Wednesday, November 16, 2011

Bond Traders vs. the European Central Bank

In January, 1993, President-elect Bill Clinton was discussing fiscal policy with several economic advisors.

The topic was deficit reduction, and his aides were telling the newly elected President that the success or failure of his administration depended on a credible deficit reduction plan. If he failed, the bond market would punish the economy with higher interest rates.

According to Washington Post author Bob Woodward - as detailed in Woodward's book The Agenda - Clinton's face turned red with anger as he said:

"You mean to tell me that the success of the program and my reelection hinges on the Federal Reserve and a bunch of f**king bond traders?"

I was reminded of this anecdote when as I have been reading about the ongoing euro bond debacle.

The success or failure of the euro zone ultimately will not rest on any particular politician or grand strategy. Instead, it will rely on whether the countries most at risk - Greece, Spain, Italy, et. al. - will be able to finance themselves at reasonable levels of interest rates.

So far, the "f**king" bond traders do not seem to be impressed.

Reuters is reporting this morning that the European Central Bank has been intervening heavily in the bond trading of Italy and Spain. Even with the ECB intervention, yields have been soaring for euro bonds from these countries.

Italian euro bonds now yield almost 7%. The contagion is now apparently spreading to other countries, even France. The yield spread between French euro bonds and German bonds is at levels not seen since the early 1970's.