Sweden's Riksbank sells the bonds it once hoarded — into an inflation scare

Most months the Riksbank, Sweden's central bank, performs a ceremony that in its larger counterparts went the other way long ago. On September 11th it held an auction at which it offered for sale an inflation-linked Swedish bond, 3104, with a planned volume of SEK 400m, maturing in 2028. The ritual barely moves a screen. Yet its direction is the whole point: the buyer of last resort for Swedish government debt has become a seller, and it is selling just as the country begins importing an inflation scare.

From hoarder to vendor

The habit of buying was itself abnormal. The Riksbank began purchasing its government's bonds in 2015, and during the pandemic added an envelope of SEK 700bn on top of earlier purchases, making it one of the largest creditors of its own state. Since April 2023 it has been unwinding the pile, selling in regular auctions toward a residual long-term holding of about SEK 20bn of nominal bonds. Nearly a decade of buying now un-spools a month at a time.

The exit was meant to be painless. A central bank trimming an emergency balance sheet was, in the textbook, simply reversing the medicine once the patient had recovered. The trouble is that monetary tightening does not stop at the policy rate.

Tightening into a scare

The Riksbank has held that rate at 1.75%, unchanged through the summer, and warned that there is "some probability" of a rise later in the year; some economists already expect a move to 2%. The pressure is not home-grown. Economic activity is weak, and underlying inflation is low. It is imported: the war in the Middle East, and in particular disruption around the Strait of Hormuz, has pushed up energy prices — a shock running for nearly four months, long enough for the Riksbank to say the risk of inflation "becoming too high" has grown. Sweden is a small, open, energy-importing economy. It takes these prices as given, and takes the hit.

Hence the two-front squeeze the auctions make visible. A higher policy rate pulls money out of the economy through the front door; the shrinking balance sheet drains liquidity through the back. In 2020 the two forces worked together to throw cheap kronor at markets. Now they work together to withdraw them, just as a supply shock carried through energy prices has not yet run its course.

The borrowed smoothness

Why has none of this hurt yet? The Riksbank's own analysts offer an answer that should temper any relief: its tightening has so far had limited effect on risk premia and bank deposits, largely because banks and hedge funds soaked up the bonds it sold, financing the purchases with loans. The smooth unwind has been engineered on leverage.

That is a claim on the future. Levered buyers are the marginal holders of precisely the duration a shrinking central bank is pushing out. When the funding that supports them — the market for repurchase agreements — tightens, as rising repo rates already hint, the marginal buyer demands better compensation or steps aside. The risk premia that a seamless exit was supposed to avoid then appear at the moment the balance sheet can no longer absorb them.

The larger lesson travels beyond Sweden. This is a compressed preview of the dilemma awaiting every central bank that printed through a crisis: an emergency balance sheet cannot be dismantled in tranquillity while the shock that justified it still smoulders. For the investor watching from a distance, the details are a warning about assumptions. "Rates have peaked" is not the same as money getting cheap; the cost of capital can stay high through the back door of a shrinking balance sheet even when one policy rate stands still. And the smooth removal of stimulus so far was bought on borrowed confidence, not earned. Sweden, a country that printed kronor and lent them out cheap, is now learning what un-printing costs. Everywhere else would do well to read the auction results.