be forced to buy 10s, 12s and 15s so we could potentially see more longer dated issues come to market, on the back of demand from private investors.”

Covered bond issuance slowed ahead of the ECB’s announcement – with four euro deals launched this week compared with 14 last week – but syndicate bankers were confident that primary market activity will resume at its normal pace next week.

“I don’t think it has done a whole lot to our business here,” he said. “We stepped on the brakes on Wednesday, but I would assume that the market is going to get restarted by early next week or whenever issuers feel like going. The market is there, it just depends if the issuers are there as well. Investors are there, they have become used to the yield environment, however painful it may be.”

But another syndicate official said that although a lot of financial institutions are looking to hit the market on Monday, Greek elections on Sunday have to be navigated first.

“It is extremely positive, of course, but don’t forget there is Greece,” he said. “To be honest, things are a touch too rosy to me. It has been going in only one direction for one week now, and I think a correction is overdue, and anything that disappoints on Sunday or Monday morning may push everyone to take profit, so we have to be very careful.

“I don’t want to be pessimistic, but I would not put a trade in the market first thing on Monday morning. I would wait and make sure that the market really is opening in the right direction, and not stable at 8am and then everything red at 8.15.”