- German court ruling threatens the ECB’s QE programs and, by extension, Italy and other troubled Eurozone nations
- ADP report expected to show 21 million job plunge
- Treasury today will boost the size of its quarterly refunding operation
German court ruling threatens the ECB’s QE programs and, by extension, Italy and other troubled Eurozone nations — The German Constitutional Court on Tuesday created a big problem for the ECB and the EU as a whole by saying that elements of the ECB’s QE program are potentially unconstitutional. Moreover, the German Court rejected the final ruling of the EU Court of Justice, which is supposed to take priority over national courts. That could cause a breakdown of EU unity where national governments and courts simply start ignoring European laws and legal judgments.
The German Constitutional Court gave the ECB three months to come back with an explanation of how the QE programs meet the Court’s requirements, or else the Bundesbank will be barred from buying German bonds under the ECB’s program. The ECB in its QE programs uses national central banks to buy their own securities, which explains how the Bundesbank is involved in QE.
The ECB responded to the decision with a simple recitation of its legal mandate to maintain price stability and with a reference to the previous ruling in its favor by the EU Court of Justice, essentially saying that it is following EU law regardless of the opinion of a handful of German judges.
The German Court’s decision on Tuesday applied only to the ECB’s original QE program, i.e., the Asset Purchase Program (APP) that the ECB first began in 2015, ended in 2018, and then restarted last November at 20 billion euros/month. The Court’s decision doesn’t immediately involve the ECB’s new 750 billion euro Pandemic Emergency Purchase Program (PEPP) that just started up in March. However, the PEPP program has more problems than the APP program because the ECB in its new PEPP dropped the original restraints such as a 33% limit on issuer bonds and the purchase of bonds on a proportional basis according to the country’s size in the Eurozone (i.e., according to the capital keys).
The good news is that the ECB can continue with its QE programs as usual in coming weeks. There seems to be a decent chance that the ECB will be able to satisfy the Court’s demand for a further explanation of the original APP program, thus meeting the 3-month deadline and keeping its APP program intact. However, the ECB will now see a serious legal challenge to its new PEPP program. Yet any new lawsuits against PEPP will take a matter of years to adjudicate, meaning there won’t be any immediate harm for the new PEPP program, unless the ECB decides to voluntarily reimpose the APP restrictions.
If the ECB voluntarily reimposes the restrictions on the PEPP program, then the ECB would have to curb its purchases of Italian bonds. That could lead to the start of an Italian sovereign debt crisis if the markets believe that the Eurozone is cutting Italy loose. However, Italy still has a big bailout option by tapping the OMT fund, which specifically allows the ECB to buy the securities of a single nation. In total, the whole mess seems likely to be sorted out eventually, but not before causing uncertainty for the markets.
The Italian 10-year bond yield on Tuesday surged by +10 bp to 1.86% on the German Court’s decision. The spread of the Italian 10-year bond yield over the German bund yield rose by +11 bp to 245 bp, up sharply from the pre-pandemic level of about 135 bp, but still moderately below March’s 11-month high of 279 bp.
ADP report expected to show 21 million job plunge — The consensus is for today’s Apr ADP employment report to plunge by -21.0 million jobs to 108.1 million jobs. The expected report would reverse nearly all of the 22.1 million job gain seen from the trough of the Great Recession to February’s record high of 129.5 million jobs. The only good news is that some of the lost jobs will come back quickly as the U.S. economy reopens.
The consensus is for Friday’s April unemployment report to show a -21.25 million plunge in payroll jobs. The unemployment rate is expected to surge to 16.0%, which would easily take out the post-war record of 10.8% posted in 1982 but remain below the Depression’s record of 24.9%.
Treasury today will boost the size of its quarterly refunding operation — The Treasury today will likely announce a big increase in the size of next week’s quarterly refunding operation to cover Washington’s various bailout and emergency spending programs. The Treasury’s last refunding operation in February totaled $84 billion and consisted of $38 billion of 3-year T-notes, $27 billion of 10-year T-notes, and $19 billion of 30-year T-bonds.
The Treasury on Monday said that it will have to sell a net $3 trillion worth of Treasury securities just in Q2 in order to cover the massive budget deficit. The Treasury said it expects another $677 billion of net new debt in Q3. The expected $3 trillion surge in the national debt in Q3 would push the national debt from the current level of $25 trillion up to a new record high of $28 trillion. The new debt level would be up by about $8 trillion (+40%) since President Trump took office due to the combination of long-term chronic overspending, the 2018 tax cuts, and now the pandemic debacle.
The good news is that the Treasury should be able to easily sell a massive amount of debt securities in coming months due to strong safe-haven demand, low inflation, and low short-term rates. Nevertheless, the picture could turn very ugly down the road if the U.S. does nothing to curb its national debt, which is soon expected to be above 100% of GDP. The U.S. will really be in trouble if inflation ever breaks out, and interest rates rise sharply, which would cause interest costs to soar and potentially cause a U.S. sovereign debt crisis.
