For years it was uncontested convention that the lower the rate the better. Stimulus was, after all, intended as a borrower boost. Make the cost of adding debt low and lower, then it was assumed borrowers would borrow more than they otherwise might have with recovery the promising result. Every time rates went lower, the common refrain of “stimulus” went up.

All that changed in the “global turmoil” of 2015/2016. To begin with, central bankers never did answer for why rates went lower more so without QE than with it (so-called term premiums, too). In fact, the most cursory review of bond markets all over the world shows handily that lower rates almost always coincide with the worst sets of circumstances, economy as well as money. It was a way to ensure a credibility crisis as much as anything; you can’t just label all lower rates “stimulus” and expect the coincidences of negatives to be ignored forever.

This year has been different alright, but not in any of the ways it was supposed to have been. Throughout 2015, and even right up until the end, punctuated almost perfectly by the Federal Reserve voting to “hike rates” on the same day its IP statistic turned negative for the first time, weakness was loudly proclaimed “transitory”, a soft patch through which only time was necessary. From that view which prevailed incessantly in the mainstream, the global economy would quickly rebound in 2016 as sure as the unemployment rate in the US indicated full employment.

Having instead witnessed and experienced a continued and in many places continuing downside still, the possible end of credibility was by mid-year this year in sight. Some light soul searching was offered, but mostly in the form of questions. The linkages between monetary policy and actual economic functions had never been well understood and for the most part taken for granted. But in the past before 2016 those missing pieces were never discussed publicly, and certainly not in the context of active monetary programs like QE.

It was never that simple, and now policymakers are beginning to admit it. There is a vast array of processes and complexities starting with money itself that can and has intruded into the mix of turning what is supposed to be stimulus into fruitful recovery. The character of interest rates as they actually are is one of those, if not the biggest one. Low interest rates may not have been so “stimulative” as they were made out to be, especially where the yield curve and embedded time value, the most essential elements of modern finance, shriveled so far into unrecognizable bearishness. Curves matter, but really they have always mattered it’s just that policymakers are for the first time starting to see why.

The Japanese were first, but you have to believe that this was a topic of blanket discussion throughout Jackson Hole in August. It is not random coincidence that the Japanese in September announced explicit “yield curve control”, or at least the so-far unsuccessfully tested intentions for yield curve control, in lieu of additional QQE and then today the ECB adopts a similar approach. I wrote at the time that the gathering in Wyoming was unofficially titled, “How Do We Get Ourselves Out Of This Mess We Created?”, and now I think we are starting to see their first attempt at an answer.

Most attention has been focused on the tapering of the pace of QE starting in April 2017 (from €80 billion per month to €60 billion). That focus isn’t wrong, but unappreciated perhaps in the mainstream is the other parts of the announcement. The parameters for the bond buying were changed so that the various NCB’s could buy down to 1-year paper, a maturity range of 1 to 30 years rather than 2 to 30 years. In addition, the Governing Council changed the language on money rate adherence, where before NCB’s were forbidden from buying any securities with yields below the deposit rate floor (currently -40 bps).

In actual operative function, yields have been persistently below that level anyway in so many bonds there never was spoliation risk to begin with as it related to the preservation of the money corridor (which is, as I have to point out regularly, now a complete joke). But by allowing that short bias in addition to the maturity softening, the ECB has effectively copied the Japanese in what looks like a strong “steepener” trade.

There are, of course, several problems that immediately come to mind. The first is the same as when always-lower interest rates were called stimulus no matter what; is the economy and are economic agents so financially illiterate so as to not appreciate the difference between a yield curve that is steep because of true recovery and one that is artificially steep because of intrusiveness? The sordid history here of bond curves proves all-too-well just who has been monetarily uneducated.

Just as bond market participants understood the difference (over time apart from the few exceptions based on risks, such as 2013) between actual rate stimulus (liquidity effect) and low rates due to persisting economic deficiency (income effect), I doubt very much that any new attempts to instead manipulate just the yield curve shape will provide anything more than entertainment as markets adjust to whatever yield curve effect might arise. The standard of interpretation will just shift, as it always does (i.e., if 50 bps in the 2s10s used to be cause for concern in German bunds, bond market investors will realize instead that the 50 bps threshold is now set at 70 bps if it is determined that the ECB’s “steepener” has added 20 bps to the yield curve). That’s already happened to some extent in Japan, where JGB 10s aren’t supposed to be above 0.0%, yet they are and have been (+4 bps today).

The bigger risk relates to the current infatuation with “reflation.” As I write for my RCM column tomorrow (preview):

I believe that one of the interpretations of all this from the “market” perspective is that there has been a belief going back to July and the Bank of Japan “helicopter” rumors that finally this official admission that QE didn’t work would lead to the next set of “stimulus” which would then produce the full recovery and normalization that the last set based on balance sheet expansion did not. This expectation or just hope, I believe, is what has been underwriting this “reflation” dream that has swept the world of late…


The primary danger to it is not that central banks might disappoint in that next round of “stimulus”, but rather that there won’t be a next round at all.

Certainly some reflation expectations are being driven by factors other than monetary policy, fiscal spending and more friendly regulatory/tax agendas, but I don’t think it is coincidence that all this got started in July with the BoJ. There is, in my view, a heavy belief in these markets that central banks can do a great deal if they ever stopped being so stubborn about past policy regimes. This year, for the first time, they did.

But yield curve targeting is not likely to be what was in mind. It was, after all, rumors of the “helicopter” that first ignited “reflation.” What the BoJ and now ECB have offered is not actual money printing, quite the opposite in many ways, just more and different financial manipulation. That was all QE ever was no matter how many people believed otherwise, and to simply replace one form of manipulation with another isn’t actually, meaningfully different.

In the realm of “How Do We Get Ourselves Out Of This Mess We Created?”, it doesn’t seem as if they yet have any actual answers. In the department of the smallest silver linings, at least central bankers have finally been introduced to curves. For the global economy, it remains a highly negative signal that central bankers used the last seven years of global depression just to arrive at Finance 101.

ABOOK June 2016 Bund Curve Shrivels ABOOK June 2016 Bund Curve UST