Tag Archives: ECB

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Do Central Banks tell us too much for our own good?

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I read in The Times last week that the Shadow Monetary Policy Committee (a panel of economists and Bank of England alumni) thinks that the Bank of England should announce a freeze on UK rates for an extended period of time. The Federal Reserve also had this policy (now replaced by even more explicit guidance about the unemployment rate and inflation levels), as did the Bank of Canada. In the past few years the Fed has spent weeks debating its communications strategy. Elsewhere we get monthly press conferences (including in Trichet’s time as head of the ECB the use of the explicit codewords “strong vigilance” which meant “rates going up next month”). We also get Inflation Reports and Financial Stability Reports, fan charts and GDP forecasts from which market economists pronounce that the Bank’s two year ahead projection means no more QE just yet. I wonder though whether we’re being given too much information, and that in telling us exactly what they are going to do, central banks risk either a) having to not change their policy even if economic circumstances mean that they should (for example if economic growth comes back strongly yet they’ve promised to keep rates on hold for years), or b) lose face, credibility and trust with the market by going back on their promise. Each of these actions has a cost, and should lower an economy’s potential GDP rate.

Is the promise of low rates forever fuelling the return of those Four Horsemen of the Bondocalypse – CLOs, PIK notes, CCC rated high yield issuance, and mega – LBOs? Does it lead to complacency in investment? To schemes that can only survive if rates don’t ever rise? Is current central bank policy generating asset bubbles? And what are central bankers left with, without the ability to surprise and shock? Worse still, what if “low rates forever” has the opposite effect than intended? Does it say “doomed, we’re all doomed”? Perhaps central bankers should realise that keeping us guessing is their most powerful tool (OK maybe QE Infinity is their most powerful tool, but still).

The clip below is of Diego Maradona, scoring against England in the Mexico World Cup finals in 1986.

I was reminded of it when I picked up a copy of Steve Hodge’s autobiography The Man With Maradona’s Shirt in the sales. Maradona was fortunate enough to swap shirts with Nottingham Forest legend Hodge after that game. Anyway, back in 2005 Bank of England Governor gave a speech in which he said the most interesting thing a central banker ever said.

“The great Argentine footballer, Diego Maradona, is not usually associated with the theory of monetary policy. But his performance against England in the World Cup in Mexico City in June 1986 when he scored twice is a perfect illustration of my point. Maradona’s first “hand of God” goal was an exercise of the old “mystery and mystique” approach to central banking. His action was unexpected, time-inconsistent and against the rules. He was lucky to get away with it. His second goal, however, was an example of the power of expectations in the modern theory of interest rates. Maradona ran 60 yards from inside his own half beating five players before placing the ball in the English goal. The truly remarkable thing, however, is that, Maradona ran virtually in a straight line. How can you beat five players by running in a straight line? The answer is that the English defenders reacted to what they expected Maradona to do. Because they expected Maradona to move either left or right, he was able to go straight on. ”

If Maradona had put out a press release and a booklet explaining exactly what he was going to do, it could never have happened. But by keeping the England team guessing and by shifting his weight from left to right (the footballing equivalent of raised eyebrows) he scored the greatest goal of all time.

anthony_doyle_100

Another year over – 2012 returns in fixed income markets

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It’s been another massive year for the global economy. Europe saw LTROs, Greece got a haircut, sovereign downgrades and record high unemployment rates. The peripheral European nations attempted to implement austerity measures with limited success. The US re-elected President Obama and the focus quickly shifted to the upcoming fiscal cliff. In the UK, an Olympics induced bounce in growth was the sole bright spark for an economy which appears to be stuck in quick sand and may well lose its prized AAA rating in 2013.

The IMF, being unusually succinct, probably summed up the state of the global economy the best by entitling their latest World Economic Outlook “Coping with High Debt and Sluggish Growth”. The advanced economies account for around two-thirds of global GDP and if they are sluggish then global growth will be sluggish too.

With all this uncertainty and risk in 2012, how have fixed income markets performed? Surely government bonds will be the safe haven of choice?

In absolute and local currency terms, it’s been another great year for the markets with everything generating a positive return except UK linkers. It’s been a fall in grace for UK linkers, which were actually one of the best returning asset classes of 2011. The UK linker market was buffeted in 2012 by weak growth expectations and uncertainty surrounding proposed changes to the RPI calculation.

But looking elsewhere, investors had the opportunity to secure some excellent returns in 2012 by taking some risk. The best performing asset class of our sample was European subordinated financial debt which registered a return of 29.5%. European high yield wasn’t far behind with a return of 27.1%, followed by Sterling banks which returned 23.0%.

ECB President Mario Draghi and the ECB’s measures to support the Eurozone also had a positive effect of debt investors in peripheral Eurozone debt, with an index made up of bonds from Greece, Ireland, Italy, Portugal and Spain government bonds up 18.7%. Not a bad return for investors considering the question marks hanging over the ability of these nations to service their respective debt obligations in an environment of political uncertainty and recessionary levels of growth.

Other highlights include global high yield (up 18.7%), European peripheral financials (up 17.0%) and US high yield (up 15.6%). At the less risky end of the spectrum, European investment grade corporates returned 12.8% and US investment grade corporates returned 10.2%. Emerging market debt also did well, with EM sovereigns debt posting a fantastic return of 21.4%.

The dash for trash – YTD total returns in fixed income

As outlined earlier, it appears that the global economy faces some substantial fundamental headwinds. So how was it that the riskiest asset classes in fixed income have performed the best? Three little words – “whatever it takes”. Mario Draghi’s speech in late July supercharged returns for the riskiest asset classes and stimulated the “dash for trash”. “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough”.

Well Mr Draghi, the markets have certainly believed you. For example, an index of government debt issued by Greece, Ireland, Italy, Spain and Portugal had up until the speech date generated a return of around 5%. The index ended up generating a 17% return, with investors comforted by Mr Draghi’s comments.

Super Mario to the rescue

It seems to us that the Ostrich effect (the avoidance of apparently risky financial situations by pretending they do not exist) had a significant impact on markets in 2012. And in a world of ultra-low interest rates and negative real returns in cash, investors must take on risk. It is precisely what central banks are encouraging us to do. But uncertainty breeds volatility and in order to generate higher returns investors must face this volatility head on. It will be a feature of the market in 2013.

About the only thing we can say for certain is that it is unlikely that fixed income will continue to generate excellent returns across the spectrum from government bonds to high yield. For example, double-digit returns in European investment grade are not normal and has occurred only three times in the last seventeen years. On the other hand, the asset class has posted a negative return in only two of those seventeen years, with the largest loss being -3.3% in 2008. In US high yield, the consensus amongst analysts is that high yield markets will generate a return of around 4-6%, the result of coupon clipping. Analysing returns for the asset class shows that a coupon-clipping year has occurred only once in the past twenty-five years.

We posted our bond market outlook last week. It looks like the US may experience a housing induced growth spurt, Europe will eventually get round to dealing with its issues and the UK has a long way to go to secure economic growth. We like non-financial corporates, are worried about EM debt valuations and remain confident that there are still attractive investment opportunities in several areas of the fixed income universe. For an expansion of these views and more, please see here.

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Jim’s outlook for 2013. Eurozone volatility, poor emerging market debt valuations and a sterling collapse. Merry Christmas!

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It may not have felt like it, but 2012 has actually been a pretty good year for investors. Bond holders in particular have had a decent 12 months: the government bond bull run has continued and investment grade and high yield corporate debt appears on track to deliver some excellent returns. Major equity markets also look likely to end the year in the black.

These broad-based gains on global stock and bond markets have occurred against a still challenging macroeconomic backdrop. In fact, looking back at our last annual outlook, many of the things we were worried about then – “double dips” and rising indebtedness in developed countries and the risk of a significant policy error worldwide – have not only remained unresolved but have become, in some cases, more of a concern. But it’s not all bad news and we’re pleased to note pockets of progress in some parts of the world.

So what does 2013 have in store for financial markets? In our latest Panoramic outlook, Jim outlines his macroeconomic and market forecasts for the year ahead. And remember, there are still a couple of days left to enter the M&G Bond Vigilantes Christmas quiz for 2012.

Enjoy!

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Central Bank Regime Change: an update following the Fed last night, and Carney the day before

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Last night’s move by the Federal Reserve to change its approach to US monetary policy to effectively reduce the focus on the inflation target was just the latest step in an accelerating project by the world’s monetary authorities.   In a world where unemployment rates are well above pretty much anyone’s estimate of the natural rate, and in many geographies well above 10%, the need for growth is seen as much more pressing that the fear of missing the 2% inflation targets.  So at the latest FOMC meeting the Fed decided that inflation would be tolerated if it nudged higher to 2.5% as long as unemployment remained too high (above 6.5%).  You can read the text of the Fed’s statement here.

We call this move by the world’s authorities away from the old idea of 2% inflation targets Central Bank Regime Change.  We wrote this blog about it in March. The chart is worth showing again.

central bank regime change

The chart from the IMF shows us that in the period post Paul Volcker’s appointment to the US Fed in 1979 (the orange line), the monetary authorities kept interest rates higher than the rate of inflation (they were reacting to the damage that inflation caused in the 1970s).  As a result inflation steadily fell – and as well as high “real” rates, the rhetoric was all about inflation (inflation targets, the Bank of England’s Inflation Report, independent central banks).  It’s been an awesome 30 years (on the whole!) to be a government bond investor, as yields fell in response to inflation fighting credibility.  However, I’ve added another line to the IMF chart (blue), showing how central banks have behaved since Lehman went bust, and the credit crisis was followed by the sovereign debt crisis.  It’s a very different story, with sharply negative real yields.  Nominal interest rates are near zero in much of the developed world, yet inflation has been sticky above 2%.  This is deliberate central bank policy – negative real rates are designed to make it attractive to borrow to invest and stimulate growth (and to deliver gains to indebted consumers), and also to encourage risk taking as investors reach for yield (government bond investors buy credit, investment grade investors buy high yield etc.).

Negative real rates also have an impact which we’ll discuss in more detail another time – debt reduction for bust governments.  There are a few ways to reduce debt burdens:  strong real growth (seems out of reach for the foreseeable future), austerity (unproven and probably counter-productive, although some point to Canada and Sweden as success stories), default (will be necessary for some Eurozone economies without their own currency to depreciate) and inflation.  It’s the last that’s likely to be effective – and as the red line on that chart shows, it’s the method by which the western economies reduced the war debts following WWII.

So whilst we don’t believe the world’s central bankers and finance ministers are sitting high in some Swiss cable car complex, stroking white fluffy cats and cackling maniacally, plotting to generate super high levels of inflation, this is becoming the pragmatic (only?) response to a world without other policy responses (no fiscal flexibility left).  Now the Fed’s latest move to target both inflation AND unemployment rates is very interesting – when I was a young student of economics, the idea that you could chose BETWEEN inflation and unemployment was discredited.   To quote, er, Wikipedia on that idea, known as the Philips Curve “while it has been observed that there is a stable short run tradeoff between unemployment and inflation, this has not been observed in the long run”.  So the idea that you can choose both is probably even more far fetched.

Anyway, what does the Fed’s action mean?  Well watching Bernanke’s press conference last night it struck me that in changing the Fed’s guidance away from the “no hikes until 2015” towards the unemployment and inflation numerical targets should actually be seen as a potential monetary TIGHTENING.  After all, we are exceptionally bullish on US housing as a driver for growth in 2013 and 2014, so if things go well we could end up with the Fed raising rates ahead of the old 2015 date.

So I’ve asserted that Central Bank Regime change is taking place, but I thought it would be worthwhile to put together a brief list of the evidence so far.  Here it is.

Evidence for Central Bank Regime Change

  1. The level of real rates set by the Central Banks: the best evidence is obviously shown on the graph itself.  Are central bankers hitting inflation targets?  Not really – for example the Bank of England has only had CPI at or below the 2% target for 6 months in the last 5 years, and for much of that period it’s been above 3% (and above 5% at one point!).  On latest data the UK, the Eurozone and the US all have negative real rates of 1.75% or higher.  Western central banks are even considering setting negative NOMINAL interest rates.  Only Japan of the major economies has positive real rates at the moment – although we think this might change dramatically, as I’ll discuss below.
  2. The US refocus on the dual mandate: after three decades of inflation targeting, the Fed has been moving towards this new objective for a year or so now.  First Charles Evans of the Chicago Fed started floating the concept of an unemployment target, then Janet Yellan (Bernanke’s probable successor) of the San Francisco Fed joined him, leading up to last night’s actions.  This was pushing on an open door for Ben Bernanke who has written the following in his previous academic life…
  3. Bernanke’s 4% inflation target for Japan:  in this paper, Japanese Monetary Policy: A Case of Self-Induced Paralysis, written whilst he was at Princeton in 1999, Bernanke argues that the solution for an economy like Japan with a burst property bubble, broken banks, sluggish growth and deflationary pressures should be to target inflation of between 3% and 4%.  Looks similar to the US situation, so why wouldn’t Bernanke think that this is the correct response from the Fed for the US?
  4. Mervyn King’s softening stance on the inflation target:  I guess actions speak louder than words, and the lack of actual inflation targeting in the UK for the last 5 years should tell you more than any speech, but I’d never heard the Governor soften his rhetoric until these words in this speech Twenty Years of Inflation Targeting this October.  “There may be circumstances in which it is justified to aim off the inflation target for a while in order to moderate the risk of financial crises”.
  5. New Bank of England Governor Mark Carney talks about a new regime of nominal GDP targeting rather than pure inflation targets: in a speech to the CFA Society of Toronto this week, Carney (who takes over at the BoE next year) suggested that when policy rates approach 0% (the “zero bound”), targeting nominal growth might be more effective than targeting inflation rates.   He even used, for the first time from a central banker (?) the term “regime change”.  “Under Nominal GDP targeting, bygones are not bygones and the central bank is compelled to make up for past missed on the path of nominal GDP.”   Of course, targeting nominal GDP is a very effective way of reducing debt levels in an economy too.
  6. Japanese regime change, the “Abe Trade”: this weekend Japan goes to the polls with opposition leader Shinzo Abe of the LDP favourite to emerge as the new Prime Minister.  Japan has yet to recover from its bust, decades ago, and Abe wants to aggressively target growth.  With deflation of 0.4% in Japan despite the BoJ’s 1% inflation target, Abe wants the central bank to do MUCH more.  This would include raising the inflation target to 2% (or even 3%) and doing whatever it takes (more QE, currency intervention) to achieve that.  This is a manifesto commitment that might get watered down at a later date – but having seen a BoJ member in Tokyo recently I get the feeling that a hike in its inflation target is inevitable.
  7. Europe: hard evidence is more difficult to find, but with hawkish German ECB members like Axel Weber and Juergen Stark both resigning in 2011 (“It’s generally known that I’m not a glowing advocate of these (bond) purchases” – Stark) the ECB has been much more open to extraordinary balance sheet expansion (LTRO, SMP, OMT).  And to more “traditional” Quantitative Easing at a later date?

So with all of this evidence that the authorities are changing how they think, and act, on inflation, you would expect that bond markets would have reacted badly right? If Ben Bernanke thinks 4% is an appropriate level for inflation in the US, you wouldn’t be lending money to the government at 0.65% for the next 5 years would you? And with Mark Carney taking over at the BoE next year, breakeven inflation rates (i.e. market inflation expectations) would be overshooting the 2% inflation target over the next few years too? Well 5 year Treasury yields are still well below 1% (helped by QE buying of that sector, announced last night) and UK breakeven inflation rates on a CPI basis are below the 2% inflation target. In both cases it feels as if state intervention in these markets (financial repression through QE, capital requirements etc.) will keep yields low despite high inflation. And this is entirely necessary – with half the US Treasury market maturing in the next 3 years or so, if yields ever did adjust higher then western governments, with marginal solvency in any case, could go bust quickly.

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Panoramic: central bank regime change – inflation targeting or inflation hunting?

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Given the success that central banks have had in targeting inflation over the last decade or so, the recent increase in their powers, and the broadening of their remit to include economic growth, has been largely welcomed by the markets. But have we put too much faith in central banks abilities? And, with record levels of peacetime government deficits and the clear political incentive to tolerate higher levels of inflation, have we come to overestimate their commitment to reining in prices?

In this note, which is part of our quarterly Panoramic series, we argue that we are seeing potential upside risks to inflation as central banks continue to preside over the biggest coordinated global monetary stimulus that we’ve seen in recent history. In our view, the expansion of central banks’ balance sheets signals an unspoken shift in these institutions’ remits that could have important consequences for future inflation rates. It is a phenomenon we have coined “central bank regime change”.

The Bank of England and European Central Bank seem no longer to be primarily focused on delivering price stability. Their new mandate now covers supporting domestic banking systems, offsetting the effects of government austerity measures, bolstering trade and implementing the conditions needed to generate jobs and economic growth.

With central banks’ macroeconomic responsibilities straying ever further into what was previously the state’s domain, their independence is looking increasingly fragile. The hijacking of monetary policy by politicians cannot be ruled out, especially if it enables them to inflate their way out of their growing debt burden. If we get to this stage, inflationary pressures will rise, although central banks’ credibility will be tarnished and policy responses rendered ineffective.

In our view, there are potentially plenty of reasons to expect the current period of low inflation to come to an end. Central banks are still thinking of new ways to ignite growth and they appear to be increasingly tolerant of above-target inflation. But are they moving ever closer to a major policy error that could ruin their inflation-targeting credibility? And should we all start thinking about inflation again?

To read the latest Panoramic, please follow this link.

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ECB to ECP (European Centre for Politics)

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The ECB is modelled on the idea of an independent central bank, where decisions are made to enforce economic rather than political discipline. Recently however, its role and mandate seem to be changing.

This move by the ECB to become more an arm of the state is typified by Mr Weidmann’s comments recently. He draws comparisons of the recent potential bond buying announcement, with that of aggressive state financing via the printing of money by non independent central banks.

Not only has the ECB agreed to become more like an arm of the state, it is potentially attempting to become the state. Its bond purchase programme is dependent on a sovereign state meeting certain conditions, which means it is now aiming to have the powers of a state, in terms of controlling net taxation and spending. It would therefore control the printing press and control expenditure. It would then automatically face the tricky political task of switching the printing press off if conditions are not met by its subjected member state. No wonder Mr Weidmann does not approve.

This is not the only way the central bank has become more political recently. By having the explicit aim of saving the euro at all costs it has basically made a political decision. Currency unions are by definition a political construct. Therefore, its recent move to a dual mandate of inflation targeting and saving the euro is a move towards a more politically focused ECB.

One of the problems the ECB faces as a political animal is its construction. It has not exactly been constructed in an efficient, democratic manner. Firstly, one country one vote means proportional representation is out the window, potentially annoying the larger members who do not agree with the policy and have to pick up the bill (Germany). Secondly, the appointment of its council members is undemocratic. Thirdly, council members, as national central bank governors, tend to be economists!

There is always a connection between a central bank and the state that it is theoretically acting in the independent interest of. The ECB is becoming more like the ECP (the European Centre for Politics). Will European governments give it this increasing power? Will it be able to exercise this power correctly?

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Paying the locusts – what the PSI means for Greek bond investors

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Early this morning it appears that at last Greece and the European authorities are at the final stages of  launching a bond swap with the private sector – known as the private sector involvement (PSI) procedure – which will aim to reduce Greece’s debt-to-GDP ratio to 120.5 percent by 2020 (currently 160 percent). The deal will receive blanket press coverage, we are going to focus on the PSI element.

The PSI ensures that the private sector will suffer a real loss while the public sector (national European central banks and the ECB) will not suffer any losses. Central banks have this privileged position as they are prepared to provide further finance to Greece (akin to a rescue rights issue diluting existing shareholders). Of course, it is not in the politicians’ interests for the central banks to bear any losses as a result of lending to Greece and of course it is the politicians that set the legal and regulatory framework. Not only can politicians change the goal posts, they can change the ball you are playing with. Politicians, and the authorities, are exercising their imbedded power.

This deal will cause the private sector to suffer a disproportionate level of losses both in absolute and relative terms to the public sector. This punishes the private sector investor in Greek debt relative to the private speculator who was short Greek debt. We noted in an earlier blog that governments perceived owners of their debt to be good investors, whilst investors holding short positions in government debt are evil speculators.

The problem with the PSI procedure is that it does not reward these economic agents accordingly. This PSI precedent means that in the future, should a government debt crisis occur, private investors will be less willing to support troubled government debt, and speculators will be rewarded for being short. Obviously this will impact the sustainability of government finances at precisely the time they would be seeking to generate confidence in their ability to service their debt obligations.

What does this PSI look like in pounds, shillings, and euro cents? Those investors that are short Greek debt will make money, the legal power of the state means the authorities suffer no damage, while the private sector will suffer losses. The locusts will feed well, the authorities will not eat less, and the private investor will waste away.

mike_riddell_100

The ECB’s bazooka has hit the target

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The ECB finally realised it had no choice and fired its bazooka in December.  The impact has been huge.  Two year Italian government bond yields have more than halved from the high of 7.5% seen at the end of November. Many hedge funds who were betting on Italian government bonds selling off have either changed views and taken profits or have been stopped out of their positions as the market has gone against them.  Real money investors have been returning to the Eurozone sovereign bond market after a long absence.  Just as Italian bank bond yields spiralled upwards with the Italian sovereign, so they have plummeted down too, and banks have been able to issue bonds to the market again this year (albeit almost solely covered bonds or senior bonds so far).   The chart below highlights just how much Italy’s borrowing costs have fallen.

Those who doubt the sustainability of the ECB’s policies are entirely correct when they argue that  hurling liquidity at the Eurozone debt crisis does nothing to solve the structural problems at the heart of the Eurozone.  If you put lipstick on a zombie sovereign or zombie bank, it’s still a zombie.  The potentially terminal problems of huge competitiveness divergence between countries (ie current account imbalances) are still to be resolved. One answer is total fiscal union, which requires Northern Europe to take on Southern Europe’s debts and Southern Europe to let Northern Europe tell it what to do (exceptionally unlikely).  Alternatively, it  requires Germany and the Netherlands to be willing to run consistently higher inflation rates than the rest of Europe (also unlikely). As Milton Friedman succinctly pointed out in 1999 (see Q&A session), “the various countries in the euro are not a natural currency trading group. They are not a currency area. There is very little mobility of people among the countries. They have extensive controls and regulations and rules, and so they need some kind of an adjustment mechanism to adjust to asynchronous shocks—and the floating exchange rate gave them one. They have no mechanism now”.

But just because the ECB’s policy response hasn’t addressed the underlying problems, it doesn’t mean the response is immaterial.  Quite the opposite.  We know from 2009 how powerful the effect on markets can be when central banks fully deploy their balance sheets.  In light of this, the rally in the riskier fixed income assets that we’ve seen of late arguably has further to go, and in the past few weeks I’ve even bought Italian government bonds for the first time ever.

The flip side is that the current yield levels of core government bonds is a concern, and duration appears less attractive.   In May last year, government bond yields were more than 1% higher than they are today and yield curves were much steeper.  It was expensive to be short duration at the time, as argued here.  The situation has changed a bit since then,  presumably because of Eurozone stress and perhaps also because of China.  If Europe is no longer in a downward spiral (indeed the crucial Eurozone PMI data released this morning suggests there has been a bounce in economic activity in January) then government bonds really do look vulnerable.

mike_riddell_100

Für einen deutlich schwächeren Euro müssten die Renditen auf deutsche Staatsanleihen sehr weit in negatives Terrain fallen. Das könnte leicht passieren.

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This post was originally published on 11.01.12 in English and has been translated for our German readers.

2011 hat der Euro gegenüber dem US-Dollar 3,2% verloren. Nach allem, was 2011 in Europa passiert ist, sind viele überrascht, dass der Euro nicht schwächer abgeschnitten hat. Zahlreiche Kommentatoren rechnen für 2012 mit einer deutlichen Schwächung des Euro.

Wie es bei Wechselkursen meistens der Fall ist, lässt sich die Entwicklung des Euro gegenüber dem US-Dollar größtenteils mit der Veränderung der Erwartungen für die kurzlaufenden Zinssätze erklären, die an den relativen Renditedifferenzen zwischen den kurzlaufenden Anleihen der verschiedenen Währungsräume abzulesen sind. Die Stärke des Euro gegenüber dem US-Dollar in der ersten Jahreshälfte war auf die unterschiedlichen geldpolitischen Strategien der Fed und der EZB zurückzuführen. Die Fed blieb bei ihrer Aussage, dass sie für einen längeren Zeitraum einen außergewöhnlich niedrigen Leitzins beibehalten würde (und ging im August sogar noch einen Schritt weiter, als sie erklärte, dass „die Wirtschaftslage wahrscheinlich bis mindestens Mitte 2013 ein außergewöhnlich niedriges Leitzinsniveau rechtfertigen wird“). Die EZB dagegen hob im April und im Juli letzten Jahres munter die Leitzinsen an, obwohl der ganze Markt diesen Schritt als unsinnig verurteilte. Wie zu erwarten (siehe hier), begannen die Märkte kurz nach der zweiten Zinserhöhung vorwegzunehmen, dass die EZB gezwungen sein würde, ihre Zinsschritte wieder rückgängig zu machen (was sie dann auch im November und Dezember tat). Der Euro schwächte sich im restlichen Jahresverlauf ab.

Die obere Grafik zeigt die Renditen auf deutsche und US-Staatsanleihen mit Fälligkeit Oktober 2013. Das untere Diagramm zeigt die Entwicklung der Renditedifferenz zwischen deutschen und US-Anleihen im Vergleich mit dem EUR/USD-Wechselkurs. Die Korrelation ist – wie erwartet – recht stark ausgeprägt. Allerdings befindet sich der Euro jetzt auf einem 15-Monats-Tief gegenüber dem US-Dollar, und dieser Abwärtstrend kann nur anhalten, wenn eine der folgenden drei Entwicklungen eintritt:

1. Die Fed müsste ihre Meinung drastisch ändern und die Leitzinsen vor Mitte 2013 anheben, was eher unwahrscheinlich ist.

2. Die normale Korrelation zwischen dem EUR/USD-Wechselkurs und den kurzlaufenden Anleiherenditen müsste komplett zusammenbrechen. Das ist durchaus möglich.

3. Die Renditen auf deutsche Staatsanleihen müssten sehr negativ werden.

Was den dritten Punkt anbelangt, so ist es Deutschland tatsächlich erstmals gelungen, Anleihen mit 6-monatiger Laufzeit mit negativer Rendite zu begeben (siehe hier). Wenn man sich allerdings das untere Diagramm ansieht, muss man davon ausgehen, dass für einen Rückgang des EUR/USD-Wechselkurses auf 1,15 die Renditen für kurzlaufende deutsche Staatsanleihen bis zu 90 Basispunkte unter die Renditen für kurzlaufende US-Staatsanleihen fallen müssten. Zweijährige US-Staatsanleihen rentieren gegenwärtig mit +0,24%, die Renditen für die deutschen Titel müssten also unter -50 Basispunkte fallen. Die Folge wäre eine interessante Konstellation, bei der Anleger in zweijährigen deutschen Staatsanleihenfutures („Schatz“) short gehen, den Kontrakt nicht rollen und bei Fälligkeit Geld geschenkt bekommen können (wenn sie die Volatilität verkraften können).

Könnten die Renditen auf deutsche Staatsanleihen sehr weit ins Negative rutschen? Wenn die Anleger zunehmend die weitere Existenz des Euro in Frage stellen, sind negative Renditen auf deutsche Staatsanleihen eine durchaus rationale Folge. Diverse Analysten haben versucht zu ermitteln, wie neue D-Mark, Francs, Lire, Peseten oder Drachmen gegenüber dem Euro notieren würden, und jeder scheint damit zu rechnen, dass die neue D-Mark gegenüber dem aktuellen Niveau des Euro zulegen würde. Die Spanne der Erwartungen ist allerdings recht breit gefächert: Einige Analysten nehmen eine Aufwertung von 5% an, andere bis zu 40% (ich selbst bin, nebenbei bemerkt, nicht überzeugt, dass eine neue D-Mark höher notieren würde als das aktuelle Kursniveau des Euro, wenn man bedenkt, welchen Schaden ein Zusammenbruch des Euro im deutschen Bankensektor anrichten würde). Natürlich ist das alles reine Spekulation; es lässt sich aber kaum abstreiten, dass eine neue D-Mark viel stärker wäre als beispielsweise ein neuer französischer Franc und insbesondere eine neue spanische Pesete, italienische Lira oder griechische Drachme.

Zunehmend negative Renditen auf deutsche Staatsanleihen und wachsende Renditeabstände zwischen Deutschland und anderen Ländern wären also eine rationale Reaktion auf die steigende Wahrscheinlichkeit, dass die Eurozone auseinanderbricht und die deutschen Staatsanleihen in eine neue D-Mark redenominiert werden. Die Redenominierung in eine neue D-Mark könnte dem Inhaber einer kurzlaufenden deutschen Staatsanleihe mit einer Rendite von -0,5% einen Wertzuwachs von vielleicht 40% einbringen, oder vielleicht sogar einen Wertzuwachs von 90%, wenn der Anleger in Griechenland wohnt. Die negativen Renditen auf deutsche Staatsanleihen könnten sehr leicht noch negativer werden, wenn das Risiko eines Auseinanderbrechens der Eurozone zunimmt, was zu den hier erörterten Problemen führen würde. Der Euro könnte also noch deutlich schwächer werden.

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German government bond yields may need to get very negative for the euro to weaken much further. And it could easily happen

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In 2011 the euro underperformed the US dollar by 3.2%.  Given everything that’s occurred in Europe, many people have been surprised that the euro has not been weaker, and numerous commentators continue to call for a much weaker euro in this calendar year.

As usual with FX rates, most of the euro’s behaviour versus the US dollar can be explained by changes in expectations of short term interest rates, as seen by the relative differences between the regions’ short dated government bond yields.  The euro’s strength against the US dollar in the first half of last year was due to the contrasting approach of the Fed and the ECB.  The Fed continued to state that it would maintain an exceptionally low Fed Funds rate for an extended period (and then in August went a step further by stating that “economic conditions….are likely to warrant exceptionally low levels for the federal funds rate until at least through mid 2013″).  Meanwhile, despite almost the whole market telling them it was daft, the ECB merrily hiked rates in April and July last year.  Very predictably (see here), soon after the second hike, the markets promptly began to anticipate the ECB having to reverse its hikes (which it subsequently did in November and December) and the euro weakened over the remainder of the year.

The top chart shows the yield on German and US government bonds maturing in October 2013.  The bottom chart shows the difference in the two yields plotted against the EUR/USD exchange rate, and the correlation is strong as you’d expect.  However, the euro is now at a 15 month low versus the US dollar, and for this weakening trend to continue, we need one of three things to happen.  Firstly, the Fed needs to do the unlikely, have a big change of heart, and hike rate rates before mid-2013.  Secondly,  which is quite possible, the normal correlation between EUR/USD and short term bond yields needs to completely break down.  Or thirdly, German government bond yields need to get very negative.

Regarding the third point, Germany did indeed manage to issue 6 month bills at a negative yield for the first time (see here).  If you eyeball the bottom chart, though, for EUR/USD to go to 1.15, you may need short dated German government bond yields to be as much as 90 basis points below short dated US government bond yields.  Two year US government bonds currently yield +0.24%, so you’d be looking at  German yields below -50 basis points.  You’d end up with the interesting dynamic of investors going short of two year German government bond futures (the ‘Schatz’), not rolling the contract, and making free money (if they can ride out the volatility) at maturity.

Could German government bond yields get very negative?  Well if investors increasingly doubt whether the euro can remain in existence, then negative German government bond yields are a totally rational outcome.  Various analysts have had a stab at guessing where a new Deutschemark, Franc, Lira, Peseta or Drachma would trade versus the euro, and everyone seems to expect the new Deutschemark to strengthen against where the euro currently trades, although the range is huge with some going for 5% appreciation and some as much as 40% (for what it’s worth I’m actually not convinced a new Deutschemark would necessarily trade higher than where the euro currently trades given the damage that a euro breakup would do to Germany’s banking sector).   It’s all obviously a total guess though as nobody has any idea,  however it’s hard to argue against a new Deutschemark being a lot stronger than, say, a new French Franc and particularly a new Spanish Peseta, Italian Lira or Greek Drachma.

So increasingly negative German government bond yields, together with widening yield spreads between Germany and other countries, would be a rational response to the rising probability that the euro breaks up and the German government bond is redenominated into a new Deutschemark.  Redenomination into a new Deutschemark could end up returning the holder of a -0.5% yielding short dated German government bond perhaps a 40% capital gain, or maybe even a 90% gain if the investor is living in Greece.  Negative German government bond yields can very easily become more negative as the risk of breakup increases, leading to the problems discussed here.  And the euro could therefore weaken a lot further.

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