The Great Disconnect – Central Bank Driven “Markets” Have Nothing To Do With Economics

The German bund yield is soaring like a rocket today. After touching on the truly lunatic rate of 5 bps only a few weeks back, it has just crossed the 60 bps marker. Needless to say, when a blue chip 10-year bond widely held on @95% repo leverage moves that far that fast—–there is some heavy duty furniture breakage happening in fast money land.

But don’t cry for the bond market gamblers. They already made a killing front-running the ECB.  During the 16 months between January 2014 and the April peak, speculators in German 10-year bunds would have made a 350% profit using essentially zero cost repo funding. So in the last few days they have given a tad of that back while making a bee line for the exit.

BUNL data by YCharts

Yet during the uninterrupted march of the bund into the monetary Valhalla depicted above, how many times did you hear that the market was merely “pricing in” a flight to quality among investors and the dreaded specter of “deflation”. That is, what amounted to sheer lunacy—– valuing any 10-year government bond at a deeply negative after-tax and after-inflation yield—-was attributed to rational economic factors. 

No it wasn’t. The manic drive to 5 bps was pure speculative caprice, triggered by the ECB’s public pledge to corner the market in German government debt. What gambler in his right mind would not buy hand-over-fist any attempt to corner the market by a central bank with a printing press——especially one managed by a dim bulb apparatchik like Mario Draghi!

Never has an agency of a state anywhere on the planet pleasured speculators with such stupendous windfalls. Yet any day now we will hear from the talking heads on CNBC that, no, massive bond buying by central banks does not repress or distort interest rates because once Europe’s QE started, rates actually backed up. And, furthermore, this is entirely logical because QE will enable the economy to escape its deflationary trap, meaning that investors are discounting an imminent resurgence of growth!

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Author: Travis Esquivel

Travis Esquivel is an engineer, passionate soccer player and full-time dad. He enjoys writing about innovation and technology from time to time.

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