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Is the ECB Going to Taper or Extend QE After March 2017?

Is the ECB Going to Taper or Extend QE After March 2017?

Talking Points:

- Today’s European Central Bank meeting wasn’t expected to produce much, as December brings fresh forecasts and deductively make for a more opportune time for the bank to make any potential announcements.

- There was a quick instance of volatility around the opening of the ECB’s press conference, and this may be telling investors a key message about what to watch around the European economy in the coming months.

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This was one of those Central Bank meetings where not much was supposed to happen. The European Central Bank was set to release updated forecasts in December. This would’ve been after U.S. Presidential elections, which could possibly become a harbinger of risk for global markets; and the bank would still have plenty of time to pre-position with whatever decision they made (whether to extend or taper) well-ahead of the current end date of March of 2017. So today felt like a boilerplate type of Central Bank meeting where the objective would be to merely avoid triggering volatility.

And if we look at the transcript throughout the press conference accompanying the statement, much of what Mr. Draghi said was opaque and not indicative of which way the bank might be leaning; he did a really good job of side-stepping some very serious questions from an aggressive European press pool that were hitting on a number of questions that markets have had around the ECB’s QE program; mainly on the topics of scarcity of bonds that still fall under the ECB’s QE umbrella, and whether or not the bank discussed the prospect of tapering their bond buying program.

But price action tells a different story. During the release of the statement, as we neared the press conference 45 minutes later, Euro was down slightly after the bank didn’t make any modifications to rates. But as the presser began, price action in Euro began shooting higher after Mr. Draghi’s evasive responses to questions pertaining to extending QE. This was a really fast, and very violent move that ended up reversing approximately 16 minutes after the press conference began.

Chart prepared by James Stanley

So, while the net impact of today’s ECB decision and press conference is rather muted, the simple fact that we had this incursion of volatility around a certain series or strains of questions exposes something that markets are likely going to be focusing on in the coming months: And that is the prospect of whether or not the ECB can extend QE beyond its currently-designed March 2017 end date.

And the reason for such a theme is very logical. When a Central Bank announces that a bond buying program is going to come-online, in which the bank is going to be a near-constant buyer without selling, this is like a glaring signal to investors around the world that they might be able to get in front of the trade before the Central Bank actually starts to buy. And for markets denominated by supply and demand, the idea of getting near-constant demand from one of the biggest players in the world is really, really attractive. Case in point – the ECB announced that they were going to do QE in July of 2014, with the program set to begin in March of 2015. If we look at the chart below, much of the downward movement in EUR/USD came before the ECB program even came-online. Just days after the ECB actually started buying bonds, the Euro set a low that has yet to be broken; and EUR/USD has spent much of the life of the ECB QE program in some sort of a choppy range:

Chart prepared by James Stanley

But the Euro currency isn’t the only market impacted by QE, is it? The program is centered around bond purchases, and this is where investors can really look to integrate their strategies along with Central Bank efforts. In this particular case, the European Central Bank announced that they were buyers of bonds to a specified interest rate. So, this serves like a resistance level on bond prices as the ECB will not buy bonds below a specific yield. This means not only that investors know that the ECB are buyers, but to what level they’ll continue to buy.

And as long as the ECB remains buyers, this isn’t much of a concern as investors have the assurance of continue demand from one of the biggest players in the world. But it’s when the ECB may be pulling back from that constant demand that problems might begin, and that’s what we saw a glimpse of this morning. Just at the simple deductive illusion that the ECB may not be ready to extend their QE program beyond its current March 2017 end date created that quick rush of strength in the Euro that was faded out 16 minutes later after normalcy was restored.

This would be like a foundation of support beginning to be removed from some very critical bond markets that have been driven to exuberant highs (with low yields) on the back of the ECB bond buying program. This was the rationale behind the Bill Gross call for German Bunds to be the ‘short of a lifetime’ last April. Mr. Gross posited that with many European bonds already trading at the yield floor of what the ECB was able to buy, there was a theoretical limit to how much higher bond prices might trade. But what changed matters here was the ECB going to negative interest rates in 2015; thereby decreasing the yield floor even more, and giving bond prices another shot-in-the-arm higher.

Chart prepared by James Stanley

With the ECB’s current bond buying program nearing its previously-designed end date, markets are beginning to worry that the ECB may not have the ammunition to do more stimulus, as ABS (Asset-backed securities) markets in Europe are significantly less-developed than those in the United States or Japan (both places that have done extended QE).

So, it’s looking more and more like the ECB is going to need to make a significant move at their December meeting: Either extend QE, give another top-side run to bond prices as yields drive even lower, or start to look at tapering QE – which will likely prelude a deluge of selling as investors all run for the door at the same time as a foundation of support is removed from markets.

Nobody knows which direction they’re going to go, and at this point even Mr. Draghi may not know as he was quite evasive at today’s meeting. It’s not likely that the ECB hasn’t yet noticed this risk and that it’ll stay unaddressed. So, for those looking for the ‘big short,’ they’d likely want to steer their attention away from controlled-events that Central Bankers are likely going to try to avoid (like creating panic). More interesting to the ‘big short’ themes are uncontrollable variables like European Banks or the continued slowdown in China.

--- Written by James Stanley, Analyst for

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