Getting Shorty

Hey Draghi, Is the ECB All About Germany?

Bundesbank's short-end hoarding is making life difficult for everyone.

European Central Bank President Mario Draghi is set to preside over a lot of nothing happening at Thursday’s policy meeting. This would be a missed opportunity.

Bundesbank actions are worsening already-dangerous inefficiencies in European markets, and undermining the impact of the ECB's bond purchases. Draghi has to demonstrate that his Governing Council is not controlled by the Germans. Financial creativity at the ECB played a major part in helping Europe navigate through its crisis. It is time again for some blue-sky thinking to balance out the playing field.

While French bond spreads widening to Germany have caught a lot of attention, this is a two-way process. It's not just that political fears have driven sellers of French government bonds, but demand for safety and for top-quality collateral has fueled a headlong plunge into German bunds, particularly in shorter maturities at increasingly negative yields.

How Low Can you Go?

Swiss, Czech, Danish central banks may have joined Germany in short-end buying

Source: Bloomberg, Commerzbank

This has been led by a Bundesbank that's seemingly driven to lower the average maturity of its QE holdings in order to be able to exit the whole program at the soonest possible date. Its February bond purchases show a sharp drop in average maturities to just 4.3 years from 9.4 years in January, according to Credit Agricole. At that average, yields are below the ECB's minus 40 basis points deposit level, so to achieve that they had to have been buying paper substantially negative in yield.

This is a big reason why the 2 year Schatz approached a record low yield of minus 0.96 percent last month. This makes life harder for pretty much everyone within the region's banking system -- it raises the costs for national central banks to buy their own bonds back, and commercial banks struggle to operate when interest rates are upside down. It is hard to see who benefits from this ram-raid -- besides, perhaps, Germany

Furthermore, the Bundesbank released less than 5 million euros ($5.3 million) of its bund holdings for use by repo market counterparties over the year-end, a paltry amount given that the region is mired in the worst collateral crunch in the history of the common currency. That is being deliberately intransigent and worsens liquidity strains from such a large-scale purchase program removing so much government debt from the market.

Bundesbank Gets Shorty

Sharp drop in weighted average maturity of QE purchases

Source: RBS, Credit Agricole, Bloomberg

Political, technical and legal issues prevent the ECB from preventing what looks like a repeat of December's repo collateral squeeze at the end of the current quarter, Reuters reported, citing unnamed sources.

The legal and technical detail could have been sorted out long ago as the ECB has surmounted trickier obstacles before. If there is a political will there is a way, and this is the nub of it. The ECB seems to have political reasons for not addressing these market strains, and is allowing one national central bank -- the Bundesbank -- to complicate life for everyone else.

It's not just in the plumbing of Europe's financial system where Germany's creating trouble -- it's also the driving force for the planned tapering next month of the Public Sector Purchasing Program to 60 billion euros from the current 80 billion euro monthly pace. That direction of travel is coming too fast for the weaker members. Losing central bank support for yields poses a real risk that they'll shift materially higher, a rerun of the 2011 crisis.

How Cheap It Is To Fund Like This

Only maturities beyond 5 years yield above the ECB deposit rate of -40bps

Source: Bloomberg, Credit Agricole

The PSPP is also running out of Irish and Portuguese bonds to buy, hampering the ECB's ability to deliver support where it is needed. ECB officials have mentioned tackling this problem through temporary deviations from the capital key, which is the share each euro-area’s national bank buys weighted to its GDP, to allow a greater share of purchases in the periphery. But what's needed is aggressive and permanent change. It's hard to shake the feeling that if the Germans supported this, it would have happened by now. 

Draghi will not resolve matters by letting them slide until June. Risks abound in the meantime, including from Dutch and French elections, and the U.K. triggering Article 50. Come on, Il Maestro, time to razzle dazzle us.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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