Bond-market demonization watch, eurozone edition

By Felix Salmon
December 8, 2010
covers it today, under the headline "Central Bank and Financiers Fight Over Fate of the Euro". Let's see if we can spot a theme here:

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Did you know there’s a fight to the death going on in Europe? The NYT covers it today, under the headline “Central Bank and Financiers Fight Over Fate of the Euro.” Let’s see if we can spot a theme here:

On one side is the European Central Bank, which is spending billions to prop up Europe’s weak-kneed bond markets…

On the other side are hedge funds and big financial institutions that are betting against those same bonds…

The war keeps escalating as traders position themselves for what some believe is inevitable: a default by Greece, Ireland or perhaps even Portugal…

The head of the International Monetary Fund, meantime, urged Europe to take broader action to fend off speculators…

The speculators keep coming back…

No single hedge fund, after all, can hope to outgun the central bank…

By emphasizing that the central bank is “permanently alert,” Jean-Claude Trichet, its president, has raised the risk for speculators who might try to profit by selling short Greek, Portuguese or Irish bonds…

Speculators have been maintaining large positions in credit-default swaps on Spanish bonds and on the debt of Spanish banks.

OK, that seems pretty clear. On the one side there’s the ECB, nobly trying to defend a young and embattled currency; on the other side there’s hedge funds and traders and big financial institutions—collectively, “speculators”—looking to destroy the euro and collect a big payday, in a manner reminiscent of when George Soros broke the pound.

But who are these speculators? The NYT never specifies. It talks about Pimco selling euro-periphery bonds last year; about JP Morgan clients also being eager to sell their sovereign holdings; and about one hedge fund which made money in the CDS market over the summer and which has now closed its position. The first two can’t really be considered speculators, because speculators are people making a directional bet, rather than simply selling bonds they own and which they fear might fall in value. The hedge fund does count as a speculator, but it’s anonymous, and the size of the trade is not divulged, and it’s far from clear that such funds have any ability at all to move the market.

The NYT also fails to link to any story about the head of the IMF warning about speculators, which is sad, because I’d like to see exactly what he said. Was it this? I can’t see anything about speculators there.

It seems to me that blaming speculators for anything going on in Europe is lazy and unproven. There’s obviously credit risk in various European sovereign bond markets, and those markets are naturally going to trade at levels commensurate with that risk whether they’re full of speculators or not. So long as the ECB remains essentially the only buyer in the market, there will be tension about where the price should be. Real-money investors will tend to consider bonds overvalued and want to sell them at the ECB’s levels: that’s not speculation, that’s just the way that markets work. Yes, such sales put downward pressure on bond prices—as do purchases of protection by investors worried about what might happen in an event of default.

But the fact is that a European sovereign default would almost certainly cause a huge amount of financial harm across the continent—much more than any marginal benefit accruing to short-sellers and speculators. The markets don’t want a default; they’re just trying to determine the probability of a default, and to price assets accordingly.

And by Occam’s Razor, if everything going on in European bond markets can be explained without recourse to evil speculators, then there’s no reason to talk about them at such great length or to demonize them—unless you’re some kind of politician. Journalists should beware “speculator” terminology unless and until they have concrete evidence that what’s going on really is speculation rather than perfectly normal price discovery. So far, I don’t think that evidence exists.


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Terrific post. If the product wasn’t bonds but something easier to understand like cars it would be obvious that demonizing buyers for not buying is just silly.

Imagine if the Times demonized the public for not buying Detroit cars in 2008. Or blamed condo flippers for not keeping the housing bubble going in 2007.

Posted by DanHess | Report as abusive

At the risk of sounding way sycophantic, I agree with DanHess; A terrific post indeed. Cutting through the BS written about bonds and demystifying the subject is a thing you do superbly well, Salmon.

Posted by ottorock | Report as abusive

I agree. Well done, Felix.

Posted by Gotthardbahn | Report as abusive

I saw the NYT reporter Joe Nocera on John Stewart’s show were he criticised CDS. What was apparent was that he did not really understand what he was talking about. He was just getting angry – probably because he considers that anything he is too dumb to comprehend must by definition be “evil” rather than a statement on his IQ.

Posted by Domination | Report as abusive