EC Discounting Policy Errors


Historical Stock, Securities, Certificates, Fund, Bonds

The upcoming high-frequency economic data are unlikely to sway investors or policymakers. The key issue is whether price pressures are more than transitory, as officials at the Federal Reserve, European Central Bank, and the Bank of England say quite adamantly. Investors are less sanguine.  European bond yields rose to the highs for the year last week, but US rates remain soft.  After rising by nearly 85 bp in Q1 to 1.74%, the 10-year yield drifted lower here in Q2 and is averaged less than 1.65% in recent days. 

Many observers linked the rise of European yields to US rates in Q1, but here in Q2, European yields continued to move higher, even as US rates eased. The spreads over Germany have widened considerably. Last week, the Italian premium widened to nearly 123 bp from less than 100 bp when the ECB announced it would significantly boost its bond-buying under the Pandemic Emergency Purchase Program before easing back to 116 bp before the weekend as ECB President Lagarde hint at the possibility that there were not be a policy change at next month's meeting. The hawks are expected to push for a slowing of the purchases. The premium demanded from Spain has not risen as much, but like the Italian premium, it is above the 200-day moving average (over Germany) for the first time since last summer.  

A similar story is evident in the short end of the curve. The paying down of US Treasury bills, ahead of the debt ceiling waiver expiring, and as the stimulus funding is shifted out the curve, short-term US rates are soft. Three-month LIBOR fell to new record lows last week, dipping below 15 bp.The December 2021 Eurodollar premium over Euribor has fallen to about eight-month lows. The US discount to Canada on two-year money is the largest since last April.  Still, what draws some foreign investors to the US Treasury market is that one is compensated well to hedge out the currency risk (swap dollars). Under such conditions, the demand for Treasuries is not equivalent to the demand for dollars.

Indeed, it appears the low US short-term rates are forcing global investors further out on the US curve. Consider last week's TIC data. The newswires reported that China's Treasury holdings rose by $41.6 bln in March, the most since 2013. In truth, China was an even larger seller of US bills, and in fact, overall reduced overall Treasury holdings by $3.8 bln.   

It is not just China. The hedge funds that transact out of the Cayman Islands were said to boost their holdings by $34.9 bln after selling $100 bln in January and February. This is misleading. Cayman Islands' Treasury holdings finished last year a little shy of $223 bln. They fell roughly to $211 bln in January, to $204 bln in February, and $200 bln in March. Of the top 10 holders of US Treasuries, only Hong Kong and Luxembourg reported an increase.  Combined, it was about $2.7 bln compared with a $53.3 bln reduction by the other eight.    

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Read more by Marc on his site Marc to Market.

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