Way back in June we documented the “curious” case of Sweden’s broken QE and when we used the term “broken”, we didn’t just mean that inflation expectations weren’t moving higher. We meant that bond yields were rising and the SKE was strengthening.
How was this possible, you ask? Simple. In the minds of market participants, the expectation of further price appreciation thanks to Riksbank purchases was outweighed by the risks associated with falling liquidity and a lack of market depth. Put differently, any incremental bond purchases will start raising yields as the adverse impact from the illiquidity "premium" surpasses the price appreciation benefit from frontrun central bank buying.
Here’s what Roger Josefsson, chief economist at Danske Bank in Stockholm told Bloomberg at the time: “The financial conditions -- the currency and the bond yields -- are moving in the wrong direction. The assumption is that the Riksbank wants yields to go down and the krona to weaken, but it’s been the opposite direction recently. That should pose a problem. Swedish rates continue to trade strong relative to Germany because of a lack of material in the repo market as a result of the Riksbank’s QE program.”
Of course all types of bad things can happen when you start impairing the functioning of the repo market and although the above clearly represents an abrupt transformation of the virtuous QE loop into a very non-virtuous, self-defeating death spiral, the Riksbank went and doubled down less a week later, driving rates further into NIRP and expanding QE.
As we said at the time, the explanation for this apparent insanity is with the ECB and the BoJ still in full-on easing mode, the Riksbank can’t afford to be left behind in the race to the bottom, because if the krona moves higher, inflation targets won’t be hit.
This is the same reason we said the Riksbank was taking a big risk to remain on hold in early September just hours ahead of an ECB decision which some market participants thought might include the announcement of more QE.
Well, don’t look now but the Riksbank looks set to “solve” the broken QE problem and by extension ensure it can stay in the currency war games by expanding the list of eligible assets to muni bonds. Here’s Bloomberg:
Swedish central bankers are now looking at the country’s 240 billion-krona ($30 billion) municipal bond market as a possible channel for further stimulus as its debt purchases risks distorting trading in government debt.
Riksbank Deputy Governors Martin Floden and Cecilia Skingsley on Tuesday said expanding purchases to also include municipal bonds could be an option if further measures are needed to lift inflation. Both said an even more expansionary monetary policy may be required as risks abroad are increasing.
While rates can be cut further and bond purchases expanded, “there’s of course a floor for the repo rate and a ceiling for the purchase of bonds,” Floden said. The “aim after all is to get inflation up in an orderly manner.”
Extending purchases to also include municipal bonds would add a market of 230 billion to 240 billion kronor of krona-denominated assets, according to Charlotte Asgermyr, an analyst at SEB in Stockholm. The Riksbank could probably spend some 50 billion kronor on purchases of municipal bonds, she said.
Jussi Hiljanen, head of fixed income strategy at SEB in Stockholm, said the Riksbank may have to start looking at other assets as any further extension of government bond purchases could start hurting how the market functions.
The “purchases have reduced liquidity in the market quite a lot and from that perspective, it’s becoming rather limited in terms of how much more it can buy,” he said by telephone on Tuesday. “The next step if the Riksbank would need to extend bond purchases would be to buy other assets and in such a scenario, it’s municipal bonds that would be very, very relevant.”
But the irony here is that although the ECB didn't announce an outright PSPP expansion in September, what Draghi did do is give the central bank a bit more breathing room by raising the issue share limit from 25% to 33%. And don't forget that going forward, nothing says the ECB won't ultimately become more generous in determining what ultimately counts as a "monetizable asset." And don't forget: the ECB already buys agency paper (i.e. assets other than sovereign debt). In other words, the Riksbank is already behind the curve.
In the end, none of this matters. That is, because this a never-ending race to the bottom that requires central bankers to remain wedded to beggar thy neighbor policies, all that will happen here is that the Riksbank will be forced to monetize more and more muni bonds until the functioning of that market is impaired too. Ultimately, central banks will enslave and subsequently break every market they can in an effort to avoid the situation the Fed is now in (i.e. headed towards policy divergence with the rest of the DM world) until there are no more monetizable assets left anywhere.
And because it is now obligatory when it comes to Sweden...