Yves here. Market-minded readers will take interest in Wolf Richter’s sighting of the latest ECB intervention strategy. However, I have to differ with Wolf on his claim that yield spread control by a central bank is unprecedented. The Fed attempted to do that in a clumsy way with QE and was explicit about it. It claimed it was not trying to influence yields but spreads, as in of mortgage bonds (which it was buying) along with Treasuries.
In other words, the Fed was not only trying to lower the long end of the curve but also tighten Fannie and Freddie mortgage spreads, which were pretty much the entire market post crisis. So the Fed was saying one of its big objectives was to goose the housing market by making mortgages cheaper than they would otherwise have been.
Now having said that, as Marshall Auerback pointed out, QE was inherently flawed by targeting quantities. You can’t control prices with fixed quantities. So in that sense, Wolf is correct since the ECB is going about its spread targeting in what appears to be an operationally sounder manner (assuming you agree with their aims).
By Wolf Richter, editor at Wolf Street. Originally published at Wolf Street
The ECB, which is already infamous for imposing negative interest rates, has been doing something new, something no other central bank has done before or even needed to do before. Sources familiar with the matter told Bloomberg that the ECB is controlling the yield spread between the government bonds of the 19 euro states, for example the spread between German and Italian government bond yields. According to one of these sources, the ECB has specific ideas about what yield spreads are appropriate. And to heck with any kind of market.
The ECB isn’t doing “yield curve control” as the Bank of Japan and the Royal Bank of Australia are doing, but effectively “yield spread control.”
Bloomberg reached out to the ECB, but a spokesman refused to comment on it. The fact that this strategy has now been leaked is part of the effort to accomplish the goal – with communications, whether directly or indirectly, all being part of “jawboning” the markets, what’s left of them, into doing what the central banks want them to do. Jawboning is an official tool in every central bank’s official tool kit and often works better than actually doing something.
The ECB has long been doing “whatever it takes” to keep the currency union with 19 nations glued together, dodging its legal limits against monetary financing and shrugging off court challenges.
But unlike other central banks, it faces a complex situation. Each of the euro nations is issuing its own government debt. And the ECB has limits on how much debt it can hold of each country. It has been buying government bonds to manipulate down bond yields – not the German yields, which were already low, but Italian, Spanish, and Portuguese yields, the yield of countries with the weakest economies and the most indebted governments. It succeeded years ago with this goal, which had been thoroughly communicated.
What’s new is the “yield spread control” – and that it has a specific yield spread in mind. This is different from your grandmother’s “yield curve control.”
Yield curve control was used by the Fed in mid-1942 to reduce the borrowing costs of the US government during the war. The Fed set the short-term yields at 0.375%, the 10-year yield at 2.0%, and the long-bond yield at 2.5%. It explicitly communicated these yields, and communicated that it would buy whatever it took to maintain those yields, and that’s how it went. By 1947, inflation was 18%, and the Fed gradually undid yield curve control.
The Bank of Japan followed suit in September 2016 when it introduced its “QQE with Yield Curve Control,” targeting a 10-year yield of “around” 0%, and committing unlimited purchases to obtain this yield. Between the BOJ’s holdings of government bonds, and the bond holdings of government institutions, there is no government bond market left to challenge the concept.
The Reserve Bank of Australia followed suit in March 2020 by announcing a target of “around 0.25%” for the three-year yield, which it reduced in November to “around 0.1%.”
The Fed was expected to follow suit with its own yield-curve control late last year, but has moved it off the table for now.
Yield curve control has the advantage, from a central bank point of view, that if it is credible, the central bank may not have to buy a lot of securities to enforce it, since the market knows the target, and knows that’s what a central bank with unlimited buying power can achieve, and therefore falls in line. The results of jawboning are marvelous.
And now we got the leak from the ECB about its yield spread control, which is part of its efforts to jawbone the markets where it wants them to go.
“My feeling is that this is an important thing for the ECB, they’re looking at it and they’re actually envious of the BOJ. They would love to have something like that,” Christoph Rieger, Head of Rates & Credit Research at Commerzbank, told Bloomberg.
But the ECB can’t just announce a universal target for the 10-year yield because they’re dealing with the sovereign bonds of 19 nations – forcing the Italian and German yields to be the same would apparently be a step too far. So instead, they decided what the spread between them should be.
During the Pandemic, there is no way the bond market will be allowed to have a will of its own. When a central bank pushes down yields, bond prices rise, and bond traders bet on these falling yields, and bet these yields will continue to fall. They can make money even at negative yields, as long as yields become more negative.
All heck would break loose if bond traders thought that yields would be allowed to rise, which would create a bout of selling, and yields would thereby come unhinged, and fearing this, institutions would try to unload their bond holdings, and there would be a classic bond bloodbath. But that’s not going to be allowed to happen. There is only one thing that could force that to happen: a big bout of inflation.
Since the end of January 2020, the German 10-year yield has ticked down 9 basis points, from -0.43% then to -0.52% now. The Italian 10-year yield dropped 33 basis points over the same period, from +0.92% to +0.59%. And the spread between the German and Italian yields narrowed from 135 basis points to 111 basis points. Italy is already borrowing at negative yields on debt of five years and less. All of this is a masterpiece of central bank absurdity.
Rates for trucking, ocean containers, airfreight, parcels, you name it, the costs for shipping consumer & industrial goods are surging. Read… Massive Inflation in Shipping Costs. And the Reasons
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It isn’t all that absurd when the big picture is one of steady deflation until a level of sustainability is reached and at that point “inflation” by definition ceases to exist. This sounds like Wolf is getting his yields and his prices all mixed up – which sounds absurd to a panic addict. But it will probably only be extremely boring. All the incendiary frictions of underfunded overpopulation will be contained some day. I like that idea.
But you (Wolf) are comparing two different kinds of federalism that differ very much on the spending side. Public spending can be defined as an economic measure of Public Sovereignty and in a Single Currency yield spreads mean some countries have more sovereignty than others and you are giving that to markets that decide the price each nation has to pay. In the EU, most spending is at national level. Then we are in the midst of a Situation, if it appears Wolf didn’t notice.
> bond traders bet on these falling yields, and bet these yields will continue to fall. They can make money even at negative yields, as long as yields become more negative. […] All heck would break loose if bond traders thought that yields would be allowed to rise
Seems to me the deduction is even stronger: All heck would break loose if bond traders thought that yields would stop falling. At negative yields you’d prefer cash; so even “tapering” should cause the secondary market to seize.
@Ignacio [11:48]
> you are giving that to markets that decide the price each nation has to pay.
I thought the point of the article is that the ECB is deciding the price each nation has to pay, as a spread over the Bund. They are ham-strung a little by debt limits, but the leak itself — so the thinking in the OP goes — could be an effort to spark a self-fulfilling prophecy.
@ Susan the other [10:41]
> It isn’t all that absurd when the big picture is one of steady deflation until a level of sustainability is reached and at that point “inflation” by definition ceases to exist
I can’t parse what you mean by this. The only thing deflating (in the sense of “going down”) are bond yields — just about everything else, with the exception of commercial RE, is experiencing inflation. And as for bond yields — it seems to me to be an obvious “greedy cup”; yields can only fall so far before the downside risk of having to hold the bond equals the downside risk of a better-yielding major asset class. At that point yields cease falling, and (see my first point) all non-central-bank players leave the bond market. None of this looks like stability to me…
I predict more euro exits will occur if they actually do this. The law of unintended consequences will surely prevail with some countries getting a raw deal. It makes no difference to me when it comes to Europe, but it’s obvious that dysfunctional governments everywhere are increasingly turning to bankers to fix their problems. Either way this is almost surely a further progression of a multi decade evolving political crisis that won’t go away until something large breaks.
“More euro exits”? Like what euro exits that have happened so far?
but it’s obvious that dysfunctional governments everywhere are increasingly turning to bankers to fix their problems.
I suspect that MMT has a very different explanation, where it It appears the Central Banks are the Sovereign money issuers, and the Government dependent on the Central Bankers.
MMT appears to treat the US Treasury and Federal Reserve as a single entity; that is the Central Bankers are an arm of Government. Now the question arises as to how a plurality of Government and Central Bankers can follow a single fiscal path, as both the US and the EU appear to force on their citizens.
In the US the States are “independent” excerpt for a Central Fiscal Policy., on which they appear dependent. Thus they are both independent and dependent at the same time.
Similarly the EU has a Central Fiscal Policy” where individual countries appear have some latitude, and the European Central Bank sets the guide rails.
Mix in a degree of “required self sufficiency” in terms of Balanced trade for US states and EU Countries, and one appears to have a edifice open to unpredictable events with varying effects on specific US states and EU Countries.
With the additional force of Greed pushing the edifices in the population into..
Is this Governance by Chaos management?
That’s actually one of the MMT critiques, that it treats the government as one, authocratic, when there are most of the time constraints between executive (that spends the money) and legislative (that decides where the money to spend come from, or to be more broad, decides on the degrees of freedom for both monetary and fiscal politics)
Michael Pettis has written a little on this in the Chinese context. Its one thing to say that the government, as controller of a fiat currency can simply absorb and wipe out bank debt, its quite another thing to get everyone to agree on whose balance sheet it arrives on.
Italian banks should buy german bunds to push yield lower and let ECB buy Italian bonds to maintain yield spread. Atleast italian banks would have good assets on their books . Maybe this is technique to break the doom loop in EU
With the proliferation of these sorts of operations, who is deluded enough to believe any more the orthodox fictions about how markets set rates?
It’s always been nonsense, of course, but the game is well and truly up now, surely?