The Draghi Derangement: $2 Trillion Euro Government Bonds Trading At Negative Yield

by: David Stockman

That investors anywhere in this age of fiscal profligacy would pay to own the notes and bonds of sovereign states is a testament to the financial deformations of modern central banking. But the fact that nearly $2 trillion of debt issued by European governments is currently trading at negative yields——now that’s a flat-out derangement. After all, the aging, sclerotic economies of the EU have been making a bee line toward fiscal insolvency for most of the last decade.

So it goes without saying that this giant agglomeration of pay-to-own government debt is not reflective of an outbreak of fiscal rectitude or any other rational economic development. It’s purely an artificial trading result stemming from central bank destruction of every semblance of honest price discovery. In this case, the impending ECB purchase of $70 billion of government debt and other securities per month for the next two years has transformed the financial casinos of Europe and elsewhere into a front runner’s paradise.

As today’s Bloomberg piece tracking Europe’s $2 trillion of exuberant irrationality makes clear, sovereign bond prices are soaring because traders are accumulating, not selling, in anticipation of the ECB’s big fat bid hitting the market in the weeks ahead:

“It is something that many would not have pictured a year ago,” said Jan von Gerich, chief strategist at Nordea Bank AB in Helsinki. “It sounds very awkward in a sense, but if you look at it more, the central bank has a deposit rate in negative territory, and there’s a huge bond-buying program coming. People are holding on to these bonds and so you don’t have many willing sellers.”

Needless to say, this is the opposite of at-risk price discovery; it amounts to shooting fish in a barrel. Never before have speculators been gifted with such stupendous, easily harvested windfalls. And these adjectives are not excessive. The hedge fund buyers who came to the game early after Draghi’s “anything it takes” ukase have enjoyed massive price appreciation, but have needed to post only tiny slivers of their own capital, financing the balance at essentially zero cost in the repo and other wholesale funding venues.

Indeed, the more risk, the bigger the windfall. German yields have now been driven below the zero bound on all maturities through seven years, emboldening speculators to move out on the risk curve. So doing, they have gorged on peripheral nation debt and have been generously rewarded. In the case of the 10-year bond of Ireland—-a state which was on the edge of bankruptcy only a few years ago—-leveraged speculator gains are now deep into three figures.

And there is nothing mysterious about the bond math which caused such munificent returns. After peaking above 12% at the time of the crisis, the Irish bond has rallied with nearly maniacal energy and has now broken under 1%.

And, no, there has not been an Irish miracle since the dark days of 2009-2011. The suggestion to that effect, in fact, is just one more manifestation of the corrupted Keynesian narrative promulgated by the central banks, their accomplices in the finance ministries and the EU and IMF—along with the Cool Aid purveyors in the MSM.

In fact, Ireland’s real GDP is still 4.5% below its 2008 peak level. All the current MSM cheerleading is about last year’s 3.5% rebound, but that’s just context-free Keynesian jabberwocky. Ireland was so deep in the hole that it needed double digit gains to get back on track and have any prospect of growing out from under its gargantuan debt. But the fact of the matter is that as of Q3 2014, Ireland still had recovered only about 55% of the GDP lost during its financial crisis plunge.

It does not take much reflection to recognize that neither the ECB nor the apparatchiks in Brussels have repealed the business cycle. Nor have they built a moat around Europe to shield the eurozone economies from the gale-force deflationary headwinds now emanating from China and the EM generally. So why is it reasonable to think that Ireland’s GDP will grow at 3.5% forever, world without end?

In fact, there will be another macroeconomic dislocation one of these quarters. There always is, and most especially in a global economy that has been artificially bloated and distended by the greatest spree of central bank monetary stimulus in human history. Yet none of these palpable risks are visible to Europe’s financial suzerains because the rosy future they continuously posit beyond the next quarter is based on pure hopium.

By contrast, what will actually happens around the bend does not take too much imagination. For all the excitement about Ireland’s so-called “recovery”, its debt-to-GDP ratio has not even budged since its crisis era eruption.

It is to be wondered. Can these Keynesian dream walkers say interest rate normalization? In a normalized world, Ireland’s public debt will generate a 5-7% of GDP interest burden.

Any effort to off-set that through steep tax increases or deep welfare state retrenchment will unleash a Syriza style political upheaval focused on the devastating truth behind Ireland’s phony turnaround. Namely, that the Irish debt has no sustainable political legitimacy because it was forced on the Irish government at gunpoint by Brussels in order to save Ireland’s insolvent banks—along with the British, German, French and other Eurozone institutions which had gorged on Irish paper during the earlier “Irish miracle”.

In short, the sub-1% yield on the Irish 10-year note is an economic travesty. It fails to encompass the outright certainty that Ireland cannot grow out from under its debt at any time soon; and that it will eventually—likely sooner than later—-experience another macro-economically driven fiscal crisis that will bring default risk to the doorstep of its privately traded debt.

Let’s see. What sentient “investor” in Ireland’s privately held government debt, who might be alert enough to notice Tsipras and Varoufakis twisting in the wind, wants to be “primed” by Herr Schaueble and his assigns and successors? That possibility alone is enough to justify several hundred basis points of “risk” margin in Ireland’s bond yield.

And that’s not the half of it. How is it possible to believe that the risk the euro will experience a disorderly break-up has been reduced to zero? Yet that’s exactly what is priced into eurozone debt.

As Bloomberg further noted, 88 of 346 European sovereign debt issues tracked in its index are now trading a negative yields. Throughout the periphery—-government debt trades at zero risk of a euro break-up in the midst of a Greek debt crisis that manifestly will end-up in “grexit”. There is positively no sustainable solution—beyond a few more rounds of kick the can for two weeks— that can bridge the yawning gap between Greece and its German paymaster.

Even when investors extend maturities, and move away from the region’s core markets, returns are becoming increasingly meager. Ireland’s 10-year yield slid below 1 percent for the first time this week, Portugal’s dropped below 2 percent, while Spanish and Italian rates also tumbled to records.

In fact, the political foundation of the eurozone is already on its last leg—–as is evident in the utterly obsequious posture of the quasi-bankrupt governments of Portugal and Spain with respect to Greece’s pleas for relief. The latter were the most vociferous opponents of relief at the EC meeting— remonstrating even more Germanically than the Germans—–owing to the transparent fear that even a tidbit of justice for Greece would mean a swift ejection from the seats of power by their voters in favor of Syriza-style insurgents.

And now comes word that a third Greek bailout in the range of $50 billion is being cooked up in Brussels. And within this absurd new mountain of debt, approximately $17 billion of the subscription would be on the accounts of Portugal, Spain, Italy and Ireland.

C’mon! What remains of democracy in the EU will bring about a euro shattering crisis long before the deflation-bashing Keynesians and statists in Brussels and Frankfurt can figure out what is hitting them.

Needless to say, when the eurozone does crack-up, today’s $2 trillion of negative yielding government bonds will undergo a spectacular collapse. It will become known as the bonfires of the subprime sovereigns.

Nor will the German issues among the 88 negative yielders escape the day of reckoning. German business—especially its independent mid-sized firms—is self-evidently a force to be reckoned with. But the German economy was only recently the sick man of Europe and its statist interventions and taxes are less onerous only compared to France and the rest of the enterprise-killing European social democracies.

At the end of the day, Germany has enjoyed a modest economic expansion since 2008 only because it has been able to export its high value industrial engineering and consumer performance products to the credit driven booms in China and southern Europe. As these egregious bubbles deflate—-so will Germany’s red hot exports and temporarily superior economic growth trend.

The prospect that German’s export machine will stumble badly in the coming years in itself makes a mockery of the ludicrously low 35 bps yield on its 10-year bond. But the speculators who are piling into it anyway on the basis of Draghi’s impending big fat bid need to riddle us this.

Who will get stuck with the multi-hundred billion eurozone bailout guarantees when the rest of the EU walks? To save its credit, the one word Berlin will not be declaiming is nein!

Mario Draghi will surely prove to by one of history’s greatest monetary villains and cranks. Back in July 2012, the euro was already well beyond rescue, and the PIIGS needed an exit—-orderly or otherwise—from the debt chains they had undertaken during the original euro boom.

But in three destructive words, Draghi crushed price discovery for the duration. So doing, he led the eurozone into the insanity summarized in today’s Bloomberg post: Euro-Area Negative-Yield Bond Universe Expands to $1.9 Trillion – Bloomberg Business.