Daily Archives: January 17, 2011

Research from the Bank of Japan argues that we are seeing a multiplier effect in capital flows between emerging markets and the US, and its reversal could cause a very sudden upward correction in US government bond prices.

The argument runs along these lines: investors seeking high returns have caused large capital inflows into emerging markets, causing forex intervention and leaving governments with stockpiles of US dollars. Those dollars are then invested in US treasuries, reducing the yield and making it cheaper for US investors to borrow – and to seek high returns in emerging markets. Repeat.

While no direct mention is made of the Fed’s recent $600bn stimulus, 

€2.3bn government bonds bought by the ECB settled last week, taking the emergency assistance back up to levels last seen during the Irish bail-out. Many of the bonds bought are likely to have been Portuguese, in particular during its debt auction on January 12 at which bond yields fell.

The value of bonds settling last week was 20 times that of the week before. Yields have been extremely volatile of late in struggling eurozone economies, including the “periphery” and Belgium. The cost of Greek and Portuguese debt is still falling following the latest interventions and market-calming discussions, but yields in Spain, Italy and Belgium are all rising once again.

Serbia has raised its benchmark rate to try to counter inflation, which is running more than four percentage points above target. The modest rate rise takes the two-week repo rate half a percentage point higher, at 12 per cent.

This rate increase is smaller than its two most recent predecessors, which have each added a full percentage point to the repo rate. 

An ECB council member has pointed out the possibility of bond-buying duties shifting entirely to Europe’s rescue fund. “That would be one way to have additional flexibility that at times might be found useful,” Cyprus’ central bank governor Athanasios Orphanides told Bloomberg. Senior French officials say they back the plan, though Germany – the fund’s biggest contributor – remains reluctant.

The six AAA-rated euro member states are apparently meeting to discuss the rescue fund in advance of a wider eurozone finance ministers meeting this afternoon. As well as changing the fund’s mandate to allow the purchase of bonds, one change under consideration is simply to increase the reserves at the fund’s disposal. But Austria’s finance minister has called instead for efficiency improvement and sees no “acute” need for an enlargement, while Slovakia’s PM would prefer an increase in the ECB‘s capital, saying such a move would be “more systematic”.

The EFSF can call upon €440bn at present – a sum inspiring “shock and awe” initially, but now considered “too small“. But in practice only about €250bn could be drawn down without risking a downgrade to debt issued by the facility. One way to tackle this, as FT Alphaville pointed out today, would be to accept a downgrade for the fund’s debt. That way, all €440bn could be used. Alternatively, the EFSF could issue tranches – debt with different ratings.