Tuesday, October 4, 2016

ECB Taper Trial Balloon

This is a biggie.  The ECB is sending out trial balloons on tapering QE to see how the market reacts.  If the market reaction in equities is not too negative over the coming weeks, the likelihood of a ECB taper goes up significantly.  The bond market is going to feel the pain in the coming months.  This feels like a mini version of the winter/spring 2013 just before the Fed announced their taper.

In 2012 you had a run to all time lows in 10 year yields on the back of the mini European sovereign debt crisis in 2011.  In 2016 you had a run to all time lows in 10 year yields on the back of a oil market crash.  The parallels are a bit eerie, and there are quite a few differences between the two, the main one is that stocks are overvalued now versus being arguably undervalued then.  But the similarities are there.  In both cases, central banks got too eager to provide stimulus with QE and overdid it, providing much more than the market needed.

These rumors have a lot of substance because the ECB is starting to run out of Bunds to buy.  Remember, Germany doesn't have much of a budget deficit and has a much smaller stock of bonds than US or Japan.  They literally will be forced to reduce their Bund purchases anyway because of the liquidity that they would destroy if they continue beyond 2017.  It will be a monkey in the bond market's back for the remainder of the year.  Plus you have worries about a Fed rate hike in December.  Lots of negative catalysts now lining up in bonds.  Be careful bond bulls.

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