Where finance and media intersect with reality


In the Blind Spot (Germany, Finanzagentur, Andrew Bailey)

Screenshot 2022-10-24 at 08.46.22

Business, Finance, Markets etc:

  • German parliament approves giant fund to tackle energy crisis.

    If the UK bears a “moron premium” consider the degree to which Germany [exposed to the same degree of inflationary and stagnation risk] potentially carries an “obfuscation discount”.

    If I were an investor I would be more focused on what has not been priced into the European picture, not what has been overly priced into the UK. Why should Germany’s massive spending spree be forgiven but not the UK’s?

    In an energy-constrained and inflationary world, it is Germany’s economic model that faces the gravest existential risk. Unlike Germany, the UK has the power to reinvent itself and flourish in a global digital nomad world that values not just English speakers but the entire “as a service” concept. A devaluation of the pound, meanwhile, can help the UK better sell its digital services abroad. No matter how cheap the euro gets, German-speaking washing machine support staff simply aren’t going to cut it in Asia.

    The UK government budget, meanwhile, can also be buttressed by sovereign creativity and financial repression to alleviate the worst effects of the crisis and put off austerity. Everything from the issuance of perpetual sovereign “Elizabeth” bonds or NFTs to regulatory capture which forces domestic institutions to load up on gilts can make a difference. But what options will ordoliberalism have with its fear of anything uncosted or potentially inflationary?  Why wouldn’t the prospect of Germany attempting to dodge the same sort of austerity it wanted to impose on Greece and the other periphery states spook the markets to an even greater degree given its historical baggage? How will the market cope when the supposed anchor to Eurozone stability suddenly turns profligate? That is the shock that needs guarding against.

    What’s more, the data is already looking shaky. As Politico reports, the Eurozone’s current account balance (largely supported by Germany’s industrial largesse) registered a record deficit of 50.9bn in August. The trade deficit for the EU as a whole spiraled to €64.7bn. – IK

    Here’s the chart:

  • Weak demand for Bunds has reached beyond tipping point and the press release that has changed everything for Germany.

    If ever you needed further evidence that the UK bond market hissy fit was mostly a canary in a coal mine ahead of potentially much graver events in Europe here it is.

    As the OMFIF notes, October’s seven-year bund sale failed to cover half its issuance:

    “Lacklustre demand for Bunds is not something new. As the most expensive bonds in Europe, they have always been a tough sell, but their safe haven status and scarcity value have made them a must have for investors. But recent transactions by Germany’s Finanzagentur show demand is not just lacklustre, but extremely weak. On 18 October, the sovereign received bids of just €1.9bn for the issuance of a new €4bn seven-year Bund – making the deal less than 50% covered and having Germany’s second lowest bid to issuance ratio, according to analysts at Commerzbank.

    Germany suffered again in the public market last week with the sale of a new 30-year Bund via syndication, which was sized at €4bn rather than €5bn-€6bn that the market had been expecting. The deal subsequently seriously underperformed in the secondary market.”

    Even more significant, however, is news that the Finanzagentur — the equivalent of Germany’s DMO — has announced that it will tap 18 outstanding bonds by €3bn each, to use in the repo market so it has additional flexibility to cover its huge energy crisis financing needs.

    The context here is important. When technical issues manifest in liquidity markets, central banks deploy so-called open market operations to soothe temporary imbalances that risk escalating into liquidity crises. Their preferred intervention comes by way of repo markets. If the problem is one of insignificant liquidity in the market, the solution is easy. Central banks purchase securities from the market with self-generated cash liquidity. But if the problem is one of too much liquidity, they need to absorb that liquidity either by selling debt securities back into the market or by lending securtities to the market (a scenario that is analogous to the government borrowing cash liquidity from the market in exchange for bond collateral).

    What people seem to have forgotten is that from the earliest days of QE it was well understood that the greatest risk of inflationary impact from the extraordinary policies would be at the exit/unwind point — i.e. the point that it became necessary for central banks to start offloading their inventory back into the market. This is why the Fed ran endless test scenarios with money-market funds, helping them to park their cash in short-term securities in exchange for better-than-market interest rates.

    Of course, those tests were occurring in the context of a shortage of safe assets and negative market interests rates. Who wouldn’t want to lend money to the central bank at zero when everyone else was asking you to pay them for the privilege of converting your cash into the safety of a government-backed collateral exposure?

    But that is not the case anymore. Now we have a market that is increasingly sceptical of sovereign debt and excessive government budgets. That means markets, not the central bank or government, will drive the clearing rate of such transactions. In so doing, they will seek ever greater compensation to avoid being inflated away. If central banks and governments fail to deliver the rates demanded, the liquidity will instead keep sloshing through the system until the private sector delivers the rates needed to lock it up or direct it where it is needed. [In the current scenario the sector most likely to compete with the government should be the energy sector, due to the prospect of guaranteed windfalls. Unfortunately, growing financial repression means even that’s not going to happen. In that case, the liquidity has no choice but to move abroad to the jurisdiction least likely to stifle investment opportunity. This is why the appreciation of the dollar is occurring. But who knows, if Biden also moves to repress the energy sector there, that liquidity might be inclined to flow to China or even crypto – especially if someone was to launch fusion-coin.]

    But it’s potentially even worse than that. The general assumption underpinning QE exits was always that the motivation for central bank QT or reverse repos was to absorb and extinguish the liquidity outright. But we are now in a position where governments actually need that liquidity themselves, meaning the chances of it being extinguished is falling rapidly. In the UK, these forces have already seen QT offset with technical OMO-style QE to ensure the UK government can keep borrowing at a favourable rate.

    But in places like Germany, where the Bundsebank has a unique structural arrangement with the Finanzagentur when it comes to open market operations, this could in theory allow for some stealth government financing.

    In the UK OMOs are carried out by the still just-about independent central bank, meaning any liquidity absorbed remains in the control of the central bank. If the BoE was to run out of assets to repo (which given it has plenty of them is unlikely), its next recourse would be to the DMO’s special and standing gilt facility. The DMO has the power to generate de facto lookalike gilts that are needed in the market to ease market conditions. But (as far as I understand) the financing generated through this mechanism is absorbed immediately by the central bank. It does not go to the Treasury at any point.

    In Germany, the Finanzagentur has no such power. Instead (as far as I understand it — and I would be keen to hear from any experts who can expand on my knowledge here) it holds back a certain tranche of any issuance it brings to market in a sort of limbo reserve in case it needs to be used in OMO operations one day. I’m actually not sure if it’s the Bundesbank or the Finanzagentur that conducts the OMOs, but the act of putting the securities into the market financialises the reserve on behalf of the German Treasury. It is, therefore, the easiest way to generate extra additional revenues for the public purse.

    The Finanzagentur has now announced it is adding an extra €54bn to those OMO holdings, meaning (I think) that the previous reserves must have been tapped out. *UPDATE* JC Kommer suggests that’s unlikely. German law says no more than 20 per cent can be held in own holdings in an issue. That means the latest move is merely increasing held back sums from 9 per cent to 13 per cent.

    I suspect this is what the reference to the Finanzagentur intervention (press release linked) in the OMFIFF report is all about. And why the market is finally beginning to focus on Germany.

    The added problem for everyone is that the Finanzagentur is one of the least user-friendly data providers in the world and despite many years of trying, I’ve never properly worked out how it manages its data or what determines its capacity to tap these theoretically reserved sections. Join us for Spot Markets Live today at 11am UK time to discuss further.

  • Philip Pilkington argues in The Spectator that the UK’s troubles were not caused by Truss and Kwarteng’s economic decisions.

    I obviously agree with Pilkington on the UK. Also, In terms of who is really to blame for the UK bond-market fiasco, the lack of scrutiny in the mainstream press over the role of Andrew Bailey, governor of the Bank of England, is infuriating. There are three things that need to be remembered about the bond panic: 1) As Albert Edwards, of Socgen reminds us, it happened the week the BoE decided to double down on QT. As Albert has noted in a Tweet:”Gilts were stable for a week before the budget as 90% of the measures were already factored in,” he noted in a Tweet. “Gilts started their collapse the day BEFORE the budget as the BoE reaffirmed aggressive QT. We have no idea how much of the collapse was due to QT, LDI or the budget.” 2) The Bailey was the one who denied inflation was a thing. 3) When Bailey finally realised inflation was a thing he talked it up not down! His comms are WORSE than those of Truss!

  • The Economist’s piece on the multifaceted economic winds buffeting housing markets.
  • Average long-term rates for mortgages in the US rise to 6.94 per cent.
  • In an ominous sign for the American housing market, almost 60,000 real estate deals were cancelled in September.
  • French rail worker strikes mean US crude is not entering France for the first time in four years.
  • CNBC supply chain heat map shows that china is losing manufacturing and export share to neighboring Vietnam, Malaysia, Bangladesh, India, and Taiwan.
  • How the increasing power of asset managers may have changed the structural nature of western economies.
  • Elon Musk’s fortune has fallen by more than $100bn in a year.

WW3 Watch:

Commodity Watch:

  • The Helium shortage never went away.
  • A good explainer on what is going on in the TTF gas market and why the price falls were predictable, but don’t mean the crisis is anywhere near over.
  • The German government has guaranteed an €800m loan for commodity trader Trafigura.

Miscellaneous Intrigue:

Covid is Not Over:


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