Draghi's 'Doom Loop' Revealed


In the old days there was a very definite relationship between sovereign bond yields, the sovereign exchange rate and the sovereign currency interest rates. In its simplest terms weak currency equals high interest rates and high bond yields. And vice versa. So when there was high demand for a particular sovereign bond the currency would strengthen (because currency would have to be bought to buy the bond) and both the yield and interest rates would fall. All things being equal. And if the was a net selling of sovereign bonds the currency would weaken and both interest rates and yields would rise.

So non sovereign bonds in a particular currency would be issued priced relative to some bench mark sovereign bond. Like 10 year Gilts. And this would act a very simple FX / interest rate risk proxy. This worked really well until all hell broke lose in the late '60s and the whole system fell apart in the early '70’s. This would be the very simplest derivative bond product.

Nowadays things a lot more complicated but to use the example of home mortgages in a country that does not use covered bonds the mortgages could be pooled and then securitized and then either sold on or repo-ed. But the bond for the securized product would not priced relative to the home country baseline sovereign bond. As the securitized bond would be issued through a shell company in somewhere like Ireland or the UK it would be denominated in dollars or even euros but the base rate used would be LIBOR. Or some derivative from LIBOR.

Even that is a fairly simple scenario by modern standards. Basically anything that has a predicable cash flow can be turned into a bond. And for companies in the ClubMed countries when it comes to enbonding cashflows LIBOR is the only number that really matters. The domestic sovereign bond yields can go up or down but in most cases the only eurozone number that might any bearing on pricing would be exchange rate. And even the ECB cannot control that. No matter how much money they create. So for an Italian or Spanish or French company creating derivative bond products the domestic sovereign bond yield is pretty much irrelevant. At least as a first order variable in the pricing.


Thanks JMC

Would you say that when the sovereign yields start to show signs of financial stress (or panic), that the pricing (new issues or secondary market) of these products moves accordingly ? Obviously if you have bought the instrument and are a holder to maturity and have rock solid financing that is not affected by the mark-to-market, then sovereign yields are or little interest.

However, as many banks discovered in the financial crisis, if sovereign yield stress begins to affect the market-to-market of other LIBOR linked instruments from the country, then the funding base starts to crack (the bond markets are ultimately highly levered markets with huge amounts of asset held on margin). Even where your bond is fully hedged / swapped and all financing also locked in, the fact that you have large amounts of the asset exposed to a sovereign that is under great stress will cause you problems.


Interesting post on Zero Hedge showing just how powerful Draghi’s Doom Loop has been (so far)


Moodys grades the US+UK at just under AAA ?!

Moodys grades Ireland as just above pure junk ?!
(and with good reason given Ireland’s indebtedness - on a proper like-for-like basis is worse than Greece

If the Draghi Doom Loop is unwound AND Irish Banks (main buyers of Irish sovereign debt with Draghi’s cash) have been booking profits at the above yields - it could get nasty !


Ireland gets bumper demand for first post-bailout bond


The awesome power of Draghi’s Doom Loop revealed this morning for Irish Governemt Debt.

To put the ‘screen’ yield of 3.27% for Irish Government 10 year in context (asjusting for Ireland’s ‘real’ GDP)

Gov Debt…73% (*)…125% (156%)…155%(**)
Gov Deficit…4.5%…7.5% (9.4%)…4.5%
10 Year Yield…2.95%…3.27%…8.08%

(*) I have left out the US QE debt as they have bought asset with it (I would be like adding NAMA bonds to Irish debt)
(**) Greek debt is harder to estimate (there are banking elements) - this figure is some a detailed Jefferies report.

All of this mornings demand are Irish banks with 0% ECB debt. The Irish banks are not allowed swallow up primary new issuance with 0% ECB debt - it violates monetary financing rules (they can with their own funds which they will have used this morning) so they use foreign banks (i-banks) and brokers to buy it for them. They then buy it off them in the secondary market with the 0% ECB money. The foreign bank earn a decent risk-free commission on this - hence their press releases on Reuters on behalf of the Irish. We will see in 6-12 months time that the Irish banks have purchased virtually all new net new issuance of Irish sovereign debt in 2014. As you will understand from the above table, no international investor is buying Irish sovereign debt at 3.27% when they have better options.


Table from jake76 that is worth adding to this post - update on who is buying Irish sovereign debt.

LTRO facilities ran from Q3/4 2011 to Q1/2 2012 (then it ended).
LTRO money was not used to fund PIGS banks to buy their own debt.
This is a new facility that dates after Draghi’s OMT / ‘whatever it takes speech’


Observer, would you agree that the 3.27% yield on these bonds reflects the success of ECB support to the PIGS and especially to their banks?

I see this successful bond sale, the recovery in employment, and indeed even the increases in house prices as a reflection of a successful policy of avoiding large scale defaults and bank failures, indeed a reflection of the success of the FED in avoiding further recession in the US and globally by pumping billions monthly into the system. it is hard to counter that the measures are being successful at this point in time is it not?

That sovereign debt levels are unprecedented, that personal debt levels are starting to increase again, and that many assets backing bank and the FED balance sheets are at best overvalued is cause for concern IF there is a jolt to the system. That is a very big IF and so far the system is managing the jolts, whether it be NAMA avoiding more widespread property price decline in Ireland, China keeping the bubble afloat with more and more infrastructure, or the global banks rapidly recovering balance sheet strength through subsidized profits. In the end the system seems capable of knocking back the challenges, even the Germans have gone quiet on the inherent risks of ECB supports.

Are we then just seeing a coordinated devaluation of fiat currencies which will play out over several more years, assets recovering in value to support the great and good while inflation gradually rises to sweep away some debt. Wages of course would not rise in step, taxes would not fall, just a gradual bleeding of the masses to pay for the excesses of the boom? Capitalism at work. That turmoil will strike here or there is of little impact, Greece or Ireland or Iceland or Syria, even Iran or Japan would not rock the boat enough if the US, China, and the EU as a hole stands firm and keeps the money flowing.

That the piper will need to be paid someday is not a given, it is fiat currency after all, the EURO is perhaps the biggest challenge to that as the PIGS will have to bear their debts but handouts and cheap money can help for a long, long time. That trade may suffer as imbalances grow may too help to rebalance global production, return some manufacturing to southern EU countries, to the US, and push China to depend less on exports to the EU and US. The winners are the politicians and the bankers, the losers the poor of the world whose ranks will likely swell. However, technology is again playing a role after being somewhat dormant in the past 10 years, renewable energies are gaining scale in second and third world countries, places where the sun typically does shine, reducing cost structures and allowing for big leaps in productivity and self-sustaining enterprises.

The issues of the day are somewhat like the Irish housing market, with coordinated support it does not have to be rational for long periods of time, long enough to allow rationality to actually change. That the long term legacy will be awful remains a very strong possibility but it seems our global leaders are more than happy to take that chance.

Hence the value in Irish bonds, they pay out more than many other asset classes, who would have thought!


If I was to pick a year from the last time around that most resembled the last year I’d have to pick 1978. Inflation was down and both the collapse of Bretton Woods in 1971, the Oil Crunch of 1973 and the decade of price / wage inflation seemed to be coming under control using traditional post war macroeconomic policies.

Then 1979 happened…

By 1981 all the can kicking of the previous 15 years finally reached the end of the road.

What happened in 2006/2008 was only the first round. We still have to have the second round. The capitulation phase. And like 1979-1981 its going to be very very nasty.

When I look at 2014 it feels remarkably like 2008. Just one unexpected event away from a great non linear unraveling. It could be an escalation between China and Japan. It could be the attack on Iran. It might be the FN being the biggest party in the French May Euro elections. A bank collapse in Italy. Who knows. There is hell of a lot of tinder around at the moment and a lot of people trying to strike matches. Maybe we’ll get lucky like in 1962 and 1983. But I would not count on it.

So far we have not even got to the end of the beginning of the current crisis. You’ll know when the beginning of the end starts. It will be the same kind of political earthquake and dislocation that Volker / Regan and Thatcher wrought in early 80’s. These kind of crises play over a decade or two. And the end result is always the same. Major political and institutional change.

As for Ireland it is still stuck in a Groundhog Day style Argentina in 1997 loop. No country whose national finances and banking system reached the state that Irelands has in the last five year has ever recovered without a massive political and economical dislocation. And a large drop in its standard of living.

This time will not be different. Its just a matter of when. And how bad. Pretty much everything done since since 2007 by the ECB and the Fed has just been postponing the inevitable rather than taking active steps to recover and build what comes next. And Ireland? Just taking out more credit cards to pay off the minimum monthly payment on its current credit cards. A winning long term strategy we’d all agree.


I would agree jabaar - as I have posted elsewhere (thepropertypin.com/viewtopic.php?p=752962#p752962), Draghi is doing amazing things for Ireland (vs. Trichet) and pumping us with sizable ‘carry trades’. Yes, it would be nicer / faster to just get the debt write down / retrospective re-cap, however this route, if kept going, will be just as powerful in the long term.

You are also right re the long-term issues - all of this is to reflate assets one more time which requires more debt. A bubble however at ultra low interest rates will - in my view - be the last bubble of our lifetime. Sadly, I’m not sure in the short-term there is much other choice. The legacy of Greenspan is difficult to get out of without Paul Volker-type pain. I’m not sure the world is ready for this yet.


Funny jmc, I just finished replying to an earlier post and mentioned the name Paul Volker and then see your post now.

I do think that in Ireland, things had gotten so out of whack (2011/12) when the proverbial ‘patient’ almost died on the operating table, that with Draghi’s more positive / supportive (with real cash) to Ireland, we should (and I believe are) experiencing a recovery.

Given the quantum of the debt in the Irish system (which is still at most levels in excess of all other nations - including Greece), we need another Draghi plan to get us to a more sustainable recovery.

I’m told that in 2012 we did have agreement form the ECB on retrospective recapitalisation of the Irish banks (which would be a real game changer and would produce a really vigorous recovery) but I’m sure to Noonan’s frustration, we don’t seem to be getting it.

The carry trades being run through Ireland (Prom Note, Sovereign Bank Debt Deals, Bank Senior Debt deals) are pretty material and over time will have a strong effect (although I do fear the Government uses some of them for ‘pet projects’ vs. debt reduction).

Only time will tell - however interesting observation you have.


Ah. Your posts make more sense now. You’re waiting for “the second coming” - post apocalypse.


Nope. This every 30/40 year cycle has a pattern. First they try to prop up the old order when the first phase of the crisis happens. Events rumble on for a while. Then the whole edifice collapses. And something new replaces it.

As of now its not obvious what will replace the current orthodoxy. And just how benign it will be. But replaced it will. Sooner or later. And once started the finale tend to happen very quickly. The US of 1934 was very different politically and economically from the US of 1930. And the UK of 1982 was very different politically and economically from the UK of 1978.


If our bonds are ju8nk status who’s buying them?


Financial geniuses :laughing:



From Draghi’s perspective it puts the PIIGS sovereign’s banks ‘ass in the pan’ as a sovereign default is now a domestic banking collapse.
This is very like what the Greek & Cypriot banks did (under their government direction) in 2009/10 which led to their collapse.

From the German’s perspective, doing a repo facility instead of LTRO III, meant that the ECB’s balance ‘technically’ stabilised.
(I say ‘technically’ as the ECB’s exposure to PIIGS debt is effectively growing - although its Target2 imbalances are offset).

From the PIIGS banks’ perspective it is a no brainer.
Irish banks converted insolvent tracker mortgage books - earning <1% at +200% LTV - and repo’ed them for Irish debt @ 5% carry.
It injected large carry into the Irish banking system (but created a perverse situation where Ireland has had zero mortgage foreclosure).
More importantly falling sovereign yields gave US investors (who think ECB is same as FED) courage to buy Irish assets off Irish banks.
(the effective knowledge of the typical US REIT active in Irish real estate market about things like Draghi’s Doom Loop is weak).

The problem now is who is really guaranteeing this PIIGS debt AND what happens when the PIIGS banks run out of collateral to pledge.
As any bond trader knows, when new money dries up, prices fall (i.e. needs a constant ‘flow’ of buying - the FED has learnt with QE3).
We will therefore definitely need another LTRO III for this (and many more IF the PIIGS don’t use the lower bond yields to reduce debt).
A huge moral hazard is that PIIGS governments use the carry of Draghi’s trades for political projects, and not pat down debt.
This would be a disaster for Draghi as to maintain sub 5% PIIGS sovereign yields, constant LTROs would be needed.

Parts of the ECB are therefore getting cold feet about the quantum of PIIGS bank domestic sovereign debt buying.

There are also calls from the ‘Bundesbank’ (remember that institution), to apply risk weightings to sovereign holdings in PIIGS banks.
The PIIGS banks however are no so overloaded with their own sovereign debt, such a step would make them insolvent.
The cessation of sovereign PIIGS debt build up by PIIGS banks (nobody else wants it at these yields), would see yields explode again.

If the ‘Draghi Doom Loop’ is ever stopped / reversed, the consequences will serious on multiple fronts - sovereigns, banks, everthing!


Please stop just making s*** up! This is idiocy on two levels:

A) you’ve already been given the investor base distribution for recent Irish syndications and the vast majority aren’t even banks. No one is buying anything on behalf of anyone else, the local banks can either try and participate in the issuance or buy the bonds on the secondary market later JUST LIKE EVERYONE ELSE

B) in auctions (typically, there are rare exceptions) only primary dealers (generally big banks) are allowed to participate - THAT’S WHAT A PRIMARY DEALER IS. They buy the bonds and sell them to their clients.

LTRO is a repo facility, just a very long dated one. The ECB is still offering shorter dated ones (3 month is the current max). Really - just go to the ECB website and look under “open market operations”

How many bond traders do you actually know? Have you run any of this past them?
(Hint: bond prices are available every day, even when there is no new issuance - so by definition every transaction involves a buyer and seller)

Look, I’m not trying to harsh on you - there’s an awful lot going on here and Ireland and Europe aren’t in a great place, and it’s right and proper that people are asking how we got here and what’s next. But please don’t speculate in one post and then turn that into “fact” in the next.

And stop reading zerohedge, it’s for conspiracy theorist loons. (Or keep reading it, but realise it’s written by conspiracy theorist loons.)


LTRO is a repo facility, just a very long dated one. The ECB is still offering shorter dated ones (3 month is the current max). Really - just go to the ECB website and look under “open market operations”

How many bond traders do you actually know? Have you run any of this past them?
(Hint: bond prices are available every day, even when there is no new issuance - so by definition every transaction involves a buyer and seller)

Look, I’m not trying to harsh on you - there’s an awful lot going on here and Ireland and Europe aren’t in a great place, and it’s right and proper that people are asking how we got here and what’s next. But please don’t speculate in one post and then turn that into “fact” in the next.

And stop reading zerohedge, it’s for conspiracy theorist loons. (Or keep reading it, but realise it’s written by conspiracy theorist loons.)

Agree with pretty much all you say. The signal to noise on ZH is very low. But still very useful for seeing what the current noise is. Because the real world is a very high noise environment.

The real world bond market at any given moment is a very opaque except to those on the trading desks, and they are not telling anyone. I’d be interest to know if anyone has any clues to about current market sentiment on the buy side for buyers of bonds like the NTMA 3%'s? Are they re-balancing portfolios? Are they rotating out riskier sovereign bonds for less risk? Is it part of the regulatory balance? Part of a particular hedging strategy? All of the above? None of the above?

Or maybe its pure random walk just like 2006 and every buyer has their own rationalization for what is currently a fairly irrational market. And we all remember what Keynes said about irrational markets.


**Bill Gates steams in to buy Irish bonds in bet on recovery
independent.ie/business/iris … 07734.html


Steam of his p*ss maybe, out of a total worth of 75,800 million dollars, he owns 20 million dollars of Irish government debt.


They Snuck In Eurobonds Through The Backdoor - -> theautomaticearth.com/debt-r … -backdoor/


On any given solvent day, Greece would have difficulty getting it’s bonds away.
Bonds are being priced based on the implied guarantor.