When and how the ECB will intervene in bond markets

Of Leonida Stergiou

The ECB has already developed a package of two tools and is ready to activate it in order to restore liquidity problems in the bond markets, due to a change in monetary policy or due to speculative movements.

According to information from capital.gr from sources that are able to know, Frankfurt distinguishes two different cases in the bond markets, where it is called to intervene, which differ from a general increase in yields due to macroeconomic and fiscal environment.

Both cases where it intervenes are related to monetary policy and to risks that can be transmitted to the financial system.

Special situations

The first group includes dealing with special situations, such as speculation. According to capital.gr sources, the available tools, such as PEPP through repurchases or new bond purchases, can not solve all the problems.

Conversely, selective support with bond purchases, in a period of rising interest rates and the withdrawal of bond purchase schemes, may favor, for example, the development of speculative phenomena.

Nor is it a key scenario for the ECB to raise interest rates on the one hand and continue to inject liquidity through bond markets on the other.

The plan envisages a transition to normalcy, ie an end to the bond market and positive interest rates. Of course, with care, gradually and flexibly due to a change in monetary policy.

The case of speculation, for example, is different and is found when the expansion of spreads is not explained by the basic size of the economy and the effectiveness of fiscal policy.

Apart from speculation, there may be other conditions where the spreads are not explained by the basic sizes.

Such problems can arise under different circumstances, especially in an environment of uncertainty and risk due to war and energy crisis, but also a change in monetary policy. Therefore, there can be no one-size-fits-all tool for each market.

For these reasons, the ECB will create, on a case-by-case basis, specific tools to address specific problems and act as a deterrent to the next speculative move. Although they will be configured on a case by case basis, their main characteristics will be:

Independently, that is, they will not need, for example, approvals from the Commission / Eurogroup, such as the one created during the financial crisis, the so-called OMT, which only concerned countries under enhanced supervision.

Simple and flexible, designed to be created and used immediately.

Effective in correcting problems and dissuasive for next speculative move. This will be achieved by increasing the cost or risk to the for-profit position.

Absorption of any inflationary liquidity that the support tool may cause.

According to sources, such tools are not announced or used with the first upward movement in a bond market, when they are not accompanied by systemic, budgetary and other risks.

This also applies to PEPP support, because if the market sees that every time it pushes, for example, Greek bonds, the ECB comes and buys them, then it will push more and more. And if this is done, then comes the intervention that will make speculation expensive.

Malfunctions and dangers

The second category includes problems and malfunctions in the bond markets associated with the change in monetary policy.

For example, the lack of liquidity or depth of a market is reported, with risk ejection and, consequently, costs, creating problems for financing the economy and businesses, with an increased risk of transmission to the financial system.

And in these cases, the markets of bond countries with high debt and low credit rating are more vulnerable.

To address such situations, the ECB has left open the PEPP program for targeted repurchases of bonds maturing by 2024. The Greek government bonds have been included in this mechanism and a special reference was made in the ECB announcement.

At the same time, it keeps open the possibility of expanding repurchases or even starting a new cycle with net bond purchases through PEPP, if necessary (intense and more generalized phenomena).

The ECB first referred to this tool in March and in more detail last week, with the aim of reducing market uncertainty.

Generalized rise

The above cases differ from the increase in returns due to inflation, the energy crisis, the war, the general macroeconomic and fiscal environment, the uncertainties and the willingness of the markets for investment risk, etc.

In such cases, the ECB has no reason to intervene, unless it is found that there is a risk of financial stability (directly and indirectly).

In each case, they have seized it, despite obstacles we can scarcely imagine. ”

At this juncture, uptrends in yields are considered expected and, according to analysts at investment firms, are likely to continue in an environment of uptrends.

It may be more intense for countries with higher debt or some days it may be stronger as the discounting of interest rate markets is confirmed by announcements. They are also mainly related to fiscal policy, economic size and the credibility of an economy.

Indeed, following the ECB’s announcements last Thursday, even German bond yields have risen.

No, as strongly as Greek and Italian. In the last month, the yields of 10-year German bonds increased by 68 basis points, the Greek by 103 basis points and the Italian by 117 basis points.

Of course, there is a bigger increase in Greek and Italian both in the last days and at the level of the year, a fact that is connected with the public debt and the credit rating. For this reason the yields on Greek 10-year bonds are higher than Italian and much higher than German.

All bond yields have been up since inflation rose. In the last 12 months, the yield on the German bond has increased by 190 basis points.

In all 10-year AAA-rated bonds in the Eurozone, yields have risen by 120 basis points since March (when the ECB set a bond-closing and interest rate-raising timetable), while those of all bonds (except those with AAA-rated ratios) rose by 200 base units.