A disagreeable blog about Finance

The melting down of Euro – TPI Special

In part 3 of this series we talk briefly of the new spread control tool from the ECB. A few significant developments have come out, so here is an impromptu follow-up on that topic.

Quick recap

The Melting down of Euro series goes into more detail. But here is the quickest recap of the missing parts.

The ECB did announce a 25 basis point rate hike sometime ago. Despite the marginal significance of this hike, especially in the face of the raging inflation we are stuck with, the market’s response to the news was awful.

ECB balance sheet expansion. Dyno for reference.
ECB balance sheet expansion. Dyno for reference.

The ECB has under its belt a lot of financed debt. Most of it pertaining to the more indebted, less performing economies. I’m not listing them here but, regardless, the perspective of a sensible rate hike implies making the sovereign debt of the most troubled economies more… the term I’m looking for here is competitive.
Which of course means more troublesome to service on the debtor’s part. That is what made the markets nosedive hard.

But the worst part is that this made the yields of EU sovereign bonds go all over the place, with significant spreads. When mama ECB is not flooding the bond market with freshly invented money, then price discovery takes over and the most risky assets are free to reach their true valuations. It happens all the time. It will happen again. 

This is what kept the ECB stuck for years, preventing any significant rate hike. But the current geopolitical environment, inflation in particular, is now forcing the ECB’s hand. Therefore a new tool deemed capable of capping the spreads across EU bonds was announced. No clear details on how that was supposed to work were known at the time. Markets were left to speculate.

What happened since then?

After an amount of time which is hardly excusable, the ECB did indeed deliver some details about this new financial facility. The new tool is called TPI, standing for Transmission Protection Instrument.

Since the last time we spoke about it, the ECB has doubled down on its initial take on the interest rate hike, performing instead a 50 basis point raise, which is double the amount initially announced. Still a tepid move, but at least they made an effort. Simultaneously, the TPI was introduced, in order to stabilize the spreads.

What was the market response?

The TPI was designed to hit the market in the “on” mode. Making its effects known immediately.

Accordingly, no further market degradation happened in the short term, and bond spreads remained under control. So far so good right?


The ECB put together a tight press release, explaining what the TPI is supposed to be, and how it is supposed to work. Read all you want, it’s a bunch of good intentions expressed in legalese. But a few tidbits are out, and we can discuss them.

For starters, what is known about this tool, apart from its terrible naming, is that it consists of the ECB selectively performing purchases of member-state bonds under certain conditions. The aim is to keep spreads under control by supplementing the demand of other investor entities.

At the end of the story this rather verbose definition means, in layman terms, that the ECB will be acting as a preferential market maker in the bond market. The ECB has been at it since 2014, so no changes there.

When the TPI was announced but not yet clearly defined, the market decided to price it immediately by making an assumption: “This is just more Q.E. but marketed with a different name“.

Was this assumption proved to be correct?

Spongebob says: Obviously

But let’s dig deeper. It turns out that one of the conditions necessary to enable this facility is, not kidding here, observing the markets not being aligned with the fiscal policy of the grantee member-state. 

As if the ECB knew better than the free market. No changes there too: the call of the ECB to dictate to the markets what is worth what, instead of the other way around, is a long standing one.

The noticeable thing is that today the ECB has graduated from the naivete of the early years and it seems that the carrot-and-stick approach is the way forward. 

Therefore there are constraints put in place to prevent indiscriminate access to the TPI. Some conditions have to be met. Conditions that are meant to coax the governments to take on a virtuous path toward growth and therefore debt control.

Let’s look at them:

Carrot and stick clipart
  • the member-state must not have any outstanding infringement procedure. Thank God.
  • the member-state must be in compliance with the EU fiscal framework, implying that its deficit spending is in check and that it has responded to EU council recommendations
  • the government must exhibit an absence of severe macroeconomic imbalances, which is sort of redundant with the previous point (but you know, lawyers…)
  • it must demonstrate fiscal sustainability, based on debt-sustainability analyses by the EU Commission.

And here is the ambiguity: the way I see, and the way the market sees it, if a member state is committed to satisfy these conditions long-term, there is no reason for their bond yield to go haywire. In this scenario, the markets don’t have any compelling reason to shame the country’s bonds into oblivion. 

On the contrary, meeting all of these criterias make up for a terrific investment. Those are hallmarks of an economy which strives to be healthy and develop itself. A safe haven.

I am getting mixed signals here. The occurrence of the conditions necessary in order to access the TPI lifeline, implicitly negate the scenario in which the TPI is even needed.

On paper, the ECB seems to be of the opinion of activating this facility when everything is good. It’s a catch-22 on their part


Apologies. My background is in engineering. It is notorious that those of our kind are cleansed of any emotional gauge as part of the unspeakable ritual that leads us to become what we are.

Perhaps it is that missing emotional gauge that prevents me from correctly evaluating the rules of engagement of the TPI. You see, the only things I am looking for in this press release are entirely missing: numbers, ratios, thresholds. Good old brutal boolean conditions that can only be undeniably true or false.

It irks me to see rules of engagement worded like this. Why? Because the TPI is a lifeline. It is an a-la-carte market maker with unlimited liquidity. It is born under duress primarily to push a specific member of the EU. 

Not having hard boundaries and known KPIs that can be evaluated in order to access the TPI is a mistake. It leaves the decision on BCE’s lap. The yes/no response stems merely from a bunch of guys arguing over it. The alpha one gets to decide. Whether this tool will be used or not, and how, will be the fruit of entirely subjective decisions

Anyone seeing the danger here?

We are on the verge of entering a financial downturn in which central banks can not be of any help. Inflation must be stopped. They can only keep raising interest rates higher. It is the worst possible one-two punch for any economy.

And for those economies, accessing the TPI means easy money. A nice line of much needed coke.

Here is a list of countries that right now are other potential fruitors of the TPI:

  • Belgium
  • Cyprus
  • France
  • Greece
  • Portugal
  • Spain

Ask me in 3 months, the list will be longer.

All of these countries have displayed remarkable performances and guidance, at least compared to the first-in-line fruitor of the TPI, whose name shall not be spoken. It’s going to be hard to make a case against any of them accessing the same facility.

Which brings us here: with the addition of the TPI, the ECB might have derailed its attempt to raise interest rates. The TPI has all the numbers to entirely defeat the purpose.

But wait, there is more.

The TPI is designed to work in an ON-OFF fashion.

This is a minor offense, but a very naive one. It causes a known hysteresis effect for which the TPI will be invoked in times of need, and the times of need will simply not end. The reason is simple, it’s due to the anticipatory reaction of the markets.

TPI on” means kicking the can down the road and having a happy time. Let’s just not kid ourselves here: it’s a line of coke, that’s all it is.

The consequence is that transitioning back to “TPI off“, or even having a set deadline to do so, will induce a painful shock. A knee-jerk reaction. Market tantrum. Call it whatever you want, but what the market will discount in this case will probably have the effect of inducing another TPI call shortly after.

Market do like money.
Market do tantrums when no more money. 

Osho, not really.

It’s as simple as that.

This new facility from the ECB wraps together the best of their good intentions, inside a thin veil of words. I guess we will see down the line its effects. Right now, and I have the feeling I’m in good company with this, the only takeaway is that

TPI is de-facto more QE.

Sacro, 2022. (Sorry for screaming)
Yes, more Q.E!

Which means that no measure is ever going to be enough.

According to the way the TPI activation logic is worded, and I suspect intended, debt sustainability is part of the evaluation. I think they didn’t really have time to sit down and think this through. 

Here is the problem as I see it. Typical scenario:

  1. The ECB raises interest rates
  2. a member state, as a consequence, cannot service its debt. It is now “not sustainable”
  3. the ECB is forced into using the TPI to control spreads
  4. the debt of the member state deepens
  5. GOTO 1

This causes a runaway effect. I mean, it’s evident. Just look at the code above, clearly it is an endless loop.
But no, seriously, one cannot expect the solution to excessive debt burden to be more debt. It’s two steps away from the definition of insanity.

I am quick to assume that the intervention of this tool can, and will, be overextended. To further complicate things, it seems that the ECB has not put in place any safegard on the circulating money supply. I can be wrong on this, so please correct me, but it seems that the money supply generated by the TPI does not need to be counterbalanced on the ECB side. This would also imply further dilution of the currency pool. 

The Euro is trading at 1.01 against the US Dollar as I am writing this.

Any buyers? None?
Too bad, I wonder why.