How The ECB Is Distorting Euro Money Markets

As we continue to pound the table about the effects central bank asset purchases are having on market liquidity, it’s nice to know that there are at least a handful of people out there who agree that maybe — just maybe — depriving the market of high quality collateral by monetizing everything that’s not tied down could serve to destabilize markets and may indeed introduce systemic risk. The list of those speaking out on the issue has grown with the size of central bank balance sheets and has recently come to include SEC officials, BoJ officials, and investment banks. Here’s what we said on Thursday: 

As central banks work to monetize all net (and sometimes gross) government bond issuance in their respective jurisdictions [they destabilize] markets by sapping liquidity which in turn inhibits price discovery and creates volatility. This is on display in Japan, where 2 out of 3 dealers think the JGB market is impaired thanks to BoJ asset purchases and where many officials are beginning to get more vocal about the possibility that a lack of liquidity could have “dire consequences.” Similarly, market financing via shadow banking conduits has declined by nearly half since 2008 in the US, and with dealers unwilling to hold inventory of corporate paper thanks to tougher capital requirements, the stage is set for what the Center for Financial Stability recently called “an accident.” As a reminder, here’s what  the SEC’s Daniel Gallagher had to say recently about liquidity in the US corporate bond market (via Bloomberg): “Lack of liquidity in corporate bond market is ‘systemic risk’ not addressed by regulators, SEC Commissioner Daniel Gallagher says in public remarks.”

Even as the Fed has wound down asset purchases in the US and may be set to raise rates later this year (which, as UBS recently noted, may cause corporate spreads to widen against a backdrop of limited liquidity in the corporate bond market), the ECB is set to inject more than €1 trillion across the eurozone on the way to monetizing three times net euro fixed income issuance. Here, courtesy of Barclays, is what this means for euro money markets: