EU Pulling the Strings

[Bumble]

You may recall that back in May, in Italy, a coalition of 5-Star and Lega won the election and nominated Savona as finance minister. Savona is a euro-skeptic and favours either withdrawing from the euro, or introducing a new Italian currency alongside it. There was a subsequent rise in the yields of Italian government bonds - meaning that the bonds were sold off and became cheaper. I thought at the time that this was simply a market reaction. Turns out, this wasn't the case. The European Central Bank, which has been constantly buying government bonds under its QE program, decided to fire a warning shot across Italy's bow and stopped buying Italian bonds for one day. The result was an immediate spike in Italian interest rates of two whole percentage points, from 0.4% to 2.4%. The Italian president, Mattarella, duly kowtowed to the EU by vetoing the appointment of Savona the next day.

Lessons learned. The ECB can whip into line any country in the euro-zone that does not do what it wants. And without the prop of QE, interest rates in some European countries would be a lot higher.

 

[caloundracats]

Good thing the UK decided to retain its own currency?

[KDave]

No risk of this in the UK, Carney could not raise interest rates if his life depended on it. I don't think he knows how. 

This is a good find. I see evidence that the EU QE programme will continue indefinitely as it gives them political power, and this removes any doubt regarding the myth of separation between central bank and the state if anyone was still under that illusion. Also the central banks are the market, in complete control, who knows how long it can last. 

[sixgun]

The ECB is buying government debt (bonds), in other words it is lending governments its fictional currency. We are told the Italian financial system is on the edge, potentially it could collapse at any time. If you lent the Italian government 100€ @ 0.4% it would take 250 years to pay the principle back in interest. It is self evident nonsense.

[Pipers]

Why would anyone buy debt at that level, it is just nonsense and Governments are/were stupid to get used to it rather take the borrower as an idiot. 

[Martlet]

2 hours ago, Pipers said:

Why would anyone buy debt at that level, it is just nonsense and Governments are/were stupid to get used to it rather take the borrower as an idiot. 

They buy because any % is better than 0, (perceived) lower risk than elsewhere and, in the case of most Europe, the pension funds are apparently mandated to hold certain amounts of sovereign debt.  On the flip side the entire point of QE is to lower the yield so far that it encourages money to go elsewhere to spur economic investment, so you're not supposed to buy government debt at this level (unless a pension fund).

[sixgun]

6 hours ago, Pipers said:

Why would anyone buy debt at that level, it is just nonsense and Governments are/were stupid to get used to it rather take the borrower as an idiot. 

They create this currency out of thin air. They never worked for it. They are forced to keep buying - if they stop their system collapses. They are going to print so much currency their worthless currency will be just that - worthless. Keep stacking, swapping out their junk fiat for real money.

[KDave]

I take it all back. He's gone and done it. Raised rates a whole .25%. Better get that second referendum on the way and vote the right way before he does it again. 

[sixgun]

37 minutes ago, KDave said:

I take it all back. He's gone and done it. Raised rates a whole .25%. Better get that second referendum on the way and vote the right way before he does it again. 

Barclays raises UK variable mortgage rates by 0.25 percent

It does not sound much but it will start to weigh on house prices and pockets.

[KDave]

Yes it's bad for house prices given the market is driven by affordability of debt and access to debt. Any non fixed mortgage holders, buy to leters, will feel the squeeze. I've not verified but I'm told the pound has done nothing in reaction, no strength. The raise is too little too late perhaps. 

[Bumble]

The interest rates set by the central banks are just the rate at which the banks lend to each other overnight without collateral. The interest rate on a bond is determined by what investors are willing to pay for it. If investors buy bonds, the price goes up and the rate goes down. Under normal conditions this means that the rate would be determined by the aggregate behaviour of the market, and would correctly reflect the perceived riskiness of the bonds by the market participants. QE disrupts this process by creating artificial demand for bonds, in order to keep the rates low.

The result is that even now, short dated Italian government bonds are paying 0.8%, while US bonds are paying 2.7%. Which would you rather own? The USA certainly has plenty of problems of its own, but it is the least dirty shirt in the laundry. If bond prices properly reflected the currency risk and default risk, Italian bonds would be cheaper than US bonds and so the rates would be higher, perhaps even 4% or 5%. The ECB say they will end QE, but without it the rates seem set to rise.

The same problem will likely affect the UK at some stage. It is all very well the BoE setting the bank rate at 0.75% but without QE the rate on UK bonds will reflect how investors perceive the currency risk and default risk. If they don't like what they see, rates will be forced up, whether the BoE likes it or not. The bond market worldwide is huge: much bigger than any government.

[sixgun]

Just put an order in to short the IITB - an Italian government bond ETF