The ECB drives Euro area short-dated yields even more negative

The recent trend for world bond yields has been for them to rise. This has been particularly evident at the longer maturities. The clearest example of this comes from the US Long Bond or thirty-year yield which spent late summer around 2.3% and is now 3%. There was a rise before the advent of President-Elect Trump which accelerated quickly afterwards. We will never know now what effect a President- Elect Clinton would have had but I suspect it would have been similar. As to the pre-Trump rise in US bond yields this was mostly driven by hints and promises or what is called Forward Guidance from the US Federal Reserve about a second interest-rate rise. Although of course it has been hinting that for all of 2016 so far without delivering it yet.

The international context

This new trend has had effects in places like Portugal where the ten-year yield is 3.6% and Italy where it is 2.1%. This is of course nothing like the levels seen at the peak of the Euro area crisis but there are two points to note. Firstly government’s tend to spend the gains from lower bond yields ( as the gains are not widely understood politicians can take the credit for their largesse) meaning any reversal can create fiscal issues. Secondly the ECB is of course buying considerable numbers of these bonds as it purchases around a billion Euros of Portuguese government bonds and 13 billion Euros of Italian government bonds each month. So we see a rise in spite of all this buying.

A similar situation has arisen in the UK where the “sledgehammer” QE bond buying of Chief Economist Andy Haldane has been swept aside in yield terms by the recent moves. So far an extra £38 billion of Gilts purchases have been made but whilst the ten-year yield is now at 1.37% below the level at which this started it is not be much and this particular phase is underwater overall. Some of the purchases are well underwater in price terms. Perhaps this is why Bank of England Governor seems to be finding the time to do this according to the Financial Times.

Mark Carney has urged the government to seek transitional arrangements with the 27 remaining members of the EU as it negotiates Brexit in an attempt to smooth the path of leaving the EU for companies and for financial stability.

I guess anything is better than discussing why he eased monetary policy into a currency decline and economic growth which one of his colleagues ( Kristin Forbes) admitted is faster than last year’s! I guess some will also be mulling how Mark Carney rejects politicians interfering in his work yet seems happy to interfere in theirs. I wonder how he would define independence. Still if monetary policy gets any worse I guess we can expect more speeches on climate change.

This higher yield trend has also seen some bond yields depart the negative zone. For example the ten-year bund yield of Germany has risen to the not so giddy heights of 0.22% pulling other Euro area yields out of negative territory as well. Even Japan has seen its ten-year yield nudge above zero albeit marginally and ended at 0.016% today. This is a bit awkward for the Bank of Japan as yields have risen in spite of its rhetoric about “unlimited purchases” as I discussed only last Monday.

A problem for the ECB

This arises at the shorter maturities and is especially evident in Germany. As you review the chart below please remind yourselves that under its rules the ECB QE bond buying cannot buy at yields below its own deposit rate which is currently -0.4%.

This is what are called Schatz bonds in Germany and they have pulled prices on other Euro area bonds higher and yields lower as well. For example the two-years in both Belgium and France yield -0.68%. Perhaps the Italian two-year is a clearer example because in spite of the risks around the upcoming referendum the yield is a mere 0.22%. There was a time yields shot higher in response to such risks!

A Technical Issue

The essential problem here comes from something I have pointed out before which is that central bank bond buying tends to freeze up bond markets. Of course it also destroys the price discovery mechanism but volumes and liquidity dry up. This was quite noticeable in the early days of the Greek crisis where buying by the Securities Markets Programme saw volumes drop to a tenth of what they were. That remains an issue which has recurred in Japan but the current phase is being driven by the repo market. Reuters looked at this last Wednesday.

The European Central Bank is looking for ways to lend out more of its huge pile of government debt to avert a freeze in the 5.5 trillion-euro short-term funding market that underpins the financial system, central bank sources told Reuters.

Why should it care about this?

it has taken away the key ingredient for repurchase agreements, or repos, whereby financial firms lend to each other against collateral, typically high-rated government bonds such as Germany’s.

So it has inadvertently damaged the “precious” which is the banking system. Also it has shot itself in the foot as regards its own objectives.

Repo is used by investment funds to finance trading and is regarded by the ECB as a key avenue to transmit its own monetary stimulus to the economy.

A freeze in repo activity risks undoing some of the ECB’s stimulus by hampering lending between financial companies and leaving bond markets vulnerable to sharp sell offs.

The situation was so bad we even got an official denial that anything was wrong!

“The ECB’s securities lending is proving valuable for smooth market functioning, and it is being reviewed on an ongoing basis,” an ECB spokesman said.

The situation is driven by the way that derivative portfolios now need more collateral to be held against them whilst there is less top-notch collateral to be had.

With the ECB now owning more than a quarter of all outstanding German bonds, funds pay up to 1.5 percent to borrow a 10-year Bund, up from some 0.40 percent a year ago, according to Icap data.

Another problem on the list for pension funds and hence in time pensioners.


As you can see the side-effects from the ever-growing amounts of central bank QE are growing. This was met with an official denial which sat oddly with the recent changes made by both the Bundesbank and the ECB to try to ameliorate things. It sat even more oddly with the market reversal on the 23rd in response to hopes/hints of a change of policy as shown in the chart about . Since then those hopes have been extinguished, until the next set of rumours anyway. So we get a bond market where the battle between central banks ( price highs) and inflation trends leading to price falls continues.

Meanwhile thank you to @sallycopper C for highlighting an issue which I think may lead to problems for the game of paper, scissors,stone. From Bloomberg.

Paper made from rock tempts Japan’s biggest printer to invest.

Meanwhile I pointed out earlier to the Financial Times that for an article telling us this “the cost of Christmas dinners is almost unchanged from a year ago ” the headline on Twitter from its commodities editor gave a rather different impression.

Christmas pudding pricier after Brexit hits pound

As a Christmas pudding fan I in fact have already bought two rather nice ones for £3 but  one has already gone, after all I had to find out how good it was!




22 thoughts on “The ECB drives Euro area short-dated yields even more negative

  1. “Oh, what a tangled web we weave when first we practise to deceive!” seems to sum up neatly what is going on here. I cannot recall the exact excuse (sorry, reason) given for why QE started, but I bet that it didn’t include:
    1. Governments increasing spending as their interest bills fell;
    2. Negative interest rates;
    3. A general weakening of the banking system;
    4. Screwing the repo market;
    5. The ECB owning a quarter of all German bonds;
    6. Destroying pension returns.
    I have a feeling that this is not going to end well…

  2. Hi Shaun, I like Xmas puds too, what are this year’s best buys?

    Back to the yields, this is pigeons coming home to roost time. The Central Banks needed the excuse of big infrastructure borrowing to deflect the storyline from QE. To my mind mind Philip Hammond has NOT delivered, appears a character shadow in grey…. trying to avoid being judged for anything bold or game-changing, he has gone for more “gruel” for us. The banks need to be protected in this status quo of artificially priced financial products.

    As point out though it is entertaining and sad to see CB’s and Govts. trapped by their policies and of course grave consequences for certain groups in society.

    Lets hope that the USA trump expansionary shock… startles markets world-wide and brings some pricing reality.

    Paul C.

    • Hi Paul C

      Over the years I have found the basic Tesco one to be rather nice hence my enthusiasm for the 2 for £3 offer of which I only have one to go! So this year’s was nice too. You are right that I need to try a few others though….

      Returning to bond markets we have seen a return of an actual yield curve albeit one which is of minor slope and scale to what we used to see. Even os it could yet be the source of trouble.

      • Thanks I’ll try Tescos although I was in Aldi last night and there were a dizzying array of preium puds, you might want to look and £0.57 for a single one. 🙂

    • The long planned registration of all kinds of private wealth will go into effect in February 2017. More than 8,500,000 tax payers registered in Greece will be called to declare all moveable and immovable assets, their total “wealth”, and even cash they possess even if it is below 100 euro. Furthermore, the taxpayers will have to register changes in their assets when they occur and not annually.

      Tax authorities will upload on their website pre-filled data like real estate, declared income, income from rents, loans, vehicles etc – practically they pre-filled data will refer to data given by taxpayers in their income declaration.

      In the new scheme to have registered everything the trouble Greek owns, the taxpayers will have add moveable and immovable possessions such as paintings, antiques, jewelry, even historical weapon, etc but also the cash they have in their wallets or under the mattress

      We had that when William came to power………

      Doomsday book for the Greek people – still they dont get it


      • Hi Forbin
        For anyone having wealth over about 1.2m€, its the same in France and has been for many years. Wealth includes main residence , with some deductions. Any state with a ‘wealth tax’ collects the same sort of data.

      • Looks like Greek authorities will drown in data. If you’ve got something to hide, flood the investigator with information……

  3. Hello Shaun,

    With all this QE and QEE and not doubt QE-Three

    will they be happy with inflation ? After all it worked in one country………

    “To keep up with the rising prices, a 100 trillion dollar note was issued – enough for a weekly bus ticket – before the Zimbabwean dollar was scrapped in 2009”

    Gee , I wonder if they will be pleased if that works out ( for them , dont ask about us plebs! )

    Just to save some Bloody Banks…..


    • Hi Forbin

      I have been down in your part of the world tonight – Light Up A Life at Phyllis Tuckwell Hospice Farnham- but did note this earlier. From the BBC about Zimbabwe.

      “Zimbabwe has launched its own money for the first time since the country’s dollar was abandoned seven years ago amid rampant inflation.
      The bond note, which is worth one US dollar – the country’s main currency since 2009 – is raising fears of a return to the ill-fated local dollar.”

      From some of the messages I have seen the idea of it being worth one US Dollar needs to be expressed in the past tense now But of course officially it is a triumph.

      • They’ll need some fiscal discipline if they want their dollar value notes over the long term.

        The Bulgarian currency board is an example of success, and this christmas will be the 20th anniversity of the currency/inflationary crisis caused by the BCP Bulgarian Socialist Party.

        The current politicians who want to repeat high inflation and deficits are unbelievable. High inflation does not have good outcomes. I can only assume that the Donald wants a crisis as an excuse to eliminate US social security spending and/or that he is a KGB agent working to destroy the US economy.

  4. The FT pronouncements become or Orwellian dont they ?

    Next it will be be , four legs good, two legs better!

    Just after the Chocolate ration is increased from 100g to 50g ( amended for the younger reader)


    • Hi Forbin

      Well it did lead to something as it was the FT Commodities editor Neil Hume who was pushing the line on Xmas Pud price rises when in fact the article stated that the cost of Xmas lunch was pretty much unchanged. How did he respond?

      “You are blocked from following @humenm and viewing @humenm’s Tweets.”

      Obviously a cunning plan to boost media exposure…

  5. Great blog as always, Shaun.
    Now that it has been confirmed that Carney is staying until 2019 he really should be made to express an opinion on the Eurostat proposal to add an OOHPI (owner-occupied housing based on the net acquisitions approach) component to the HICP, since a verdict on this is supposed to be out early in 2018. It is really unconscionable that he would be shooting his mouth off on things that don’t concern him and simply ignore an issue that obviously does.
    By the way, Eurostat is now publishing the quarterly OOHPIs for most of the 30 countries that are supposed to be providing them with these estimates. For the most recent published quarter 2016Q2, it seems that only two EU countries, Croatia and Greece, did not provide data, nor did Iceland (the other EEA member that is not an EU member, Norway did provide an index). The Netherlands provided data but it is confidential for some reason.
    The data does somewhat feed the suspicion that the UK weight for new housing acquisitions is too low, as Andrew Lydon has alleged. The UK has the fourth highest annual housing price increase among the 29 countries in 2016Q2 for which HPI estimates were published but only the eighth highest annual OOHPI increase among the 26 countries for which OOHPI estimates were published.

    • Hi Andrew and thanks

      I completely agree that Mark Carney would be better off concentrating on the day job as after all banking supervision and monetary policy provides plenty to do. As you say he is being rather slack on some of the monetary policy details.

      Moving onto the house price data I know you have had your doubts about the OOH ( NA) numbers and so do I. Something is not quite right there as you highlight using the UK’s move from 4th to 8th place. The whole issue of weights for housing in the CPIH and associated numbers needs a lot of further investigation and analysis.

  6. Hi Shaun, thought I’d pop in. You probably don’t remember but I posted here a while ago that I was making a fortune on Euro denominated EZ corporate bonds – 15% at the time and I thought there was more upside well into the new year.

    All this rising of Govt yields doesn’t seem to have tightened the spread and the EZ corporate bond yields appear to have moved in sympathy as the global inflation outlook strengthens, so much so I am now down to a 10% gain so I’ve decided to take the profits and maybe put more into the UK and US stock markets as monetary trends for the UK look great for next year despite Brexit uncertainty, whilst US money trends suggest caution at the moment and it’s beginning to look like the Fed was wise to delay any further rises, Trumpism suggests a boom from mid summer 2017 onwards. The sport of gaming the CB’s and governments continues…..

    • Hi Noo2

      I do remember you posting that and if you thinking it is turning then “take the money and run” if you have a solid profit is far from the end of the world. Earlier President Draghi was saying how well the Corporate Bond buying had gone and saying it had brought benefits. He did not seem to elaborate for whom…

    • Hello JW,
      As an ex Public sector employee this holds no surprises for me. I was stuck in many a meeting where I would hear nonsense like this and then be reprimanded by my boss after the meeting for rolling my eyes in my head at what I’d heard.

      Upon Quality Assuring this type of garbage my comments were usually dismissed as me “being awkward” rather than any admission that the author(s) had made a series of calculation mistakes.

      It was a particular failing of senior managers that they just didn’t understand arithmetic.

      I remember once having to sit down with a senior manager in charge of 5,000 staff whom had increased a target for her staff by 20% but then decided to reduce it back to the original target, stating the new target would be reduced by 20% back to the “old” target and explain that the “new” target would have to be reduced by 16.66% to achieve the”old” target and take her through the calculation step by painful step speaking to her as I had to be spoken to when I was 13 or 14.

    • Please don’t send links to things like this! You’ve ruined my breakfast.
      The sheer unadulterated stupid waste of money makes me weep

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