This page has been archived and commenting is disabled.
Goldman Explains The "Self-Fulfilling Loop" Driving Bund Yields
Last week, we witnessed a rather dramatic sell-off in German Bunds. The rout was attributable to a confluence of factors including, but not limited to, data which appeared to show that euro loans to the private sector rose for the first time in three years, position squaring, the frontrunning of expected positive EGB supply in May, and the suggestion from yet another financial market heavyweight that Bunds represent a compelling short opportunity especially when you can leverage your position and achieve a positive carry along the way.
Despite the sell-off and despite the fact that net supply in Germany is expected to be (barely) positive in May, it will turn sharply negative to the tune of €12 billion and €15 billion in June and July, respectively, suggesting rising Bund yields may be a transient phenomenon especially considering the fact that when supply is deeply negative, private market holders should theoretically be able to charge the Bundesbank as much as they want all the way to the depo rate floor, a dynamic which should put pressure on yields (at least for maturities of 5 years and up) going forward.
Against this backdrop, Goldman is out summarizing the dynamics of the supply/demand equation for Bunds. Here’s more:
Unlike other large economies, however, the German government sector was running a surplus of 0.7% of GDP in 2014. On current fiscal policies, as the economy expands this will likely expand, implying an even lower issuance of bonds and larger scarcity effects. We calculate that the Bundesbank will remove 80% of the central government’s gross issuance of government bonds over the next year, compared with 40% in Italy, Spain and France (where redemptions and the new deficit are larger). If the amount the Bundesbank removes from the bond market is couched in budget surplus equivalent terms (i.e., a reduction in net issuance of securities), it would be in the order of around 6% of German GDP. Going by historical relationships, a surplus of this size would lower 10-year Bund yields by 60-70bp, controlling for short rates and macro conditions. Even so, Bund yields should not trade lower than 50-75bp – which suggests there are also other factors depressing yields.
PSPP then, will soak up more than three quarters of gross supply in Germany, which is twice as much in percentage terms as what NCBs will take down in Italy, Spain, and France. Meanwhile, some 40% of purchase-eligible German bonds are in foreign hands...
The breakdown of ownership is also playing in favour of lower yields. Two-thirds of German government debt – the risk-free asset par excellence – is held by non-German residents. No official statistics are available for how the share in the hands of foreigners is divided between other residents of the Euro area and investors outside the currency union. Combining data on foreign balance sheets with anecdotal information, we believe that as much as 40% of the stock of German securities may now be held by investors residing outside EMU. A broader diversification across the Euro area sovereign markets has been held back by the large credit rating gap that still exists between the core countries and the periphery, and ongoing tensions surrounding Greece.
Finally, Goldman reminds us that the structure of PSPP has a tendency to create sell-fulfilling prophecies…
Last but not least, the ECB has stated that bonds yielding less than negative 20bp (i.e., the deposit rate) would not be eligible for purchase. Alongside this, it has set constraints on how much of each specific security it wishes to own. As the decline in yields that has followed the liquidity injections has made its way to intermediate maturities, the market has extrapolated that the Bundesbank would have to purchase a larger share of longermaturity bonds to fill its quota. This is a self-reinforcing expectations loop, where lower yields beget lower yields. Given its nature, the loop can also switch direction. As yields rise, more bonds become eligible for central bank purchases, and the price action goes into reverse. What we have seen in recent days has offered a taster of these dynamics, especially at the very long end of the German yield curve.
We would note that this type of feedback loop could be rather dangerous in a market that is becoming structurally very thin — that is, combining collapsing market depth with a “self-reinforcing expectations loop” that can quickly push long-end yields higher at the drop of a dime seems to be a decidedly risky proposition. Combine this with the fact that supply is set to go negative again in June and July which could push yields quickly lower, and the stage is set for a volatile summer in the Bund market.
»
- 14783 reads
- Printer-friendly version
- Send to friend
- advertisements -
Yeah it's called a printing press.
"Last but least, the ECB has stated that bonds yielding less than negative 20bp (i.e., the deposit rate) would not be eligible for purchase."
Is it me, or have we completely entered the Twilight Zone?
As the following narrative is slowly being implanted into the publics consciousness:
Negative Nominal Interest Rates: History and Current Proposals
"Nonetheless, the most commonly thought method for removing the zero bound is taxing money. To begin with, the easiest way to implement such a scheme was to abolish coin and bank notes altogether. Buiter (2010, pp. 222-226) considers coins and bank notes to be redundant media of exchange, the larger part of it being held abroad for legitimate (store of value in countries with high inflation rates) and illegitimate (underground economy) reasons. In developed countries, its function of providing liquidity could easily be satisfied by bank accounts. Roughly half of Dollar and Euro notes are held abroad and of the remainder only a small fraction is held for transaction purposes.24 As stated above, without coins and currency, levying the tax on all non-bearer bonds is technically simple. . . If coins and currency are completely replaced by electronic transfers via registered accounts, in theory there is no limit to the domain over which the rate of interest can be set. In addition, there would be the additional advantage of hitting the underground economy as the absence of anonymous bearer bonds would make all economic transactions traceable."
https://www.wiwi.unimuenster.de/cawm/forschen/Download/Diskbeitraege/DP4...
ach me with an ECB paper hose
So "free" money that debases labor (lives) isn't going to save the World?
Why is this happening at this point in history?
As the world explodes in violence, war, riots, and uprisings, it is challenging to step back and examine the bigger picture. With airliners being shot down over the Ukraine, missiles flying between Israel and Gaza, ongoing civil war in Syria, Iraq falling apart as ISIS gains ground, dictatorship crackdown in Egypt, Turkey on the verge of revolution, Iran gaining control of Iraq, Saudi Arabia fomenting violence, Africa dissolving into chaos, South America imploding and sending their children across our purposely porous southern border, Mexico under the control of drug lords, China experiencing a slow motion real estate collapse, Japan experiencing their third decade of Keynesian failure, facing a demographic nightmare scenario while being slowly poisoned by radiation, and Chinese-Japanese relations moving towards World War II levels, it is easy to get lost in the day to day minutia of history in the making.
http://www.theburningplatform.com/2014/07/28/our-totalitarian-future-par...
http://www.theburningplatform.com/2014/07/29/our-totalitarian-future-par...
http://johnbeieler.org/protest_mapping/
It's just another one of those models where the divergence from reality is caused by reality being wrong .....
PS For those not yet checking into reality today, your Zen for the Day....
"A small quantity of radioactive water has leaked from a storage tank at Japan's tsunami-crippled Fukushima Daiichi nuclear power plant, Tokyo daily Asahi Shimbun reported Saturday."
Glow worm sushi is berry usefoe.
If you drop on floor, you can see and grab it before dog or cat.
goldman is the/your evil messenger
functioning to deliver your ass
to servitude and financial slavery.
what next will they prescribe?
you see, no one cares? oh f..ing no.
a very interesting piece
This is funny. We need Lloyd to explain to us that the whole world is chasing a dwindling supply of positive yield, that is not compete crap and junk?
If the Jews say so.
The algos have spoken: no change in trend for the Bund
http://twitter.com/Intellikon/status/592483453582479360
We see the same self-reinforcing loop in oil. Oil prices drop, so guess what - more oil is bought and placed into storage. Storage increases, so prices go lower! This week we saw the reverse. Oil prices rose, so less was bought to put into storage! What am I going to do - buy $60 oil, or use the $45 oil I have in storage?
Central banks buy gov't and other debt. This decreases SUPPLY of debt instruments. Supply defecit creates intricately related market distortions that no one can figure. Central bank created credit money goes through a wormhole and emerges in hard asset speculation driving up prices. People can't spend enough because they are retiring and no entity can replace the boomers. The economy is bouncing off a financial crash that is just the beginning of a big RESET which all good ZHers know will be soon coming. Fasten your seatbelts and watch the emerging credit crunch and subsequent derivatives mess.
Madness pure madness!
Atrificial valuations = artificial results.
Tyler espouses his love of Squid statistics?