After the credit crunch Quantitative Easing or QE bond buying became the go yo policy for central banks. This was because they had cut interest-rates as low as they thought they could. For example in my home country the UK the Bank of England thought that some of the building societies could not cope with an interest-rate below 0.5% so Bank Rate got stuck there. This was what was called the Zero Interest-Rate Policy or ZIRP although as you can see it was not literally 0% at this point.
Bond yields remained much higher so they hit on the idea of buying them to reduce yields and get the economic effect that they had hoped would be achieved by cutting official or short-term interest-rates. That is how the Bank of England ended up with £375 billion on its books. I had my concerns about this and suggested in City-AM in September 2013 that we should begin to reverse course by not replacing bonds that mature. It would be a slow process but there would be a drip-drip reduction and crucially we would be doing so when the economic times were good.
Second Wave and Third
This took various forms as central banks decided they could go below 0% interest-rates with the ECB going to 0.5% and introducing large-scale QE bond buying. This added another facet to the equation because it bought bonds at negative yields so it was guaranteeing a capital loss. Then post Covid it bought a lot more bonds at negative yields or if you prefer record high prices. That was relatively low risk in say Germany but short-term bonds in Italy were driven into negative yields as well. If we take the case of Italy there was a period at the end of 2020 when the five-year yield was negative ( -0.1% or so) which means QE purchases were guaranteeing a loss on expiry which is 2/3 years away. The issue is being rubbed in because as I type this the five-year yield in Italy is over 4%. If you were a bond trader you would get sacked ( probably several times) for such a performance.But as a central bank it just gets swept under the carpet because they can print themselves out of trouble. Although the ECB is a special cse in that with 19 treasuries and rising some may get upset at individual countries getting more than their fair share or capital key. As buying of Italian bonds is still ongoing with other countries bonds sold to finance this ( maturing funds from German or French bonds are put into Italian ones) this could yet lead to trouble in a way that cannot happen elsewhere.
Can the ECB QT?
The forst point here is that the ECB has got ready a new version of QE in case Italy needs more help. Below is President Lagarde at the European Parliament on Monday.
Later in July, we also announced a new monetary policy tool, the Transmission Protection Instrument (TPI), complementing our existing tools. This tool has been designed to counter unwarranted, disorderly market dynamics, with sufficient flexibility to respond to the severity of the risks facing policy transmission.
As to QT? Well that seems to have been deferred to the 12th of never for now.
ECB’s Lagarde: QT To Be Considered Once Rate Normalization Is Complete ( @LiveSquawk)
First we need to note that the US made an effort starting in the summer of 2017 to QT. The Federal Reserve did reduce its balance sheet from US $4.48 trillion to US $3.77 trillion. But the crucial point is not only was QT 1.0 abandoned it was buying more before the covid crisis blew the balance sheet to nearly US $9 trillion. That is a little awkward as whatever excuses you make the reality is that a few years later the reduction period turned into the balance sheet being doubled!
The latest version or QT 2.0 has not done much with the balance sheet dropping by US $160 billion or so and this being intended.
- For Treasury securities, the cap will initially be set at $30 billion per month and after three months will increase to $60 billion per month. The decline in holdings of Treasury securities under this monthly cap will include Treasury coupon securities and, to the extent that coupon maturities are less than the monthly cap, Treasury bills.
- For agency debt and agency mortgage-backed securities, the cap will initially be set at $17.5 billion per month and after three months will increase to $35 billion per month.
So US $95 billion a month. It is funny in a way that we have reached the point where 95 billion dollars a month does not seem much! That is of course a relative issue but the absolute one is in play.
The $24tn US Treasury market has been hit with its most severe bout of turbulence since the coronavirus crisis, underscoring how big swings in international bonds and currencies and jitters over US rate rises have spooked investors. ( Financial Times)
There is more detail here.
The 10-year Treasury yield, a key benchmark for global borrowing costs, has surged to nearly 4 per cent from 3.2 per cent at the end of August, leaving it set for the biggest monthly rise since 2003. It is on track for its sharpest ever annual rise. The two-year yield, more sensitive to fluctuations in US monetary policy, has leapt 3.55 percentage points this year, which would also mark a historic increase. ( FT)
My point is that they have torpedoed their own bond market with what have been relatively small actual sales. Even if we factor in planned sales for the rest of this year they are minor compared to the market impact.
The US bond market is in trouble which is why we are seeing statements like this.
Speaking to reporters on Tuesday, Treasury secretary Janet Yellen said the US is “monitoring developments very closely” in the UK ( @colbyLbmith )
Or indeed an official denial.
US TREASURY SECRETARY YELLEN: I DON’T SEE ANY ERRATIC FINANCIAL MARKET CONDITIONS. ( @financialjuice)
So we have both deflection and an official denial. But the heat is on as rumours like this for someone who was a key policy appointment do not just appear.
“White House officials are quietly preparing for the potential departure of US Treasury Secretary Janet Yellen after the midterms, @axios reports, citing unidentified people familiar with the matter.” ( @DiMartinoBooth)
I have long argued that the central bank plans for what they call “normalisation” which includes QT are ill thought out. Indeed they are turning out to be as stupid as I Iong feared.
The US 10 year rate just crossed above 4 percent. Mortgage rates comfortably exceed 7 percent. We are now in new financial territory. ( @LHSummers)
Their “triumph” of reducing bond yields in the pandemic has been replaced by pumping them up in this inflation crisis. What I could not entirely forsee was that via their policy of denial about inflation followed by panic they would run into the crisis with the speed of Usain Bolt.
Switching to Europe we see that even if you still have some QE you can now be in trouble as the ten-year yield approaches 5% there. As I would suspect the ECB is buying as much as it can via PEPP maturities the underlying situation is worse.
Next up is Japan which has ignored all this but even there the heat is on.From Bloomberg on Monday
The Bank of Japan buys more bonds at its regular operation, as the benchmark yield rises toward the upper end of the central bank’s tolerated trading range.
They in a way are the ultimate can kickers as they plough on.But the heat is being felt in other areas as they add buying Yen to the equities, bonds and commercial property they have already bought.
We’re caught in a trapI can’t walk out Because I love you too much, baby Why can’t you see What you’re doing to me When you don’t believe a word I say? ( Elvis Presley)