With bond yields continuing to spiral higher across the globe, you would think that central banks might have a trick or two up their sleeves to put an end to all this. I mean, if higher borrowing costs are such a headache for governments, then why not just fire up the money printers, buy up all that debt and bring yields back down?
That all sounds simple enough in theory, but if only things were that easy in practice.
After all, it wasn’t that long ago that we have seen central banks do something similar before. During the Covid pandemic, they purchased massive amounts of government bonds to support financial markets and keep borrowing costs artificially low. So, what exactly is stopping them from doing that again?
Well, this is where things start becoming more complicated considering the macro backdrop today. Let’s take a simple example.
Just imagine a government that needs to borrow $100 billion to finance its spending. However, investors are worried about its growing debt burden and are demanding higher interest rates to lend said government any money. Now, the central bank could theoretically step in and purchase those bonds. In turn, that will create additional demand and push yields lower.
So, what’s the problem here?
Well, the key difference comes down to inflation.
Back during the Covid pandemic, inflation was subdued and the global economy was struggling with collapsing demand. That meant central banks had much more room to buy government bonds and support growth without immediately worrying about inflation.
Today, inflation the real problem and it is in fact a growing one. So, central banks stepping in to buy up government debt could risk adding to inflation pressures rather than easing them. And that is where things start to get a little more messy. If investors start questioning whether central banks are actually still serious about fighting inflation, then they might demand even higher yields to compensate for that risk.
In other words, the supposed solution could end up making the original problem worse.
And we’re already getting a timely reminder of why this matters. 10-year Treasury yields are on the verge of multi-decade highs at 5.32% today, while 10-year French bond yields are on approach to 5% amid mounting fiscal concerns.
In the case of the ECB, stepping in to rescue France isn’t as straightforward as simply just buying up French government bonds. The central bank’s intervention tools are designed to address disorderly market conditions. They are not meant to be used in a way to give governments a free pass on fiscal responsibility.
Remember the UK’s own gilt crisis in 2022? The BOE intervened with temporary bond purchases at the time so as to prevent financial instability. That was never intended to be a permanent solution to the government’s borrowing problems.
And that is perhaps the limit of what central banks can realistically do during such times like this one. Monetary policy can help to calm markets and bring borrowing costs down temporarily.But fixing the underlying debt problem ultimately requires credible fiscal policy, and that lies outside the jurisdiction of a central bank.
This article was written by Justin Low at investinglive.com.