What has the European Central Bank done so far?
The European Central Bank (ECB) has less room for manoeuvre than some of its peers, given policy rates are already near the lower bound. At the scheduled meeting on 11-12 March, policymakers boosted asset purchases to the tune of EUR 120 billion by year end (in addition to the existing EUR 20 billion per month). They also enhanced the existing targeted longer-term refinancing operations (TLTRO III) programme, making the terms more attractive to banks, by cutting the rate by 25 basis points (bps) to -75bps, if the current levels of credit extended to businesses were maintained. The central bank also provided additional weekly longer-term refinancing operations (LTROs) at the deposit rate, to roll into the June TLTRO III, and reopened currency swap lines with the Federal Reserve (Fed).

Overall, the package disappointed markets, but was perhaps a message to governments that they needed to step up on the fiscal front.

With markets deteriorating rapidly, the ECB came back to the market with a far bigger statement of intent, announcing the Pandemic Emergency Purchase Programme (PEPP) on 18 March. The programme committed to EUR 750 billion (6.3% of GDP) of asset purchases, on top of already-announced purchases, meaning the ECB would be buying EUR 1.05 trillion of private and public sector assets before year end. This translates to a run rate of more than EUR 100 billion per month, compared with a previous peak of EUR 80 billion in the aftermath of the sovereign debt crisis. In a nod to the front end of the market, the ECB announced that it would, for the first time, also buy non-financial commercial paper.

The publication of the legal articles a week later highlighted the flexibility inherent win the programme, including the suspension of 33% ISIN limits and the emphasis placed on deviating from the capital key where necessary when conducting asset purchases.. This should ensure the ECB has maximum power to direct purchases where they are most needed. The programme is open-ended and the ECB has indicated that it can and will do more if needed.

Returning to the short end, the ECB’s help for the money markets has been conspicuous by its absence, when compared with actions from the Fed. The decision to start buying non-financial commercial paper is a small but important step, indicating recognition that short-term markets are not operating as normal. Arguably, though, is the move is more targeted support for corporate issuers than an effort to address liquidity issues in the short-term markets more broadly. It is still early days for this programme, and the market is still working towards understanding its scope and how pricing will work, which means it is too early to report a tangible positive impact.

An important distinction that can be drawn between the domestic US money fund industry and its European equivalent is the presence of a large and established government money market fund (MMF) sector. In the US, this likely contributed to the larger level of outflows experience by US prime MMFs, as for many end investors government funds became an obvious switch as market volatility picked up and risk aversion mounted. In a sense, the Fed felt more compelled to act.

Flows on euro low volatility net asset value (LVNAV) funds have been more volatile in recent weeks, but remained two-way. Importantly, funds have managed to maintain healthy levels of weekly liquid assets, above the regulatory minimum of 30%, giving clients sufficient comfort to continue using the product in a “business as usual” mode.

Questions remain around secondary market liquidity for short-term markets in Europe. In March, dealer balance sheets became more constrained than usual in the approach to quarter end, against a backdrop of heightened overall market volatility. Whether this eases sufficiently post quarter-end to give money market investors the confidence to resume buying remains to be seen. The ECB’s first step into commercial paper markets suggests that more help may be required to get the short-term markets functioning smoothly again. In the meantime, money funds in Europe are playing defence and holding onto liquidity. Against this backdrop of relative calm, it is questionable whether the ECB are ready to mimic the Fed in putting in place programmes more explicitly targeting the front-end liquidity issues.

What has the Bank of England done so far?

Secondary liquidity remains very challenging in the offshore (European domiciled) US dollar, sterling and euro markets, with still very little clearing on the buy side. There is some market liquidity, though it is not cheap, with a few banks bidding back on their own paper. However, bloated balance sheets and capital requirements continue to be an obstacle. Broker/dealers also continue to be full on balance sheet and not willing to support liquidity in names.

The Bank of England (BoE) has cut the Bank Rate twice to a historic low of 10 basis points, and increased its targeted quantitative easing purchases to GBP 645 billion, with an additional GBP 200 billion of UK government bond and sterling non-financial investment grade corporate bond purchases. In addition – and more relevantly for money markets – the central bank has introduced the Covid Corporate Financing Facility (CCFF) to purchase corporate commercial paper from eligible issuers that make a material contribution to the UK economy. Pricing on the programme has been set at reasonable levels, but while it will be particularly useful as a way for corporates to access funding in these challenging times, the benefit to money market funds (MMFs) will be limited, given exposure to corporate issuers in offshore MMFs is not very large – only around 2-3% in most sterling MMFs.

To support the Gilt market, the BoE also activated an unlimited three-month repo operation through its Contingent Term Repo Facility (CTRF), accepting a wide range of collateral, which could include some MMF holdings. Use of the programme would still impact on dealer balance sheets, and is probably aimed more at bridging smaller banks and building societies into the new Term Funding Scheme starting at the end of April. However, the facility will allow dealers to raise liquidity to fund large positions of Gilts absorbed during the sell-off in that market , and hence yields on overnight DBV repos will likely be capped at the rate on this facility, which is Bank Rate +15bps (25bps).