Traditional safe havens such as U.S. Treasurys and German government bonds, or bunds, have been quick to rally, pushing down yields, whenever Greece’s proposed bailout has hit snags – as would be expected amid mounting default fears. So far, so normal.
But in a curious twist, government bond yields for the likes of Italy, Spain and Portugal have also fallen in step with the traditional safe havens even as risks surrounding a Greek default and euro exit have appeared to rise.
Kathleen Brooks, research director at Forex.com, thinks the phenomenon is down to the European Central Bank’s decision to expand its balance sheet, in part via its long-term refinancing operations. The ECB provided nearly 500 billion euros of three-year loans to banks in a December LTRO and plans another three-year operation at the end of this month.
“Markets adore liquidity and central banks are providing it by the cart load right now. For the ECB, LTRO money is not only propping up the currency bloc’s banks but it is also seeping into sovereign markets so is thus working as an effective way to bring down credit risk in the weakest economies,” Brooks wrote.
That means that the ongoing expansion of the ECB’s balance sheet, which is no larger than the Fed’s, may not weigh on the euro, she contends.
“Typically when a central bank’s balance sheet expands it means a weaker currency, but the ECB is not a typical central bank and when its actions reduce credit risk it can help to prop up a currency, which is why we have seen EURUSD find good support at $1.3080 this week even though Greek tensions have notched up a gear,” Brooks said.
