The Belgian Connection

One of the biggest questions at the end of 2013 was how the Treasury market would react to the reduction of bond buying that would result from the Federal Reserve's tapering campaign. If the Fed were to hold course to its stated intentions, its $45 billion monthly purchases of Treasury bonds would be completely wound down by the fourth quarter of 2014. Given that those purchases represented a very large portion of Treasury bond issuance at that time, it was widely assumed by many, me in particular, that the sidelining of such huge demand would push down the price of Treasury bonds. Without the Fed's bid, interest rates would have to rise.

But almost five months later, yields on the 10-year Treasury bond are 50 basis points lower than they were at the end of 2013, despite the fact that the Fed has officially trimmed its monthly purchases in half. Apparently, plenty of other buyers were prepared to fill the void. Many have concluded that Uncle Sam doesn't need the Fed after all.  But a close look at international activity in the Treasury market reveals some odd patterns that should be explained.

Over the last six months Belgium has started to behave eccentrically, even by Belgian standards. No, the small country of 11 million has not decided to stop making chocolate or waffles. It has decided to increase its buying of U.S. Treasury bonds...in a very big way. According to latest U.S. Treasury Department data, since August of 2013 entities in Belgium have purchased and held a stunning $215 billion of U.S. Treasuries. This figure is equivalent to about half the country's annual GDP, and equates to almost $20,000 for every living Belgian. Prior to that time, Belgium had held its cache fairly steady at around $170-$190 billion. But by March, that total had increased by almost 130% (to $381 billion) in just seven months. The purchases represented 61% of the total increase in foreign holdings of U.S. Treasuries over that time frame. Given the fact that Belgium, as of last September, had less than 3% of the Treasury bonds held by foreign sources, this is strange behavior indeed.

Of course exactly who is buying those bonds remains a mystery. It's only known for sure that a Belgium-based clearing house called Euroclear is "likely responsible" for holding the $200 plus billion in Treasuries. It's amazing in this day and age when every e-mail and phone call is scrubbed for security content that hundreds of billions of dollars could move across borders without anyone really knowing what is going on. Of course this is likely only possible if official sources themselves are the transacting parties.

What is clear is that this is not likely the government of Belgium, or private Belgian capital, that is doing the buying. The numbers are just too large. This is particularly true in the First Quarter of 2014 when the buying averaged a stunning $41.5 billion per month (January was the biggest month with $54 billion). In all likelihood, the only European buyer with a wallet that big would be the European Central Bank (ECB) itself. But why would the ECB buy when the Federal Reserve was supposed to be tapering?

It is widely recognized that as the flow of capital increases exponentially across borders, and financial systems become more globally integrated, international central bank cooperation has increased. This is especially true between the Federal Reserve and the European Central Bank (ECB) which have closely coordinated policy to deal with the Great Recession of 2008 and the European Sovereign Debt Crisis of 2011. Exactly how, where, and why these banks have worked together is a little harder to imagine.  

Back in late 2011, when the sovereign debt crisis of Greece, Spain, Italy and Portugal threatened to fracture the European Union and take down the euro currency, the Wall Street Journal

reported the Federal Reserve was engaging at that time in a "covert bailout" of European banks. Using what was known as a "temporary U.S. dollar liquidity swap arrangement," the Fed provided billions in funds that its European counterpart used to bail out its banks. The Journal

speculated that the roundabout arrangement was followed in order to get around legal restrictions that prevented the ECB from lending to banks directly. The Journal called the arrangement "Byzantine" and questioned whether its design was simply meant to confuse the press and investors as to who was funding whom. In any event, the program seems to have achieved its end of keeping European banks solvent until the debt crisis had abated.

The Belgian head-scratcher may therefore be a simple case of central bank quid pro quo. In fact, on my radio program today, former Congressman Ron Paul shared my suspicions that there was indeed some type of "quid pro quo" coordination. While there is no smoking gun, the timing and scope of the buying is certainly suggestive of a coordinated effort. Confidence that the financial markets would stay stable during the tapering campaign was a critical element of the program's success. Any panic in the bond market would cause yields to spike, which would have a strong negative effect on stock prices and economic confidence. If the fear persisted for more than a few weeks, the Fed would have been forced to an embarrassingly early backtrack. The lost credibility would have greatly limited the Fed's latitude for further maneuver.

But what if the ECB started buying just as the Fed stopped? Better yet, what if the ECB purchases were larger than the taper? It would then appear that the Fed buying was simply a footnote in the current environment of ultra-low interest rates, not the driving force. It may not be coincidental that the Belgian buying began in earnest just as the tapering got underway. Something may in fact be rotten, and it's not in Denmark...but several hundred kilometers to the southwest.

Rather than looking to explain the unusual spike in Belgian coffers, most market watchers are fixated by recent comments by Mario Draghi that the ECB is poised to launch a quantitative easing-style bond buying campaign in order to weaken the euro and to push up inflation in Europe. If that is the case, how long could the ECB be expected to fight a two-front monetary war...carrying water for the Fed while buying European bonds simultaneously?   We must expect that any clandestine campaign by the Europeans to support Treasuries will have a brief shelf life, which could get even briefer if the ECB initiates their own QE. 

It is a testament to the bovine nature of our financial media that this story is not being pursued strongly by all the power the fifth estate can muster. But who cares when rates are low and stock prices high? Have another chocolate. The Belgian ones are the best.