Over the past days the long-end of the European sovereign curve experienced a remarkable rise in yields, following the chatter that the European Central Bank (ECB) might commence tapering its Eur80bn quantitative easing program (QE).
On Wednesday, yields on the 15 year+ sovereign curve widened by circa 260 basis points following the first ‘taper tantrum’ as investors’ digested negatively a report that ECB will commence winding back its QE program post March 2017. Are these rumours well-founded? Or is this a political market chatter which enables the ECB to fulfil its QE program?
Lead market participants are of the opinion that the recent rumour report is possibly the ECB testing the waters of a potential taper of the well-known form of monetary easing, the QE program. However, in my view investors should not be carried away by
However, in my view investors should not be carried away by rumours. Despite improving data in Europe, fundamentals are still weak. Inflation which is one of the prime mandates for the ECB, improved to 0.4 per cent in September, the highest level since October 2014. The current levels are still way below the 2 per cent inflation target which the ECB is aiming for. So why should the ECB consider tapering at such an earlier stage?
From a theoretical perspective, the sole motive I can envisage at this stage for the ECB to taper is the high probability that the Federal Reserve will hike in December, thus pushing the USD higher versus the Euro, implying a more competitive Europe in terms of exports. However, looking at the 3-month forwards contracts Eur/USD, the hike seems to be priced in by the market. Thus the re-assurance that a rate hike in the U.S. will push towards a weaker Euro is not so clear cut. It all depends on future rate hikes after that of December.
Thus the re-assurance that a rate hike in the US will push towards a weaker Euro is not so clear cut. It all depends on future rate hikes after that of December.
Big banks believe that the rumour is more of a miscommunication. For instance, Barclays expect that the QE program will be extended, however with a reduction in the pace of monthly purchases. Undoubtedly, the ECB is being faced with a tough nut to crack in terms of supply by the market. In fact, in its latest QE measures it had included selective corporate bonds in its bond buying program.
Likewise, BNP Paribas believe that such policy adjustment is premature and do not envisage an imminent move. On the contrary, they are of the view that the ECB will extend its monetary stimulus beyond March 2017.
In my view, the recent sell-off within European sovereign debt was a panic move by investors’ which opted in realising recent gains following the leaked rumour. Let’s be realistic, the ECB itself has lately pointed out that growth forecasts are unlikely to be met. So would tapering be a rational move? What definitely would not make economic sense is a further cut in interest rates, which would increase further pressure in the banking system.
Moving forward, in my view a tightening of yields is not off the table. Apart from the monetary chatter, let’s not forget the possible events which could tremor markets and thus see a shift once again to safe heavens such as sovereign bonds. Italy’s referendum for constitutional reform is next and to date polls seem to lack Renzi’s proposal, so be aware of possibly further market volatility.
This article was issued by Jordan Portelli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt .The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd. has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.