Central Bank Policy Implementation and the ECB's Plan

In order to avoid the appearance that its plan to buy bonds of peripheral governments does indeed amount to 'funding of governments by the printing press', the ECB has tied the plan to the condition that it has to happen in parallel with EFSF/ESM rescues. However, that was not all – there was another  stipulation mentioned by Mario Draghi during the press conference. We briefly remarked on this already in our summary and analysis of the ECB decision last week.  

The other part of the plan,  which is supposed to make the operation more akin to a 'monetary policy' type intervention,  is to concentrate the buying on the short end of the yield curve. The thinking behind this is that in 'normal times', the central bank is mainly aiming to manipulate overnight rates in the interbank funding markets as well as other very short dated interest rates rates. Hence intervention in the short end of the curve closely resembles this 'normal' implementation of monetary policy. With this, the ECB probably also tries to differentiate its actions from those of the Fed and BoE.


Usually, the central bank determines a 'target rate' for overnight funds, and whenever credit demand wanes and interbank rates drift below this target, it is  supposed drain liquidity. Whenever credit demand threatens to push interbank rates above the target rate, it will add liquidity.

During boom times, very little 'draining' tends to happen. As a rule, central bank target rates will be too low, and as speculative demand for short term credit keeps increasing during a boom,  its liquidity injections – which provide  banks with the reserves required to keep the credit expansion going – will aid and abet the growth in credit and money supply initiated by the commercial banks.

In the euro area, this method of overnight rate targeting has produced roughly a 130% expansion of the true money supply in the first decade of the euro's existence – about twice the money supply expansion that occurred in the US during the 'roaring twenties' (Murray Rothbard notes in 'America's Great Depression' that the US true money supply expanded by about 65% in the allegedly 'non-inflationary' boom of the 1920's).

This expansion of money and credit is the root cause of the financial and economic crisis the euro area is in now. This point cannot be stressed often enough: the crisis has nothing to do with the 'different state of economic development' or the 'different work ethic' of the countries concerned. It is solely a result of the preceding credit expansion.

Since long term interest rates are essentially the sum of the expected path of short term interest rates plus a risk and price premium, the central bank's manipulation of short term rates will usually also be reflected in long term rates.

In the euro area's periphery, the central bank has lost control over interest rates since the crisis has begun. The market these days usually expresses growing doubts about the solvency of sovereign debtors by flattening their yield curve: short term rates will tend to rise faster than long term ones. This in essence indicates that default (or a bailout application) is expected to happen in the near future. It is possible that this effect has also influenced the ECB's decision to concentrate future bond buying on the short end of the yield curve. However, as is usually the case with such interventions, there are likely to be unintended consequences.



The Rollover Problem


Recently the bond maturity profile of Italy and Spain looked as depicted in the charts below. Note that the charts are already slightly dated (this snapshot was taken at the beginning of the year), so there may have been a  few changes in the meantime, but they probably still represent a reasonably good overview of the situation:


Italy's debt rollover schedule, 2012-2021 – click chart for better resolution.



Spain's debt rollover schedule, 2012-2021 – click chart for better resolution.



There has been an enormous shift in the maturity schedule of the debt of both governments when we compare these charts to the situation as it looked in May of 2010, when the following snapshots were taken:



Italy's debt rollover schedule as it looked in May of 2010 – click chart for better resolution.



As of mid 2010, Italy had €168.2 billion of debt coming due in 2012. At the beginning of 2012, this had increased to € 319.6 billion – a near doubling. In Spain, the change is even more extreme:



Spain's debt rollover schedule as it looked in May of 2010 – click chart for better resolution.



In mid 2010, € 61.2 billion of bonds were expected to mature in 2012. At the beginning of 2012, this number had swelled to €142.2 billion.

What accounts for this enormous change? When interest rates began to rise sharply, the governments of Spain and Italy ceased to issue long term debt, opting to shorten the maturity spectrum of their debt instead. This was  done because long term interest rates had become too high for their taste. It was no longer considered affordable to finance the government at these rates when they exceeded 6% and later temporarily even 7%. 

Thus panic began to set in when short term interest rates began to rise sharply  as well in November of 2011 and again from March 2012 onward.



Spain's 2 year government bond yield  –  it was the increase in these short term rates that made it impossible for Spain's government to continue financing itself without help – click chart for better resolution.



Now we can already see what the problem with the ECB's plan is: it will tend to shorten the average maturity of peripheral debt even further once it is implemented. In fact, it already has this effect even before the ECB has bought a single bond, as rates on the short end of the curve have recently fallen sharply in reaction to the announcement.

As Bloomberg reports:


“European Central Bank President Mario Draghi’s bid to bring down Spanish and Italian yields may spur the nations to sell more short-dated notes, swelling the debt pile that needs refinancing in the coming years.


“In a way what the ECB has done is making the situation worse,” said Nicola Marinelli, who oversees $160 million at Glendevon King Asset Management in London. “Focusing on the short-end is very dangerous for a country because it means that every year after this they will have to roll over a much larger percentage of their debt.”

The average maturity of Italy’s debt is 6.7 years, the lowest since 2005, the debt agency said in its quarterly bulletin. The target this year is to keep that average at just below seven years, according to Maria Cannata, who heads the agency. In Spain, where the 10-year benchmark bond yields 6.94 percent, the average life is 6.3 years, the lowest since 2004, data on the Treasury’s website show.

“Driving down the short-dated yields provides a little bit of comfort and encourages Spain and Italy to issue more at the short-end,” Marc Ostwald, a strategist at Monument Securities Ltd. in London, said. “The problem is that you are building up a refinancing mountain.”


(emphasis added)

Even if the ECB buys the bonds of Italy and Spain, they will still have to repay them and regularly roll them over at maturity. By inducing them to shorten the average maturity of their debt further, the ECB creates new risks, especially as the economic downturn remains in full swing and is likely to worsen the fiscal situation of both countries in the short to medium term.

Interestingly, a similar shortening of average debt maturities can be observed in the euro area's 'core' countries. France is certainly considered a 'core' country and is currently treated as a 'safe haven' by bond investors. However, this is a tenuous situation, as it can still not be ruled out that the government will eventually be called upon to bail out the country's banks. At the moment all is quiet on that front, but it was only in November last year when the market was extremely worried about the risk these banks face in view of their enormous balance sheets and potential funding problems.



France also has the vast bulk of its debt rollovers scheduled for 2012 – click chart for better resolution.


A similar tendency to shorten the government's debt maturity profile can be oberved in Germany:


Germany's debt rollover schedule, 2012-2021, as of the beginning of the year – click chart for better resolution.



Now, Germany and France are obviously not expected to have problems rolling over their debt in the near term. The problem is rather that all these countries compete for the same investment funds. In other words, the shortening of the average debt maturity in France and Germany indirectly puts more pressure on the periphery, as the total of debt rollovers in the euro area has become much larger than it was previously.

It is of course no wonder that the German treasury is eager to sell lots of debt maturing in two years or less: investors are currently stomaching negative yields on this debt, i.e., the actually pay Germany's government for the privilege of lending it money. This may be great for Germany's government finances, but it it not without risk either. After all, given that Germany is the euro area's 'paymaster', it has taken on a huge and ever growing amount of guarantees.  What if the crisis worsens and Germany's guarantees are called in? In that case it could turn out that it was a big mistake to take on so much short term debt just because it looked extraordinarily cheap.

The ECB's bond buying plan meanwhile is going to pile on even more rollover risk.

All in all we are left to conclude that the euro area's governments have  exposed themselves to additional risks that could have been easily avoided.



The history of the ECB's now defunct 'SMP', via 'Der Spiegel' – click chart for better resolution.


Interest rates in the UK: the BoE has also lost control over rates to some extent. There is a growing gap between the 'target rate' and the rates charged to various types of bank customers. Chart via Ed Conway – click chart for better resolution.




Charts by: BigCharts, Der Spiegel, Ed Conway



Emigrate While You Can... Learn More




Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.


Bitcoin address: 12vB2LeWQNjWh59tyfWw23ySqJ9kTfJifA


3 Responses to “The ‘Maturity Crunch’”

  • Crysangle:

    In Europe reducing short term rates may not have any desired effect on long term rates , quite the opposite . Looking at a yield curve for Spain dated July , it is/was quite clear that the yields were only reacting ‘normaly’ where liquidity was available – after 3 yrs was a flat 7% @ . Why would the yields of longer debt reduce – after all short debt has to be rolled and until there is a surplus would not be paid off but carried year to year , keeping any one country’s solvency under continued imminent pressure , which is maybe an aim. It would be interesting to find a chart which presumed all current short debt will be rolled indefinitely and drew up yearly maturities that way over time – surely investors must think this way , and when they look at what has to be paid back/rolled in say five years in reality, it must be even more off putting , no matter that that particular country has accessed some short lending at a rate that keeps its accounts afloat.

  • They keep piling it higher, it will blow higher when it goes.

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • US Stock Market: Conspicuous Similarities with 1929, 1987 and Japan in 1990
      Stretched to the Limit There are good reasons to suspect that the bull market in US equities has been stretched to the limit. These include inter alia: high fundamental valuation levels, as e.g. illustrated by the Shiller P/E ratio (a.k.a. “CAPE”/ cyclically adjusted P/E); rising interest rates; and the maturity of the advance.   The end of an era - a little review of the mother of modern crash patterns, the 1929 debacle. In hindsight it is both a bit scary and sad, in...
  • A Giant Ouija Board - Precious Metals Supply and Demand Report
      Object of Speculation The prices of the metals fell last week, $22 and $0.24 respectively. It’s an odd thing, isn’t it? Each group of traders knows how gold “should” react to a particular type of news. But they all want the same thing — they want gold to go up. And when it doesn’t, many hesitate to buy. Or even sell. This is why speculation cannot set a stable price (I’m talking to you, bitcoiners).   Everybody wants gold to grow wings. Unfortunately it's rather...
  • How to Blow $12.2 Billion in No Time Flat
      Fake Responses  One month ago we asked: What kind of stock market purge is this?  Over the last 30 days the stock market’s offered plenty of fake responses.  Yet we’re still waiting for a clear answer.   As the party continues, the dance moves of the revelers are becoming ever more ominous. Are they still right in the head? Perhaps a little trepanation is called for to relieve those brain tensions a bit?  [PT]   The stock market, like the President,...
  • Purchasing Power Parity or Nominal Exchange Rates?
      Extracting Meaning from PPP   “An alternative exchange rate - the purchasing power parity (PPP) conversion factor - is preferred because it reflects differences in price levels for both tradable and non-tradable goods and services and therefore provides a more meaningful comparison of real output.” – the World Bank   Headquarters of the World Bank in Washington. We have it on good authority that the business of ending poverty is quite lucrative for its practitioners...
  • Broken Promises
      Demanding More Debt Consumer debt, corporate debt, and government debt are all going up.  But that’s not all.  Margin debt – debt that investors borrow against their portfolio to buy more stocks – has hit a record of $642.8 billion.  What in the world are people thinking?   A blow-off in margin debt mirroring the blow-off in stock prices. Since February of 2016 alone it has soared by ~$170 billion - this is an entirely new level insanity. The current total of 643...
  • Stock and Bond Markets - The Augustine of Hippo Plea
      Lord, Grant us Chastity and Temperance... Just Not Yet! Most fund managers are in an unenviable situation nowadays (particularly if they have a long only mandate). On the one hand, they would love to get an opportunity to buy assets at reasonable prices. On the other hand, should asset prices actually return to levels that could be remotely termed “reasonable”, they would be saddled with staggering losses from their existing exposure. Or more precisely: their investors would be saddled...
  • Despondency in Silver-Land
      Speculators Throw the Towel Over the past several years we have seen a few amazing moves in futures positioning in a number of commodities, such as e.g. in crude oil, where the by far largest speculative long positions in history have been amassed. Over the past year it was silver's turn. In April 2017, large speculators had built up a record net long position of more than 103,000 contracts in silver futures with the metal trading at $18.30. At the end of February of this year, they held...
  • From Bling to Plonk – An Update on the Debt Mountain
      Serenely Grows the Debtberg We mentioned in a recent post that we would soon return to the topic of credit spreads and exotic structured products. One reason for doing so are the many surprises investors faced in the 2008 crisis. Readers may e.g. remember auction rate securities. These bonds were often listed as “cash equivalents” on the balance sheets of assorted companies investing in them, but it turned out they were anything but. Shareholders of many small and mid-sized companies...
  • US Equities – Mixed Signals Battling it Out
      A Warning Signal from Market Internals Readers may recall that we looked at various market internals after the sudden sell-offs in August 2015 and January 2016 in order to find out if any of them had provided clear  advance warning. One that did so was the SPX new highs/new lows percent index (HLP). Below is the latest update of this indicator.   HLP (uppermost panel) provided advance warning prior to the sell-offs of August 2015 and January 2016 by dipping noticeably below the...
  • Return of the Market Criers - Precious Metals Supply and Demand
      Ballistically Yours One nearly-famous gold salesman blasted subscribers this week with, “Gold Is Going to Go Ballistic!” A numerologist shouted out the number $10,000. At the county fair this weekend, we ran out of pocket change, so we did not have a chance to see the Tarot Card reader to get a confirmation. The market criers are back in gold town [PT]   Even if you think that the price of gold is going to go a lot higher (which we do, by the way—but to lean on...
  • Good Riddance Lloyd Blankfein!
      One and the Same   “God gave me my money.” – John D. Rockefeller   Today we step away from the economy and markets and endeavor down the path less traveled.  For fun and for free, we wade out into a smelly peat bog.  There we scratch away the surface muck in search of what lies below.   One should actually be careful about quotes like the one attributed to Rockefeller above, even if it of course sounds good and is very suitable for the topic at...

Support Acting Man

Item Guides


Austrian Theory and Investment



THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Realtime Charts


Gold in USD:

[Most Recent Quotes from www.kitco.com]



Gold in EUR:

[Most Recent Quotes from www.kitco.com]



Silver in USD:

[Most Recent Quotes from www.kitco.com]



Platinum in USD:

[Most Recent Quotes from www.kitco.com]



USD - Index:

[Most Recent USD from www.kitco.com]


Buy Silver Now!
Buy Gold Now!


Diary of a Rogue Economist