Quantitative Tightening: How do shrinking Eurosystem bond holdings affect long-term interest rates?

What it says

The Eurosystem began shrinking its bond holdings in early 2023, after years of asset purchases that started in 2015. Because QT is new territory, ECB economists turn to the bank's Survey of Monetary Analysts, in which about 50 banks and asset managers forecast ten-year swap and sovereign yields, the path of policy rates and the future size of the asset portfolios. From these they build a one-year-ahead expected term premium: the gap between locking in a ten-year rate a year from now and rolling short-term investments at expected policy rates. Using surveys from December 2022 to December 2023, they find analysts who expect smaller holdings also expect a higher term premium. The implied effect is roughly the mirror image of QE estimates, larger for lower-rated sovereigns, and subject to substantial uncertainty. Policy rates remain the main instrument; QT adds to the tightening.

What to take from it

1. 1

   A €1 trillion reduction in Eurosystem bond holdings could raise the term premium in the ten-year overnight index swap rate by about 35 basis points.

2. 2

   The same reduction is estimated to lift term premia on German, French, Italian and Spanish bonds by about 35, 35, 45 and 50 basis points.

3. 3

   Earlier studies found €1 trillion of QE cut ten-year rates by about 35 to 65 basis points, so this QT estimate sits at the lower end of a mirror-image range.

4. 4

   Term premium is used broadly here, including credit and other risk premia, and the authors expect larger rises for lower-rated sovereigns such as Spain and Italy.

Put it to work on L3VLUP

• Curve Lab
• Credit spread
• Basis points