The Effects of QE on MGS

Malta Government Stocks (“MGS”) are synonymous with the Maltese investor and it is hard to find a Maltese investor who does not hold or who has never held a MGS in the past. Retail investors have historically found comfort in the stability in MGS pricing and built scores of wealth over recent years by continuing to invest more and more money in MGS. But, effectively, how much wealthier are Maltese investors, or rather, holders of MGS, following the announcement of Quantitative Easing (“QE”) by the European Central Bank (“ECB”) on 22 January 2015?

Much has been said in the media towards the latter part of 2014 that the overall Eurozone economy was in the doldrums, activity was bleak and price inflation was close to inexistent. This placed the ECB under a huge amount of pressure, which it inevitably succumbed to earlier on this year with the announcement of €60bn worth of monthly asset purchases, commencing from March 2015 for a period of at least 19 months till September 2016. The ECB’s main target is that of achieving its inflation target of 2.0% and ultimately re-vitalise the single currency area’s economic activity, by providing liquidity in the markets and correspondingly expanding its balance sheet.

This meant that the ECB, via its regional Central Banks, were given the task of purchasing domestic government bonds through the secondary market. The Central Bank of Malta (“CBM”) had its role to play here too, and that is of purchasing €36mn worth of MGS each month for the duration of the programme. There was a six week time gap between the announcement of QE and the actual implementation of the programme, which served for all types of investors (retail, asset and fund managers, insurance companies, trust companies, etc.) to position themselves for the anticipated wave of ECB bond purchases.

This resulted in a marked appreciation of Eurozone sovereign bond prices, with the larger price (and yield) moves being experienced at the longer end of the curve. There was a large rally which ensued, and MGS prices were not immune to this euphoria with the benchmark bonds reaching unimaginable levels. MGS historical lows (yields) were being registered almost on a daily basis, as did other European sovereigns. The 3.30% MGS 2024 and 4.10% MGS 2034 increased by 6.04% and 18.49% respectively since the beginning of 2015 on a total (gross) return basis (as at 04 May 2015, based on the last traded price on the Malta Stock Exchange).

The issuance of €180mn MGS in February/March did little to dampen appetite for paper as these 2 new issues were heavily over-subscribed, most notably the newly issued 3.00% MGS 2040. Activity on the secondary market picked up too across all segments of the MGS yield curve, as prices continued on their upward trajectory.

A point worth mentioning is that the direction of MGS prices takes cue from the daily CBM bid prices which in turn are reflective of yields across the Eurozone, with the CBM traditionally pricing MGS at a spread over similar dated German government bonds (“Bunds”). In the past, whenever an investor wanted to sell his/her MGS holdings and did not find a buyer on the secondary market, the CBM acted as a buyer of last resort and served to provide liquidity in the market.

This dynamic has not changed, but there is a new player in the market, and that is the division within the CBM responsible for QE purchases, for minimum quantities of €100,000. The dearth of supply (mainly due to the fact that at least a third of outstanding MGS is held by retail investors) from existing MGS holders propelled the CBM’s QE desk to out-bid the CBM as its mandate to buy €36mn worth of MGS on a monthly basis left them no option but to aggressively pitch for MGS. This has further accentuated the positive trend in MGS performance. And following comments by the CBM Governor on the Sunday Times of Malta on 19 April 2015, namely that the CBM is 45% behind schedule, I would not exclude persistent aggressive bidding. Unless of course it resorts to bond purchases of the European Investment Bank, which I think would really be a last resort.

That is essentially what QE is about, achieving price inflation through the appreciation of assets and using that additional liquidity and incremental value in wealth by consuming more, and hopefully shoring up the Eurozone economy, which has, since the start of the year, already began to start showing signs of a sustainable recovery. We would highlight that whilst the QE trade is a short-term trade, any gain which investors are comfortably sitting on right now is un-realised. If and when inflation and economic activity pick up, and yields begin to rise again, MGS prices could come under pressure resulting in gains being eroded unless these are crystallised by closing off the position, in whole or in part.

Warren Buffet was once said: “Be fearful when others are greedy, and be greedy when others are fearful.”

This article was issued by Mark Vella, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd (CC) does not accept liability for losses suffered by persons as a result of information, views or opinions appearing in this article. CC Is Licensed to conduct Investment services in Malta by the Malta Financial Service Authority.