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ECB submerges German Bund Yields, helps Cap US T-Note Yield


Feb 28, 2017

     After only 10-days on the job; the Trump administration didn’t wait too long to fire off the first shot in what might become a series of volleys in a protracted currency war over the value of the Euro vs the US$. One of Mr Trump’s top trade advisers, Peter Navarro accused Germany on January 30th – of using a “grossly undervalued” Euro to “exploit the US and its EU partners in foreign trade,” in a piece published in the Financial Times newspaper. Navarro, now in charge of Mr Trump’s new National Trade Council, cited “Germany’s structural imbalance in trade with the rest of the EU and the US.” In terms of trade, Germany broke its own record in 2016 – when it collected a net $300-billion more from selling goods and services to other countries than it spent on imports during the year, and giving it a bigger trade surplus than China’s bonanza.

     By abandoning the old Deutschemark and switching to the Euro, Germany is using a currency that is priced much lower; at around $1.06 today, versus the US$, compared to the D-mark which according to economists, would be trading closer to $1.500; if still used as an independent currency. As such, Germany’s decision to abandon its old currency in favor of the Euro is in essence, a disguised devaluation. The Euro is far weaker today than the Deutsche Mark would have been, and in turn, its been a boon for the country’s exporters.

     Over the past five years, Germany’s current account surplus has almost doubled. Berlin has been accused of not doing enough to increase its imports while having such a sizable trade surplus, and in October 2016, the US Treasury added Germany to its currency monitoring list, because of its massive current account surplus. Germany’s own Euro zone peers have accused it of slowing the currency area’s recovery in the process.

     Trump’s nationalist rhetoric, poses an existential threat to an export-based economy like Germany’s. Berlin is terrified by the prospect that these same nationalist forces will gain control of governments in France or Italy in upcoming elections. Additionally, Germany worries that Trump’s attack against the cheap Euro might encourage other Euro zone members to re-think their participation in the 19-member currency bloc.

      In his inaugural speech on January 20th, Trump said he would be putting “America first” in all his dealings with other nations, and portrayed the world’s biggest economy as ravaged by the consequences of weak borders, unbalanced alliances and bad trade deals. “For many decades, we’ve enriched foreign industry at the expense of American industry, subsidized the armies of other countries, while allowing for the very sad depletion of our military,” Trump said. “We’ve defended other nations’ borders while refusing to defend our own.” Should the Trump administration try to single out Germany, it would have to successfully argue that Berlin is supporting German exporters unfairly and then slapping countervailing duties on German exports.

     However, the primary mechanism that is used by the European Central Bank <ECB> to keep the Euro’s exchange rate submerged below $1.10- is it radical bond-buying scheme, dubbed Quantitative Easing or QE. Over the past two years, the ECB has injected €1.65-trillion into the world money markets, under the guise of its QE-scheme. The ECB now owns €3.8-trillion of Euro-zone bonds, or 36.4% of the total Euro-zone’s GDP. The ECB also owns €59-billion of corporate bonds, or equal to 10.2% of the total €575-billion in European corporate debt outstanding.

     Under its current plan to buy a total of €540-billion of Euro denominated bond thru the end of December ’17; the ECB is expected to buy around €80-billion of German notes by year-end, and as a result traders are front-running the ECB. They’ve driven the yield on the German 2 Year to a new all time low of -0.95%. In turn, the yield on Germany’s 7-year note fell to minus -32-basis points last week. Earlier today (March 28), Berlin was able to sell €4.1-billion of 2-year schatz notes at a yield of -92-bps; which means the buyers of the note must pay €72-million per year of interest to the German government, for the privilege of owning short term German debt. Who is crazy enough to buy negative yielding debt and on the hook to pay interest to the German government? The ECB.

     Ironically, the ECB’s QE and Negative Interest Rate Policy <NIRP> is also helping the US Treasury to sell its debt at artificially low interest rates. Sub-zero yielding debt in the Euro-zone makes higher yielding US Treasury notes to look relatively more attractive. In turn, the recent drop in Germany’s 7-year yield to -32-bps last Friday, has helped to put a lid on the US’s 10-year T-note yield at 2.60% in recent weeks.

     If the Trump Trade team wants to see a stronger Euro versus the US$ in order to boost US-exports, it must understand the dire consequences. In order to boost the value of the Euro, the US Treasury would have to exert pressure on the ECB to wind down its QE-liquidity injections. However, the ECB’s withdrawal from QE and NIRP could lead to sharply higher interest rates around the world. The money creation coming off the printing presses at the Bank of Japan <BoJ> and ECB amounting to roughly $165-billion per month; – dubbed; “global helicopter money,” is being used indirectly, via spread differentials, to create artificial demand for US Treasuries.

     The US ‘s 10-year T-note yield rests at 2.40% this week, because the ECB and BoJ are buying $165-billion /month of their own bonds with JGB’s yielding +10-bps and German Bunds yielding +20-bps. Without that financial repression, both bond and stock markets worldwide could sink and produce a selling panic of significant proportions. In order to prevent bond yields from spiraling sharply higher and triggering a global economic recession, the big-4 central bankers might be trapped in a QE-forever cycle. “Germany is a country that has always called for the European Central Bank to pursue an independent policy, just as the Bundesbank did before the Euro existed,” Merkel said on Feb 2nd in response to Trump adviser Peter Navarro. “We will not influence the behavior of the ECB,” she added.

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