Thursday 6th July 2017
Why take it calmly when you can get in a flap about it ? The markets contemplate changing realities ......
ref :- "German Bund Yields Surge to 17-Month High After French Auction" , Bloomberg Markets
News this morning that an auction of French 30-year securities met with reduced levels of demand had a predictable effect on already jittery bond markets. Prices took a hit as yields were pushed higher across Europe by an average of about 7 basis points, with US Treasuries and UK Gilts not far behind.
It's not as though the issue was actually undersubscribed, but it's reasonable to assume that the fact that there were fewer investors queuing up to snaffle government paper reflects the new wisdom holding sway in the market. Contrary to the previously-held belief that ECB boss Mario Draghi was still in doveish mode and not yet ready to contemplate withdrawing stimulative monetary policies, it turns out that Super Mario may be encouraged enough by improving economic fundamentals to consider tapering the ECB's bond purchasing programme after all.
In the 8 trading days since investors started to take a new view of Mr Draghi's leanings, yields on 10yr German Bunds for example have risen from about 24bp to a high this morning of over 54bp, a 17-month peak. You know, we may have been away but we've been watching and even after all these years we are constantly surprised by the market's predilection for overreaction. We're not talking so much about the price movements -- a 30bp rise in yields as the market adjusts to the realization that a scaling back of super-accommodative policies (is that a word ?) may come slightly sooner than expected is not outrageous. Rather, it's all the melodrama that goes with it .....
The whole point of the ECB's unprecedented policies was to foster growth, employment and a bit of inflation, wasn't it ? The inflation part of the equation may be lagging behind a bit but as we've discussed quite a lot recently, the fundamental dynamics behind inflation may changing .... well .... fundamentally. But with regard to the ECB's other ambitions, things are progressing well ..... something the data has been saying for some time to all those who cared to listen. Surely, in those circumstances, it's not unreasonable to see the central bank adjust their strategies ? It's worth remembering that easing monetary policy to the extent that we've seen in recent years could never have been envisaged in normal circumstances, and as economies recover it's only sensible to expect at least the first tentative steps towards policy normalization.
Any normal person, i.e. one untainted by market experience, might suggest that such a development was foreseeable, so why all the doom-mongering and talk of "Taper Tantrums", a reference to the bond market collapse of 2013 after poor old Ben Bernanke, then Chairman of the Fed, merely suggested that they might begin the process of tapering their QE programme ? Shouldn't savvy market professionals see these things coming, and hedge their bets accordingly ?
It's a very good question, and one that we're not sure we can answer. Perhaps the super-low rates and the QE programmes have fuelled the surge in asset prices for so long that some investors are reluctant to picture a future without them. There's still an argument for saying that any form of monetary tightening would be premature until inflation picks up more strongly, changing dynamics or not. Besides, never mind the data, what about forward guidance ? If the impression of a newly hawkish Mario Draghi is a correct one, that's at odds with the message he's been communicating up till now.
As a general rule of thumb, you wouldn't go wrong too often in assuming that markets will overreact. That's just what they tend to do ....***
*** ..... until they don't, that is . Does anyone else out there feel that the North Korea question is uncomfortably close to getting out of control ? If it comes down to President Trump having to ignore provocation to steer a safe passage to a de-escalation of tensions, the evidence of his presidency so far suggests that it might not be one of his strong points. But the market reaction ? Zilch .... No overreaction here, and we just hope no complacency either.***
Anyway, the prices higher / yields lower story has been in control of bond markets for so long that it's not surprising if you hear a few squeals as investors are forced to re-evaluate. But have we reached that point ? For what it's worth, and without trying to sit on the fence, the truth of the matter probably lies somewhere in the middle of the two extreme views the market might be considering (as it so often does) :
Yes .... the market is right to price in the start of monetary tightening, or rather a scaling back of monetary easing. Most of the economic fundamentals support it. But that inflation data is still puzzling the ECB, and if Mr Draghi surprised the markets the other day, ECB Chief Economist Peter Praet is still cooing like a dove. This is going to be a long, cautious and gradual process. In short : react by all means, but don't overreact.