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: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke

   
 

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:

  • How to Survive the Winter
      A Flawless Flock of Scoundrels One of the fringe benefits of living in a country that’s in dire need of a political, financial, and cultural reset, is the twisted amusement that comes with bearing witness to its unraveling.  Day by day we’re greeted with escalating madness.  Indeed, the great fiasco must be taken lightly, so as not to be demoralized by its enormity.   Symphony grotesque in Washington [PT]   Of particular note is the present cast of characters. ...
  • Credit Spreads: The Coming Resurrection of Polly
      Suspicion isn't Merely Asleep – It is in a Coma (or Dead) There is an old Monty Python skit about a parrot whose lack of movement and refusal to respond to prodding leads to an intense debate over what state it is in. Is it just sleeping, as the proprietor of the shop that sold it insists? A very tired parrot taking a really deep rest? Or is it actually dead, as the customer who bought it asserts, offering the fact that it was nailed to its perch as prima facie evidence that what...
  • The Strange Behavior of Gold Investors from Monday to Thursday
      Known and Unknown Anomalies Readers are undoubtedly aware of one or another stock market anomaly, such as e.g. the frequently observed weakness in stock markets in the summer months, which the well-known saying “sell in May and go away” refers to. Apart from such widely known anomalies, there are many others though, which most investors have never heard of. These anomalies can be particularly interesting and profitable for investors – and there are several in the precious metals...
  • Business Cycles and Inflation – Part I
      Incrementum Advisory Board Meeting Q4 2017 -  Special Guest Ben Hunt, Author and Editor of Epsilon Theory The quarterly meeting of the Incrementum Fund's Advisory Board took place on October 10 and we had the great pleasure to be joined by special guest Ben Hunt this time, who is probably known to many of our readers as the main author and editor of Epsilon Theory. He is also chief risk officer at investment management firm Salient Partners. As always, a transcript of the discussion is...
  • What President Trump and the West Can Learn from China
      Expensive Politics Instead of a demonstration of its overwhelming military might intended to intimidate tiny North Korea and pressure China to lean on its defiant communist neighbor, President Trump and the West should try to learn a few things from China.   President Trump meets President Xi. The POTUS reportedly had a very good time in China. [PT] Photo credit: AP   The President’s trip to the Far East came on the heels of the completion of China’s...
  • Business Cycles and Inflation, Part II
      Early Warning Signals in a Fragile System [ed note: here is Part 1; if you have missed it, best go there and start reading from the beginning] We recently received the following charts via email with a query whether they should worry stock market investors. They show two short term interest rates, namely the 2-year t-note yield and 3 month t-bill discount rate. Evidently the moves in short term rates over the past ~18 - 24 months were quite large, even if their absolute levels remain...
  • Is Fed Chair Nominee Jay Powell, Count Dracula?
      A Date with Dracula The gray hue of dawn quickly slipped to a bright clear sky as we set out last Saturday morning.  The season’s autumn tinge abounded around us as the distant mountain peaks, and their mighty rifts, grew closer.  The nighttime chill stubbornly lingered in the crisp air.   “Who lives in yonder castle?” Harker asked. “Pardon, Sire?” Up front in the driver's seat it was evidently hard to understand what was said over the racket made by the team of...
  • A Different Powelling - Precious Metals Supply and Demand Report
      New Chief Monetary Bureaucrat Goes from Good to Bad for Silver The prices of the metals ended all but unchanged last week, though they hit spike highs on Thursday. Particularly silver his $17.24 before falling back 43 cents, to close at $16.82.   Never drop silver carelessly, since it might land on your toes. If you are at loggerheads with gravity for some reason, only try to handle smaller-sized bars than the ones depicted above. The snapshot to the right shows the governor...
  • Heat Death of the Economic Universe
      Big Crunch or Big Chill Physicists say that the universe is expanding. However, they hotly debate (OK, pun intended as a foreshadowing device) if the rate of expansion is sufficient to overcome gravity—called escape velocity. It may seem like an arcane topic, but the consequences are dire either way.   OT – a little cosmology excursion from your editor: Observations so far suggest that the expansion of the universe is indeed accelerating – the “big crunch”, in...
  • Claudio Grass Interviews Mark Thornton
      Introduction Mark Thornton of the Mises Institute and our good friend Claudio Grass recently discussed a number of key issues, sharing their perspectives on important economic and geopolitical developments that are currently on the minds of many US and European citizens. A video of the interview can be found at the end of this post. Claudio provided us with a written summary of the interview which we present below – we have added a few remarks in brackets (we strongly recommend...
  • Inflation and Gold - Precious Metals Supply and Demand
      Reasons to Buy Gold The price of gold went up $19, and the price of silver 42 cents. The price action occurred on Monday, Wednesday and Friday though so far, only the first two price jumps reversed. We promise to take a look at the intraday action on Friday.   File under “reasons to buy gold”: A famous photograph by Henri Cartier-Bresson of a rather unruly queue in front of a bank in Shanghai in 1949 in the final days of Kuomintang rule. When it dawned on people that the...
  • Precious Metals Supply and Demand
      A Different Vantage Point The prices of the metals were up slightly this week. But in between, there was some exciting price action. Monday morning (as reckoned in Arizona), the prices of the metals spiked up, taking silver from under $16.90 to over $17.25. Then, in a series of waves, the price came back down to within pennies of last Friday’s close. The biggest occurred on Friday.   Silver ended slightly up on the week after a somewhat bigger rally was rudely interrupted...

Support Acting Man

Top10BestPro
j9TJzzN

Austrian Theory and Investment

Archive

350x200

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!
 

Oilprice.com