The ECB Has Quietly Launched Yield Curve Control… Just Don’t Call It Yield Curve Control
When the BOJ – that experiment guinea pig among “developed” central banks which now holds a record 133% of Japan’s GDP on its balance sheet and which simply can’t stop intervening or Japan’s economy will implode in an instant – launched Yield Curve Control in late 2016, most market participants knew that it was just a matter of time before this particular experiment came to every other “developed” central bank. After all, the world’s monetary experimentalists long ago found themselves permanently trapped by pushing yields to record low levels to enable a tsunami of debt by inflating a gigantic asset bubble and then hoping they can let some air out of the bubble occasionally, and let yields rise again, if ever so slowly in hopes of “renormalization.” Alas as the recent events of late 2018 showed, in a world that has over $300 trillion in debt, higher yields – and renormalization – are now impossible, which is why central banks can never stop their micromanagement of capital markets and the economy, and why digital currencies are coming as the current fiat regime is now effectively defunct.
But first, it means that Japan’s Yield Curve Control will be attempted across the world.
And while we wait for Jerome Powell to launch YCC in the US, which according to some may happen once the nascent inflationary spike pushes 10Y yields to 1.50% or higher threatening a crash in the bond market – and from there all other markets – it appears that the ECB has already launched a stealthy version of Yield Curve Control of its own, i.e., controlling and manipulating government bond yields which are only permitted to trade within a narrow range of parameters. Just two caveats: it’s “different” from the BOJ version of YCC, and whatever you do, don’t call it yield curve control.
According to Bloomberg, the ECB “is buying bonds to limit the differences between yields for the strongest and weakest economies in the euro zone, according to officials familiar with the matter, with one person saying the central bank has specific ideas on what spreads are appropriate.”
In other words, yield curve control. But since the ECB does not want to be associated with the stigma that trails the BOJ which, as everyone knows, will be the first central banks to capitulate, the European incarnation of bond market nationalization is called yield spread control.
The ECB’s stealthy market manipulation strategy, which has never been disclosed previously in any official capacity, explains for example why the spread between Italian and German debt “has stayed remarkably stable despite the Italian government nearing collapse, after the central bank raised the pace of bond buying.” It also explains why rates volatility – both in Europe and by extension, in the US – has been is at record lows.
As Bloomberg explains, “the latest insight into its strategy sheds light on how policy makers are navigating euro-area complexities that make publicly targeting bond levels difficult.” It also helps answer a long-running investor question: whether the central bank has specific levels in mind when it tries to cap bond yields. It turns out that the answer is no – instead the ECB is focusing on spreads between different countries.
“It’s different to the so-called yield curve control deployed by the Bank of Japan and Reserve Bank of Australia, which have publicly announced numerical targets for specific yields. In the case of the BOJ, it aims for zero percent on the 10-year government bond.”
The reason why the ECB, which could love to have the same luxury as the BOJ of pulling all yields to zero but can’t due to different fiscal regimes and different sovereign risks, can’t pursue an identical YCC is because ECB President Christine Lagarde has to manage the monetary needs of a currency union with 19 nations, each issuing their own debt.
While that strategy is similar to yield curve control, “they’re calling it something different,” said Christoph Rieger, head of fixed-rate strategy at Commerzbank AG. “My feeling is that this is an important thing for the ECB, they’re looking at it and they’re actually envious of the BOJ. They would love to have something like that.”
Why of course they would; and they would be even more envious of the USSR which would set all price levels by fiat and capital markets would no longer exist. But that too is coming, just not immediately.
As for YCC, the BOJ was the first central bank to adopt the policy in 2016 as a stimulus tool to boost inflation (actually that’s not true: the Fed was running under a yield curve control regime in the 1940s to keep bond yields during and after World War II). The RBA followed suit, and announced last March it would keep three-year yields at around 0.25%, and in November reduced that to around 0.1%. U.S. Federal Reserve Vice Chair Richard Clarida said late last year it’s part of the toolbox, but the Fed is waiting for yields to blow out first before launching it as it would be one less key tool in the Fed’s “toolkit.”
The YCC pledge has to be credible though…. or the central bank simply has to monopolize the entire bond market. The BOJ, which is the only price setter left in Japan does the latter. Meanwhile, as Bloomberg correctly notes, investors must believe the central bank will spend as much as needed to defend its policy, and that’s where the ECB runs into problems.
For starters, it lacks a single bond to target. That’ll change soon when the European Union starts issuing joint debt to finance its 750 billion-euro ($909 billion) recovery fund, but that plan is a temporary one linked to the pandemic – the ECB could run out of bonds to buy. The European central bank is also forbidden by EU law from directly financing governments. It has kept its bond-buying programs legal by imposing limits on what it can buy and for how long, but yield curve control is implicitly limitless.
“There are a number of issues in opting for such a strategy, or adding this to the ECB toolbox,” said Katharina Utermoehl, an economist at Allianz SE. “This could bring out the idea that actually the ECB is doing monetary financing.”
Which, of course, the ECB has been doing for years, but in a world where it is in everyone’s best interest to spread lies and pretend that rules are still followed, nobody pretends to notice.
And speaking of pretending, even though the ECB has been engaging in spread control, the ECB is now pretending it may actually launch official yield curve control, and Bank of Spain Governor Pablo Hernandez de Cos said this month that it’s an “option worth exploring.”
Hernandez de Cos suggested targeting a technical measure, the region’s overnight index swap curve. Other economists, such as ABN Amro’s Nick Kounis have proposed using an average euro-zone bond yield weighted by national gross domestic product.
Both Hernandez de Cos and Executive Board member Isabel Schnabel say the Governing Council has never discussed formal yield curve control. And why would they if the ECB is already doing it, just under a different name.
Hilariously, Bloomberg then pretends that someone actually cares about the long-term, and notes that “the measure does carry broader risks, such as encouraging reckless fiscal policy by relieving governments of some market constraints.” Uhm, guys, we are now well beyond that part: if you don’t believe us, just check out the price of bitcoin.
Meanwhile, YCC always comes with a cost, even if it is delayed. As mentioned above, when the Fed and the U.S. Treasury agreed in 1942 to cap borrowing costs to fund the country’s participation in World War II, yields were just barely above 0%. Five years later, inflation has exploded in double digits amid the post-war boom and the central bank was forced to start pulling back. It is this inflationary deluge that assets which central banks don’t (yet) control like bitcoin, are sniffing out.
Explicit yield goals also make exiting the policy a challenge. Investors are likely to dump bonds, driving up borrowing costs, the moment they perceive the target is about to be dropped. Hence why the Fed spent all of last week talking down the risk of QE tapering.
Finally, in an amusing twist of semantics, Bloomberg naively concludes that “that may ultimately mean the ECB has an edge with what Lagarde has described as an “holistic” approach to maintaining favorable financing conditions.”
“It’s not as explicit as the Japanese do it, but broader,” said Florian Hense, European economist at Berenberg. “Once it’s out that you explicitly control the yield curve, this commitment can be very expensive.”
Well, the cat is now officially out of the bag, and whatever one calls it, the fact that it is only with the ECB’s explicit intervention that European yields haven’t blown out will mean that the moment there is even the tiniest whiff the ECB may be pulling back its intervention that we will have an epic crisis.
Tue, 01/19/2021 – 20:52