The European Central Bank has delivered a two-pronged adjustment to its bond-buying programme that has surprised a number of leading bond investors.
The central bank used its December meeting to announce a predicted extension of its purchasing plans to December 2017 – or beyond if necessary – but dropped the size of future purchases.
In the lead-up to the meeting many investors had said tapering talk could produce unwanted uncertainty in the market, particularly in the context of the Italian constitutional referendum result.
The decision to extend the policy at a rate of €60 billion per month from April 2017, down from the existing level of €80 billion, has surprised some investors who fear this could foreshadow tapering fears impacting markets. However, Draghi stressed ‘tapering has not been discussed’.
Planning for political pain
Paul Brain, Newton fixed income team leader, said the outcome was a surprise but consistent with the ECB’s unwillingness to meet market expectations, while also being cautious of not causing panic.
Traditionally, the ECB tries to avoid doing what the market expects. So with the market pricing in six months of €80 billion purchases, it is not surprising they moved to €60 billion for nine months, which keeps the markets on their toes.
In addition, the extension of the deadline makes sense as it extends the purchases to underpin markets during the period which includes the German election, as well as elections in other European markets, which could cause volatility.
Tapering is a term many people are concerned about, if this indeed tapering at all. As we saw in May 2013, any move towards tapering, even talk of it, can cause a curve steepening and is seen as historically bad for bonds. But again, you have to ask if this is tapering?
Flexible focus for Super Mario
Bond specialist Gilles Pradère, who works for Swiss group RAM Active Investments, said the ECB has shown is flexibility by expanding the purchasing range, while it has not reduced scale.
The focus was always going to be on confirming the pace of reduction and how that had been discussed between the previous meetings. What we actually see is he is buying more over the period, as €80 billion over six months would only be €480 billion, so there is still greater support there.
By allowing the purchasing programme to move into areas below the deposit facility rate of -0.4% shows a flexibility to address the long-end of the curve, even though that rose immediately after the announcement. The German 10 years, for example, have been squeezed since March and the target on purchasing shorter-dated, negative-yielding debt can alleviate that.
There are some lessons from the Bank of Japan, which announced its own 10-year bond horizon focus and the market was up in arms. But if you look at the performance since then, there has been relatively stability. The ECB has done something akin to this but with more flexibility.
Extreme nervousness emerges… again
Global macro Citywire AA-rated manager Lucio Soso of Swiss group Bellevue said market expectation of a ‘silver bullet’ solution for Italy’s woes were misguided.
The ECB continues to do its job. What I have noticed is that the market tends to over react to short terms news and it has become very volatile. In particular after the ECB announcement, Italian bonds went up now they are strongly down.
I don’t know what the market was hoping for, were the hoping that suddenly the ECB would come out and save Italy? After all, the 10-year bond yields in Italy hit a low of 1%, it’s now corrected quite a bit it’s now just at 2%, which is still extremely low by historical standards.
It’s a sign of the nervousness of the market, to see this big volatility surrounding this announcement and it’s really the nervousness of the market that makes me very cautious.
The same thing could be said for the election of Donald Trump, right after election equity markets lost 5%, bonds went up and then within a couple of hours the trend was reversed. So it’s really this extreme nervousness which tells me that we might be close to a major market event.