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ECB Bond Sterilization, US Data Shows Strong Demand for Dollars

Last updated 11/16/2011 9:28 AM ET (GMT -5) 5 Comments

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Kathy Lien

Director of Currency Research, GFT

The big story this morning is the European Central Bank’s aggressive efforts to fight the rise in European bond yields and the weakness of the euro. It is said that the ECB has come into the market to buy Italian, Spanish and Portuguese bonds no less than 3 times today.   Even though ECB officials have refused to be the lender of last resort, they have come into the market enough times to support the European bond market and qualify themselves as the buyer of last resort.   The difference between what the ECB is doing now and what the market wants them to do is sterilization.   The central bank has been buying government bonds for some time, but the impact has been short-lived because they were sterilizing their purchases.   If they did not sterilize their purchases, they would effectively be undertaking the same type of quantitative easing as the Federal Reserve.   Based upon comments from ECB officials, they are not ready to go down this route – nor do they want to but the ECB is one of the few agencies in Europe capable of acting quickly to bring yields down.   Signs of ECB support can only go so far to stem the slide in the euro and unless European officials offer new commitment to prevent contagion such as the treaty change that German Chancellor Merkel has mentioned, the path of least resistance in the euro is still lower.

Meanwhile this morning has been another day filled with U.S. economic reports but once again, the data only had a nominal impact on the greenback because small changes in the U.S. economy matters little in a world focused on the uncertainties in Europe.   It is now confirmed that inflationary pressures on the consumer and producer level declined in the month of October.   CPI fell 0.1 percent, pushing down the annualized pace of price growth to 3.5 from 3.9 percent. Not only was this weaker than economists had anticipated, but it is also the softest CPI reading in 6 months. Excluding food and energy costs, prices increased 0.1 percent showing that much of the decline in overall inflationary pressures was caused by lower gas prices.   Meanwhile the latest industrial production report provides further evidence that the manufacturing sector could be leading the recovery.   Manufacturing activity rose 0.7 percent in October, a pace of growth that was much stronger than the previous month.    More importantly however, the Treasury reported big demand for dollar denominated assets in September.   Foreign investors bought $84.5 billion Treasury notes and bills, up from $60.1 billion in August.   Demand for long term assets also increased by $68.6 billion from $58.0 billion – there was a good mix between official and private demand with China, Japan and U.K. increasing their holdings.   The Treasury’s report confirms that demand for safety drove the greenback higher in September and even though the dollar has given up part of its gains since then, we expect demand to remain robust.

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Comments (5)

mbrad77

November 16, 2011 at 09:50 AM ET

could you explain what 'sterilization' of bonds means?
thanks..

Darkdoji

November 17, 2011 at 11:17 AM ET

Though I still think she should contextualize the meaning of the process and provide some explanation as to why it would make sense in this case (else how do we trust the authors understanding of the issue - as I have my doubts about this application and I know what I am talking about) - check investopedia for immediate relief.

mbrad77

November 16, 2011 at 10:00 AM ET

I think it might be: for every billion of bonds, the ECB will reduce the euro money supply by 1 billion to offset the purchase

klien

November 16, 2011 at 10:03 AM ET

This is a really great piece about ECB sterilization courtesy of the FT http://ftalphaville.ft.com/blog/2011/11/08/732761/

mbrad77

November 16, 2011 at 10:27 AM ET

good article, thank you

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.