Review & Outlook
The Latest Bond Panic
Draghi tells the truth about volatility, and the markets prove his point.
June 4, 2015 7:23 p.m. ET
European Central Bank President Mario Draghi Photo: Kai Pfaffenbach/Reuters Sometimes Mario Draghi is too honest for his own good. The European Central Bank president’s latest gaffe of blunt truth-telling was warning investors Wednesday that markets “should get used to periods of higher volatility.”
Bond yields in Europe and Asia proceeded to jump on a roller coaster as if to prove the point.
Germany’s benchmark 10-year bund rose to a high of 0.99% Thursday from 0.68% on Wednesday morning, before falling back below 0.85%.
European bond yields have been rising for more than a month before this week’s ECB policy meeting, and the reasons are open to debate. Theories include the balance between hope and fear over an EU-Greek debt accord, or, more positively, a growing belief that growth and inflation are returning to the eurozone.
One obvious culprit is tighter banking regulation introduced after the 2008 financial panic, which has reduced liquidity in bond markets and amplifies volatility when prices start to fall.
In his press conference Wednesday, Mr. Draghi admitted the ECB has no idea which of these explanations is at work or to what degree.
If markets are signaling that Europe is emerging from deflation, then the rise in yields—still ultralow by historical standards—should be manageable and even beneficial. If you believe that post-2008 regulations are making the financial system safer, then greater day-to-day volatility and bigger bid-ask spreads on bond prices resulting from reduced liquidity may also seem like a fair price to pay.
But if other factors are at work, it would be another sign that abnormal monetary policy can have unpredictable consequences. J.P. Morgan CEO Jamie Dimon made essentially this point in his latest annual letter to shareholders when he warned that a similar but more severe ruction in the market for U.S. Treasurys last October showed that, under the new monetary and regulatory normal, markets can flare up even under benign conditions.
Whatever is causing recent bond moves, the danger is that markets could overshoot through some combination of misguided sentiment, faulty price signals amid historically cheap capital, and low-liquidity volatility. An uncontrolled rise in yields would threaten the many investors who, out of want or necessity, have bought into the unprecedented bond rally Mr. Draghi and other central bankers created. That includes the banks and insurers that have piled into government bonds at the same time central-bank purchases of those securities were driving bond prices higher.
Mr. Draghi said Wednesday that the ECB intends to continue quantitative easing despite the uptick in volatility that is a preview of how choppy the eventual transition away from QE could be. He’s telling the truth about the central bank’s inability to smooth the way for markets.
Investors have to hope he knows what he’s doing when he concludes these risks are justified by the growth and inflation benefits that QE is supposed to deliver.
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