European Central Bank Takes Bond Market Manipulation to the Next Level
Peter Schiff recently explained how the Federal Reserve has rigged the US Treasury market. Well, the European Central Bank has taken bond market manipulation to the next level.
According to a Bloomberg report, the ECB is buying bonds to control the yield spread between debt issued by various EU countries. As a result of this central bank mechanization, the spread between the yields on German and Italian bonds has remained “remarkably stable” despite the Italian government teetering on the verge of collapse.
In a nutshell, the ECB buys Italian bonds in order to create artificial demand and prop up the price. Since bond yields are the inverse of bond prices, the ECB can hold rates steady by keeping the price up, thus maintaining a stable spread between the Italian bonds and other European debt. Left to the whims of the market, Italian bonds would plummet in price as they become riskier and riskier. This would cause Italian bond yields to spike and increase the spread between them and their other European counterparts.
The Fed is using essentially the same mechanics to keep US interest rates artificially low. By purchasing Treasuries, the central bank maintains artificial demand, propping up bond prices and keeping yields low, even though the US Treasury is selling a massive number of bonds to fund all of the government’s borrowing and spending. Without Fed intervention, there wouldn’t be enough demand for Treasuries in the open market. Bond prices would tank and interest rates would spike.
The ECB has reportedly upped this market manipulation to the next level by actually targeting specific spreads. According to a source quoted by Bloomberg, “the central bank has specific ideas on what spreads are appropriate.”
So much for the market.
In fact, this is market manipulation taken to the next level. And the arrogant conceit is pretty chilling. How in the world do a few central bankers know what spreads are “appropriate?”
Of course, this kind of fatal conceit is pretty common in the world of central banking. After all, policymakers were convinced that their manipulations of the housing market were benefitting humanity right up until the point the housing market collapsed in 2007.
The Bank of Japan and the Reserve Bank of Australia already engage in what is known as “yield curve control” (YCC). Typically central banks control very short-term rates, such as the rate banks earn on overnight deposits and let other interest rates move with the market. But through YCC, the central bank uses its bond-buying policy to target specific yields. For instance, the BOJ aims for 0% on its 10-year-bond. This ostensibly enables the central bank to further “stimulate” the economy when cutting rates to zero isn’t enough.
According to Bloomberg, “The BOJ adopted the policy in 2016 as a stimulus tool to boost inflation. The RBA decided last March to 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.”
As WolfStreet explains, yield curve control is an effective policy tool precisely because it doesn’t take a lot of actual action on the part of the central bank.
If it is credible, the central bank may not have to buy a lot of securities to enforce it, since the market knows the target, and knows that’s what a central bank with unlimited buying power can achieve, and therefore falls in line. The results of jawboning are marvelous.”
But the ECB doesn’t have the luxury of simply controlling yields on specific bonds. It has to balance the needs of 19 countries all issuing their own debt. A Commerzbank analyst told Bloomberg that the ECB strategy is similar to YCC, but they don’t call it that. It’s kind of like the quantitative easing the Fed launched in 2019 while refusing to call it QE.
But while the European bank can’t effectively implement yield curve control, it is engaging yield spread control. It’s just another form of market manipulation under a different name. The end result is the same — massive distortions of the economy. WolfStreet called it “central bank absurdity.”
Since the end of January 2020, the German 10-year yield has ticked down 9 basis points, from -0.43% then to -0.52% now. The Italian 10-year yield dropped 33 basis points over the same period, from +0.92% to +0.59%. And the spread between the German and Italian yields narrowed from 135 basis points to 111 basis points. Italy is already borrowing at negative yields on debt of five years and less. All of this is a masterpiece of central bank absurdity.”
The Fed was reportedly considering YCC in the early days of the pandemic. It has since taken the idea of the table – for the time being. But make no mistake, if things go south, the US central bank won’t hesitate to pluck this tool out of its toolbox. Central bank response to a crisis is pretty predictable — loosen monetary policy, encourage debt, keep interest rates low and blow up bubbles. But the fallout from these policies is much less predictable. We just know it won’t be good.