Fed and ECB Share Responsibility for latest bond Tantrum

 

From my long time friend Peter Wadkins of Thomson Reuters. Peter enters his 46th continuous year in Fx trading from all levels, including head of Treasury for 10 years at New South Wales bank. Peter was on the CME floor in 1983 when AUD began its free float. Remarkable career and from a good, honest, decent god fearing person.

 

COMMENT: Fed and ECB share responsibility for latest bond tantrum

Jul 7 6:34am By Divyang Shah

LONDON, July 7 (IFR) – If you look at the absolute change in benchmark bond yields then on this basis alone the current ECB-inspired taper tantrum is worse than the Fed taper tantrum of 2013. The absolute change in 10-year Treasury yields eight days after Bernanke’s testimony to Congress on 22 May 2013 was around 20bp, which is a lot lower than the 32bp gain in 10yr Bund yields since Draghi’s Sintra speech last week. (The percentage changes are even higher, especially for EGBs)

This is history and looking forward the potential for a more violent adjustment in bond markets is high, but for now central banks are unlikely to be too concerned. There are four key differences between the ECB taper tantrum and the Fed taper tantrum of 2013.

First, it’s not just about QE. When the Fed was shifting gears the market was aware that the gap between QE taper and rate hikes was large. In contrast, the ECB has been trying to contain the debate over sequencing and whether its negative deposit rate can be hiked during the tapering process. The market certainly believes this is possible, attaching a high probability that the ECB will have a less negative deposit rate by the end of 2018.

Second, the bias from major central banks on policy has also shifted. The BoC has been busy preparing markets for a rate hike as soon as its July meeting, the Norges Bank and Riksbank have both dropped their easing biases, and the Fed has been willing to talk about Quantitative Tightening (QT) despite downward surprises on inflation. The backdrop is one of change when it comes to global central banks and has been a surprise.

Third, Fed QT is likely having as important if not more of an impact on markets as the ECB’s tapering desire. Remember that the ECB is talking about reducing the pace at which its balance sheet rises, while the Fed is talking about reducing its balance sheet. The default explanation has been to point the finger at the ECB for the rout in bonds, but the Fed should not be ignored.

Fourth, the market has retained its bias toward investing in bonds over equities. Positioning in the bond market has extended further since 2013, with more sovereign debt trading at lower negative yields and curves a lot flatter. Equities might have rallied but this has been one of the most unloved rallies in history. The potential for a positioning adjustment is greater than in 2013.

For now, bond markets are moving largely as one would expect when policy expectations adjust, and as long as this adjustment is orderly central banks will not modify/delay their plans. While central banks are cognisant as to how markets behave, they worry more about maintaining easy policy at a time when deflation risks have ebbed considerably, risk taking and animal spirits are once again exuberant, and there have been strong cumulative gains in growth/labour markets. Loose monetary policy is at risk of overstaying its welcome. Divyang.Shah@tr.com /db/kl/jb

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