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The ECB's rules allow for the purchase of negative yielding bonds but only up to the -20 bp deposit rate. The German curve is negative for seven years, but only up to four years have negative yields near -20 bp. French rates are negative for four years, but no bond is yield is lower than the ECB's deposit rate. The Dutch curve is negative through five years, but only the 2-year note yield is below -20 bp.

One cannot draw high conviction conclusions about the pace of purchases. Of the four weeks of data, the first week was not full and the last week was interrupted by the Easter holiday. The middle two complete weeks showed the ECB buying an average of 15 bln euros of bonds a week.

One of the big concerns was that the ECB would struggle to find sellers of bonds. The first month showed little strain. European bond yields generally fell over the past month. Ironically, yields fell more Germany and France (10-year yields -23-25 bp) than in Spain, Italy and Portugal (-8, -10, 14 bp respectively).

The combination of the deflation, the ECB's negative deposit rate and now sovereign bond purchases is forcing rates negative where one might not expect to see them.  Ireland, for example, has negative yields on 1, 3 and 4 year bonds. Spain sold 6-month bills yesterday with a slight negative yield. The three month bill offers a 1 bp guaranteed loss (annualized).

When looking at the debt profile of Japan, many economists focus on the net debt rather than the gross. The net debt is the gross debt excluding the debt helped by other government agencies. Central banks are nominally independent but are part of the government. For example, many central banks remit interest payments or profits back to the central government.

As central banks buy government bonds, this distinction between gross and net becomes more significant. For example, the gross debt of the US is near 90% of GDP, but the net is closer to 67%. Similarly in the UK, the gross debt is a little above 90% of GDP while the net debt is near 63%. Japan's net debt is near 95% of GDP, but the gross debt is 235%.

Some who are opposed to QE in principle are worried not only about the distorting impact central bank activity on markets, but also because of the temptation to treat the debt central bank's balance sheet differently from other debts. From a risk and sustainability point of view, those domestic bonds on the central banks' balance sheets are not the same as private sector investors.  There are some who have suggested that central banks can ultimately forgive its sovereign debt. This seems somewhat dubious, and even if legal, could be disruptive. Others have proposed swapping the sovereign debt for perpetual zero coupon paper, which would preserve the fiction.

Marc Chandler
Global head of currency strategy at BBH
Marc to Market

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