Today is a day which the military would call a target rich environment as there is a lot happening. However the major moves are consequences of this being the day after yesterday and in particular yesterday being #ECB #QE day. I would like to take the opportunity ti step back a little and before we come to the eu(ro)phoria of some markets give some perspective on what I think was the most significant statement of all yesterday.
Draghi “We will buy bonds with a negative yield”
Just for clarity I have edited this section as at first I thought the ECB had omitted this from the official transcript but later it was pointed out to me by @LorcanRK so apologies. As well as the explicit reference there is an implicit one as shown below. From the official transcript.
Draghi: The first question is yes, the maturities range between 2 and 30 years. So it’s very long.
Firstly as it will become relevant in a moment such a maturity range covers nearly everything as most Euro area countries have relatively short average debt maturities. However on the negative yield point many Euro area countries have negative two-year bond yields. Indeed as it is buying by ECB capital key or relative economic size we can see the Germany which has a two-year yield of -0.16% will be 25.6% of all QE purchases and France which has a two-year yield of -0.11% will be 20.1% of all QE purchases.
So good luck with buying 291 billion Euros of Geman bonds and 230 billion Euros of French bonds without buying any with a negative yield…..
To Infinity! And Beyond!
Whilst there did appear to be a size for the programme take a look at this from this morning’s Bloomberg TV interview with the Governor of the Bank of Italy.
“We are open-ended,” Bank of Italy Governor Ignazio Visco said about the European Central Bank’s bond-purchase program. “That is, if we see that there are difficulties in achieving this target that we have, we have to continue.”
The immediate impact of the ECB announcement was found here as the Euro fell bounced back somewhat and then dropped like a stone especially against the US Dollar where it closed some 2% lower. That particular fall has continued this morning with the Euro registering an eleven year low against the US Dollar as it has fallen into the 1.12s to reach 1.128 as I type this. This has been accompanied by a fall against the UK Pound which also has risen to multi-year highs as it touches 1.32 versus the Euro in spite of itself falling below US $1.50 which used to generate headlines about a sterling crisis on its own.
If we return to a recent fault-line in the Currency War saga then one Euro is now worth less than one Swiss Franc as the exchange-rate is now 0.982. Exactly who or what did the Swiss National Bank think it was doing as it held it at 1.20? Another pillar of central bank credibility has been crumbling to dust.
Also in a minor diversion let me take you to the United States which in is post QE world (at least in major flow terms) is seeing a substantial currency appreciation. The trade-weighted Dollar Index has risen from 80 at the beginning of last July to 94.7 today which is quite a rise especially for those predicting the demise of the US Dollar. Also there is something to mull for those arguing the case that we will soon seer US interest-rate increases.
Bond Mania or Bubble?
I will let readers make their choice as to which of the paragraph heading that they prefer. Euro area bonds fell in the 24 hours preceding the ECB meeting and then rallied after it. But today has seen this. Boom! The futures contract on the bonds of Germany was nearly one point higher earlier today reducing the ten-year yield as low as 0.34% according to MTS. Indeed all maturities up to five-years are at a negative yield in the German bond market.
Whilst German bunds (bonds) are as the Shangri-Las put it “The Leader of the Pack” the others are in hot pursuit. Remember when Fitch downgraded France in early December 2014? Well there is quite a market critique of that in the two-year bond yield that I have already discussed but a ten-year yield of 0.54% pretty much shouts it at their offices!
If we move onto Italy we see that its ten-year bond yield of 1.47% is very close to that of the UK Gilt equivalent. So Italy which will need some form of haircut/default has the same yield as that of the UK? I would say that this is a type of definition of the distortion of markets caused by central bank manipulation except that there are two caveats. Firstly if we go to the five-year maturity then the situation is even worse as believe it or not but Italian bonds have a yield some 0.28% lower. Secondly the picture is muddied by the fact that UK Gilts have also experienced a QE manipulation of some £375 billion.
Back in the day when I worked on the LIFFE futures floor such moves (the German,Italian and indeed Swiss government bonds were traded there then) would be greeted by shouts as highlighted below.
Rally!Rally! No Top!No Top!
Sometimes of course such thoughts are indeed signs of a top but we will have to see.
Of course we also now know that things can go even higher in price terms and lower in yield terms as the ten-year yield in Switzerland has dropped to -0.2%.
For once conventional economic theory is having a decent day. After such an announcement which involves potentially open-ending QE and monetary expansionism then it would predict a falling currency (check) and falling bond yields (check). Of course this is only the first day and so far so good arguments were critiqued in the film The Magnificent Seven by Steve McQueen.
Reminds me of that fella back home who fell off a ten-story building. As he was falling, people on each floor kept hearing him say, “So far, so good.” Heh, so far, so good.
As for the mechanism by which this impacts the real economy they are likely to be weak at best and may even be non-existent. Even worse for the reasons I explained yesterday people may be misled by recovery claims when it fact it is the impact of the oil price fall.
So let me leave you with the new official theme song of the ECB.
I’m forever blowing bubbles,
Pretty bubbles in the air,
They fly so high, nearly reach the sky,
Then like my dreams they fade and die.
Fortune’s always hiding,
I’ve looked everywhere,
I’m forever blowing bubbles,
Pretty bubbles in the air.
If West Ham United had bought the rights to this song they would rise up the football club wealth list like a bullet. After all the ECB is happy to print to pay for things isn’t it?