Monday, March 16, 2015

Draghi’s Latest Pledge Pushes Yields Closer to Zero (excerpt)

Among the most breath-taking moves attributable to central bank intervention, of course, is the plunge in bond yields, especially in the Eurozone. The Spanish and Italian 10-year government bond yields are both down to 1.15% from peaks of 7.61% and 6.61% during July 24, 2012--just before ECB President Mario Draghi’s whatever-it-takes pledge two days later. Astonishingly, the German yield is down to 0.25%, which is below the Japanese yield of 0.37%.

Throughout Europe and Japan, the short and intermediate portions of yield curves are actually negative. That means that fiscal deficits can be funded with bonds that are worth less when they mature. It’s an extraordinary development. Draghi’s latest hat trick was to say the following at his 3/5 press conference: “We observe that almost half of the euro bonds are outside the euro area and we also observe that the average weighted price of bonds in the 2 to 30-year maturity is well above par. It’s exactly 124%. So how negative do we go? Until the deposit rate.” That rate was lowered to minus 0.2% from minus 0.1% on September 4, 2014.

In other words, the ECB as a buyer of bonds under its QE program won’t pay less than minus 0.2% for bonds! By saying so, Draghi in effect is pegging the entire yield curve to that sub-zero yield. The question has been raised about the necessity of QE in the Eurozone given how low bond yields are today. The answer is that Draghi wants to keep the euro down, and send it even lower. Of course, he would never admit that publicly since central bankers always deny charges of currency manipulation.

The obvious outlier is the US Treasury yield curve. That’s because US yields are torn between the gravitational pull of near zero (plus or minus) European and Japanese yields and the prospect of Fed rate hikes. If Fed officials signal that the strong dollar has become a major concern that might lead to a more patient pace of normalization, then the melt-up in US bond prices is likely to continue on a catch-up basis with comparable overseas securities.

Today's Morning Briefing: Global Melt-Ups & Meltdowns. (1) Investments 101. (2) Don’t fight them, join them. (3) Transmission mechanisms: wealth effect and currency depreciation. (4) Melt-ups in assets and meltdowns in currencies and commodities. (5) Soaring dollar is equivalent to Fed rate hike, and reduces odds of monetary normalization. (6) Will FOMC statement delete “patient” or change it to “patient pace”? (7) The Age of Central Banks. (8) Breath-taking moves in financial, currency, and commodity markets. (9) Draghi’s latest pledge. (10) If Fed goes for “one-and-done” due to soaring dollar, look for melt-ups in US stocks and bonds. (11) “Foxcatcher” (-). (More for subscribers.)

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