ECB’s Bond Recycling Grabs Investor Attention

The European Central Bank’s next big agenda item is figuring out what it wants to achieve with its debt-recycling business.

The ECB plans to stop adding to its bond-buying program by the end of this year, when holdings reach €2.6 trillion ($3 trillion), but it’ll keep plowing the cash from maturing debt back into the market, Bloomberg reported.

That reinvestment strategy will be a key focus for investors until the central bank starts raising interest rates, which President Mario Draghi says is at least a year away.

What matters is whether the process remains largely mechanical—which could increase market volatility as monthly redemptions are highly uneven and rising—or if the ECB opts to echo the Bank of Japan and Federal Reserve in targeting its spending to better support the economy. The governing council, which will meet on Thursday, hasn’t yet held formal talks on the matter.

“It’s one of the missing pieces of the puzzle,” said Richard McGuire, head of rates strategy at Rabobank International. “It’s a part of their arsenal, which they’ll wish to maintain for as long as possible in order to have that optionality should they feel the need to provide some support to the market.”

One option is to extend the window for reinvestments, currently done within three months of redemptions. That would give the ECB more flexibility to provide a steady flow of spending and smooth out the impact. Around €180 billion of debt will mature next year.

Another choice might be to use reinvestments to realign quantitative easing with the capital key, which is used to allocate purchases to national central banks—which do most of the buying—according to the relative size of their economies.

That guideline aims to ensure all eurozone countries benefit equally from the program, and to combat accusations the ECB is financing governments, which is barred by European Union law. Yet holdings are currently skewed toward large economies, as some smaller nations have run into a scarcity of available debt.

The imbalance could be redressed if national central banks cooperate to reinvest across borders. Such a strategy isn’t allowed under current rules, though those only apply until the end of net asset purchases. Alternatively, the Frankfurt-based ECB could draw on its own portfolio of bonds.