On January 22, ECB president Mario Draghi is expected to announce a plan of action to stimulate Europe via a QE policy of purchasing government bonds. Details were supposed to be hush-hush but the options are out of the bag in bright daylight.
Reuters reports ECB is Considering Three Options according to a Dutch paper.
- Buy government bonds in a quantity proportionate to the given member state’s shareholding in the central bank.
- Buy triple-A rated government bonds, driving their yields down to zero or into negative territory. The hope is that this would push investors into buying riskier sovereign and corporate debt.
- Have national central banks do the buying, so that the risk would “in principle” remain with the country in question.
Every one of those options looks ridiculous. German bond yields are already negative out to 5 years and barely above zero out to 10 years.
Yield on the German 10-year bond is 0.454% while the 10-year French bond yield is 0.738% and the 10-year Spanish bond yield is 1.64%. For comparison purposes, the 10-year US treasury note yields 1.96%.
These bonds already are hugely overpriced given the risk of a messy eurozone breakup. Option three is the most ludicrous because the peripheral countries are already overloaded in their own bonds.
Race to Negative 10-Year Yields
In a previous post, I stated Japan leads Germany in race for a negative yield on 10-year bonds. However, I overlooked first-place Switzerland. Japan is actually in second place and Germany third.
Both Germany and Switzerland have negative yields all the way out to 5 years.
For further discussion and charts, please see In Race to Negative Rates on 10-Year Bonds, Switzerland Leads Japan.
As for ECB president Mario Draghi’s plan to fix the eurozone via QE, I see eight major reasons whatever he does won’t work.
Eight Major Problems
- There are widely differing fiscal policies between eurozone member states.
- There are widely differing work rules and productivity between member states.
- There are widely differing social agendas between member states.
- As a result of 1-3 above, a one size fits all interest rate policy cannot and will not work.
- Regardless of what Draghi says, there is no fiscal or banking union between member states, and no monetary union has ever survived without such unions.
- Numerous European banks are undercapitalized and massively leveraged in sovereign bonds that are priced well beyond perfection.
- European peripheral countries have debts that cannot and will not be paid back.
- When peripheral debt defaults or is restructured, reverberations will hit the core.
The idea that all those structural issues can be fixed with monetary policy is ludicrous. Yet, that is the plan, even though driving yields lower will add more risk to the system.
Something Up Draghi’s Sleeve?
I am highly suspicious of the leak highlighting three options Draghi is allegedly considering. I suspect he will try to surprise the market with some other details.
It matters not. There is nothing Draghi can possibly do to fix all the eurozone structural issues mentioned above.
Mike “Mish” Shedlock