The ECB is Trapped Between Japan and the US


by Tom Luongo, Tom Luongo:

The ECB has a credibility problem.  It didn’t last year.  Last year it was the Fed with the credibility problem.  Today, it’s Christine Lagarde not Jerome Powell that needs to justify her policy.

Powell needed nearly a year after he began raising rates to get a significant portion of the market to believe he was serious about raising rates. Today, they don’t believe him if he making the odd dovish coo.


I don’t blame the market for its previous skepticism, it was well earned. But as I’ve pointed out many times, Powell’s incentives line up with his intentions and that has translated directly into Fed policy.

Lagarde has done the same thing, except she forgot that whole ‘incentives’ part. She has clearly tried to force her intentions onto the market to effect her masters’ policy.

So, she tried to out wait Powell, hoping that domestic US politics would force his hand into the ‘pivot’ that hasn’t come and won’t until something breaks.

That something in my mind is still the ECB. And the race is on as to whether deteriorating credit and economic conditions in the US will force Powell’s hand rather than Lagarde’s. The keys are oil prices and the Bank of Japan.

At last year’s July meeting Powell raised rates another 75 basis points and Lagarde responded by announcing the Transmission Protection Instrument (TPI) or Toilet Paper Initiative, as I like to call it.

The TPI was put in place to manage German/Italian credit spreads, because last summer they were blowing out very wide and threatening to take down the entire Euro-zone bond market. Powell’s studious application of “Rate Hikes of Unusual Size” as Danielle Dimartino Booth put it to me in the podcast we did back in February, was the cause.

The TPI announcement was paired with statements about the end of the ECB’s current QE programs. But the TPI is just QE in another form, especially if coupled with the ECB and European-adjacent jurisdictions are deploying reserves to manage the US yield curve.

But the TPI alone clearly isn’t enough. Eventually, shuffling underwater bonds from one pocket to another to massage credit spreads runs into the basic problem that Powell hasn’t stopped raising rates.

Running out of OPM

Eventually, as I pointed out in a recent article, policy limits are reached when rates themselves are the problem, not spreads. As a reminder, here’s the German 10-year weekly chart and Lagarde’s defense of 2.5%

Oh, and inflation was “stickier” than Lagarde was fronting this time last year. She was still on the “transitory” talking point. For some reason, the markets believed her. Or, more specifically, wanted to believe her.

The euro-zone bond market is a cancer patient in Stage IV. Each time there is a major event, the rot within it metastasizes again and a new alphabet program has to be invented — OMT, TARGET2, ESPP, TPI, ZOMG.

At this point, there is no internal solution, save blowing up the entire fiction of individual central banks within the EU. Lagarde needs help from the outside to keep this patient alive.

She gets that regularly from both the Biden administration in general as well as Treasury Secretary Janet Yellen specifically.

In this month’s Gold Goats ‘n Guns newsletter I laid out why I thought Yellen went to China to beg them to stop selling/start buying US Treasuries to keep a lid of global debt yields and the geopolitical implications for thiis. This morning Zerohedge reports that Yellen has already issued more than $500 billion in new debt and will sell more than $1 trillion in Q3 and another $722 billion in Q4. From the Treasury Marketable Borrowing Estimates report:

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