Investors ‘front-run’ the ECB, rush to buy bonds

If anyone was looking for more proof of how central banks’ actions are distorting the markets, here it is: investors are trying to “front-run” the European Central Bank (ECB) – in the words of analysts at Bank of America Merrill Lynch — by buying investment grade bonds.

They do this in the hope that they can make a quick profit when the ECB’s asset purchasing programme comes into force for corporate bonds as well, starting in June.

Last week, the ECB gave more details about how its corporate bond purchases will proceed. The bank will buy the bonds of non-bank and insurance companies that have a credit rating of BBB- or above, with maturities of up to 30 years.

So what’s happening now? Capital flows data analysed by Bank of America Merrill Lynch show that investors are buying more credit at the expense of equities, in their attempt to profit from the ECB.

The week ending April 20, the one for which the most recent data is available, was the seventh straight week of inflows for investment grade credit, which is the main target of the asset purchasing programme. (Incidentally, about the same time has passed since ECB head Mario Draghi first announced the central bank will buy corporate bonds).

Investors poured $2.9 billion in the asset class, followed by $1.3 billion that went into emerging markets debt funds, which saw their ninth straight week of inflows. Government bonds saw outflows worth $900 million, their ninth straight week of outflows.

High-yield bond funds saw inflows too, worth $800 million, which shows that investors’ risk appetite has returned.

Judging by the Bull/Bear indicator, it’s possible that this appetite will stay for a while. The reading is neutral, after the indicator spent around three months in bearish and extremely bearish territory.

The indicator spent a long time in extremely bearish territory. Source: Bank of America Merrill Lynch

The indicator spent a long time in extremely bearish territory. Source: Bank of America Merrill Lynch

Despite this, last week investors took money out of equities everywhere except for emerging markets, which saw their first inflows in four weeks, albeit very modest at around $300 million.

European equities seem to suffer the most because of the ECB’s policy of buying bonds. They saw 11 weeks in a row of outflows, the longest losing streak since May 2010. In the week that ended on April 20, investors pulled out another $2.1 billion from the asset class.

Japanese stocks also saw their biggest redemptions since November 2014, worth $2.6 billion, while US equities saw their largest outflows in nine weeks, worth $4.2 billion.

So far this year, commodities have posted the best returns, worth 8.4%, followed by bonds with 6.4% and equities with 3.3%. Cash returned only 0.1%.