Back then we experienced strong support from central banks in order to prop up the markets and more broadly our countries. Led by the United States with the FED, extraneous central banks decided to go dovish on their decisions i.e lowering rates at a territory never known before. The rates plummeted towards zero and even negative figures.

What does that mean ? Why is this relevant nowadays ?

Well, economies are driven by central banks’ decisions. As long as federal fund rates are low, your favorite bank at which you borrow cash to fund your next home will act in harmony with low rates. But when the opposite happens, it’s getting harmful for everyone and demand decreases as cost of money is skyrocketing. You may now think that dovish politics has no blight effects as people can enjoy money at a bargain and finance their activities. Everyone is happy and the economy is back on steroids ! It’s more complicated, rest assured.

Let’s illustrate the last point with the FED’s balance sheet from 2002 up until now :

In this graph, one must understand that a major event occurred in 2008 : the junk mortgage crisis. The FED decided to react by buying massive amount of assets (all sort of bonds from T-Bonds to MBS). They had no other solution to save the economy even if the bubble had already imploded at that time. If we keep following the curve, we notice a steadily increase but nothing dramatic. The other key date is 2020 of course with the late COVID-19 that hit a major part of the world. Same macro environment, same tactics. Buy more bonds, more assets in order to rein in slow growth and economical damages for households.

What does that imply for rates ?

The relation between the FED balance sheet and rates lies in this second graph :

As long as the FED’s BS increases, the rates plummet. They are inversely correlated. Before 2008, rates were surprising high if one takes in consideration the post 2008 crisis era. Now rates hit lowest while USD issuing and assets balance sheet are hitting their ATH. It means that the economy is flooded with newly created money (more than 10 trillion $ printed in the last 2 years with QE) but growth is not in the same dynamic. And here we are with the start of unfathomable bubbles being created in the stock market, real estate and even cryptocurrency in 2021. You may wonder how this money is issued right ? Let’s assume you are a big tech company or a big bank and have massive debt to finance your everyday operations. The world is waiting on you as you are the backbone of our modern societies so you have not the right to feeble. But don’t worry, central banks are there to back you even more if you are on the verge of collapsing. TOO BIG TOO FAIL. When we were talking about assets; we were relating to bonds and corporate bonds held by banks and big companies. This is where these central banks come into play, they just acquire these massive bonds (implicitly huge amount of debts) in order to send you fresh issued USD directly to your bank account. You just have profited off the rates decline and have now massive USD to do whatever you want. This is the essence of quantitative easing. That’s where people think that dovish economic politics ensures a safe economy from unpredictable events and murky days. What do you these big players are doing when their debt is being acquired for a lot of new USD ? Well, if you’re a big company, you do buybacks. Why take more risks when you can just pump your own bags and thus increasing your equity at nearly no costs ?

Of course, it would be deceitful to not take into account the easier access to money for regular people to finance their mortgage or their business needs. But as you might see me coming now, these politics profit solely for the richest. Yes I mean the evil BlackRock that is buying all the US’s real estate, or LVMH which is doing buybacks and acquiring Tiffany for a penny through complex structures.

How do you think it ends up ? Inflation, inflation, inflation.

The last CPI (consumer price index helping to measure inflation) print speaks for itself :

Yes, you read right. 8.0%. Never in 40 years, we saw such a high number.

The central banks created bubbled and helped inflation to soar to ridiculous levels. Ironically, the former goal of any central bank is to curb inflation and control it under the 2% threshold. Now the regular people will pay the price of all of this. Don’t be fooled by folks that try to explain you that Ukraine war caused this damage.

It’s just a matter of time before we witness more contestations such as Dutch and Italian people lately.

Is is the Ukraine war that brought up Cali average real estate prices to this level too ?

Sink that in for a minute.

Now let’s go back to the main subject of this writing.

Why the EURO zone may be in jeopardy ?

Well, as you might or not know, the Europe’s central bank is named the ECB (stands for European central bank). While the FED decided to take into account that inflation is finally not transitory by hiking rates as you can see in the above graph, the ECB takes a way slower path. Lagarde’s ECB isn’t reacting as one would like.

Another worrying trait of Euro zone is that almost every single country needs to pay their debt in USD, and trade commodities in USD too.

I let you answer this question, what happens when FED decide to hike and take a hawkish path while the ECB doesn’t act accordingly ?

The EUR/USD decreases sharply, the treasuries (bonds) drop and interest rate inherent to these treasuries surge. Best illustration is Draghi’s Italy willingness to resign as public protestations take place all around the country. Italians know that their indebted country can end up like Greece a decade ago.

The unknown parameter is whether Italy and its peers will remain coalesced if a bleak event would have to occur … such an event is more than likely to happen in the coming months.

While the pair EUR/USD keeps falling, it’s giving more and more fuel to inflation that can become anything but manageable. (Never forget that a lot of European countries pay their imports and commodities in … USD ….).

The whole world and specially the ECB face a dilemma. Hiking rates meaning less economic growth and a recession or high inflation with average people holding worthless fiat currency.

Hard landing might be the best solution. Not taking decisions lead to irreversible consequences as our world may face sooner or later a big recession alike 2008.

10 Year Italian Treasury Bond Yield on a one year time span (source: Investing.com)

Italy German 10 Y bond spread between the respective countries 10 Y bonds (source: ychart.com)

Italy sits in a dangerous area and one must keep an eye on this in the coming months as the Italy’s bond yield is eating the German’s one.

How Italy will be able to pay off its interest with surging rates and slow economy that might pop up in a desperate stagflation environment ?

Will Europe be there to support Italy ? Or big countries will let another neighbor on the side alike Greece ?

‘’There’s a quiet storm and it never felt this hot before’’ - Sade’s “The Sweetest Taboo”.