The leaders of the ECB are worried about how they will deal with bonds worth 8.8 trillion. euros that the bank has accumulated in its portfolio, and so far the markets are calm. This sense of calm narrowed the spread between German and Italian bond yields, known as the spread, to around 190 basis points from 250 basis points. where he was in September. And that calm will cheer up ECB officials at their meeting next week when they announce how they will continue to cut the bank’s portfolio. But whatever they are planning, there is a risk that they will cause new volatility in the bond markets.

As Ute Rosen, a derivatives expert at Union Investment, points out, “The situation is shaky and ECB officials might think they might risk an aggressive contraction of his portfolio because spreads are so low. The challenge lies with President Christine Lagarde and her colleagues, who are expected to announce their portfolio reduction strategy on December 15 along with the next interest rate hike of at least 50 basis points. And while they have every reason to focus on how to curb inflation, which is at its highest level in decades, a major market shock would be an especially costly side effect.

Meanwhile, the US Federal Reserve, the Fed, is signaling to the market that it will move with more moderate interest rate hikes, and investors are now betting that the global monetary tightening trend will ease. Uncertainty around the eurozone, higher interest rates and the need for government loans could disturb the calm in the markets. We have experience of what happened a few months ago in the UK market with Liz Truss’ experiments in economic policy. Aware of the volatility of the situation, ECB officials tend to accept the idea that they should start shrinking the bank’s portfolio indirectly to avoid investor attention and project interest rates as the main tool of monetary policy. Most board members tend to take Ms. Lagarde’s “balanced and predictable” approach of not reinvesting maturing bonds instead of selling them. It is not yet clear if they also prefer to set a cap on portfolio shrinkage as additional insurance.

Bundesbank chief Joachim Nagel hinted last week that such precautions might not be needed, noting that markets “seem to be very resilient” and “logically could handle the ECB’s passive portfolio contraction.” Probably, very soon his theory will be tested in practice.

Most members of the bank’s board of directors tend to use the Lagarde approach rather than reinvest maturing bonds.

The biggest risk is economic uncertainty. The picture emerging from the polls has revived hopes that the recession may not be as deep this winter, meaning that inflation could remain high for some time. Of course, deteriorating conditions could affect demand and further accelerate price increases.

Another unknown factor is how much debt governments will have to issue if the public needs more support to overcome the energy crisis, and how investors will react to issuing new debt. The ECB has already warned that if too much support is offered, it could lead to further interest rate hikes. And, of course, any concerns about debt sustainability could be further heightened if fiscal discipline rules, which remain suspended until 2023, are eased. Italy is the most vulnerable part of the eurozone as new prime minister Georgia Meloni tries to curb demands for fiscal easing. manifested in the ruling coalition.

Moody’s has warned that Rome may fall short of public finance targets. However, even without the Italian crisis, the situation is precarious. Analysts at Goldman Sachs are discounting the yield on Germany’s 10-year bonds to 2.7% by the end of the first quarter of the new year, up more than 90 basis points. compared to current levels. Even the ECB’s cautious approach could be dangerous if there is too much time to announce details, leaving room for speculation.