A real chance of European Central Bank taper tears

Despite scepticism, there may be scope for an ECB taper tantrum that dominates the bond market in coming months.

No ECB officials have put their name to the taper talk. Picture: Sean Gallup/Getty Images.

If investors really believed that the European Central Bank was considering tapering its €80 billion ($118bn) per month quantitative easing (bond buying) program before it expires in March 2017, the reaction in global financial markets on Wednesday would have been much greater.

But while the market is understandably sceptical, it’s hard to discount the possibility that the ECB has indeed floated a plan to start tapering.

The consensus has in fact been that the ECB will extend its QE program, so when Bloomberg reported that unnamed ECB officials said the central bank will probably wind down its bond purchases before March, it caused a sharp rise in European bond yields that flowed through to global bonds, equities and precious metals.

Together with property, these assets have been major beneficiaries of central bank bond buying, which has been a major driver of record-low interest rates and liquidity globally. A reduction in ECB bond buying could trigger a substantial correction across the board, similar to that seen after former Federal Reserve chairman Ben Bernanke floated a tapering of US QE on May 22, 2013.

The US “taper tantrum” saw benchmark US 10-year yields rise from 1.92 per cent to 3 per cent over the next three months, while the US S&P 500 share index fell as much as 6.5 per cent over four weeks, and spot gold fell about 24 per cent over 18 months. Of course the Fed made tapering contingent on economic improvement and didn’t actually start the process January 2014 — 20 months after the idea was floated.

Back then, the stockmarket soon got over such concerns because investors felt the Fed had their back. Also, in 2013, the fallout on global markets was partly mitigated by the fact that other central banks were still cutting rates and firing up their quantitative easing programs. That is largely still the case, except that the US has ceased its QE and has started lifting official interest rates, and the BoJ seems to be getting cold feet on increasingly negative interest rates.

But even with the lack of official comment so far and the ongoing asset buying in Japan, there may be scope for an ECB taper tantrum that dominates the bond market and rubs off on other assets in coming months.

That would be bad for the “bond proxies” near the top of the “bondcano” that Credit Suisse strategist Hasan Tevfik warned about two weeks ago.

Yield plays underperformed again on Wednesday, with Transurban down 3.2 per cent, Scentre Group down 2.6 per cent and Sydney Airports down 1.9 per cent versus a 0.6 per cent fall in the share S&P/ASX 200 index.

Benchmark Australian 10-year bond yields rose 6 basis points to 2.13 per cent on Wednesday and the charts would suggest that if they were to break above the September high of 2.17 per cent, the bondcano could erupt.

But as far as Saxo Bank strategist Kay Van-Petersen is concerned, the ECB taper talk doesn’t stack up.

“If it is really from ECB officials, then it reeks of politics and is not going to be on the cards anytime soon, and definitely not before you have gotten through the Italian referendum on December 4 nor worked through Brexit details,” Van-Petersen says. He also rightly points out that eurozone inflation is lacking, with core CPI is running at a paltry 0.8 per cent versus the ECB’s target of 2 per cent.

According to Van-Petersen the ECB is almost certain to extend the asset purchase program through March. Still he notes that “if the ECB was to hypothetically throw in the towel at some point, the euro would lift by 2-3 figures easily and bund yields would fly.”

But while no ECB officials have put their name to the taper talk, Bloomberg cited more than one official, and it had the added detail of a potential €10bn ($14.73bn) a month reduction in bond buying, although it said no decision had been made and QE could still go past the current end date. Of course the ECB now holds the upper hand — an untoward sell-off in global markets would almost certainly generate a denial.

But IG’s chief market strategist Chris Weston notes that at 1.6 per cent, eurozone GDP has been growing above trend for some time, credit growth is showing signs of green shoots and European corporates are issuing more debt than at any other point in history.

As far as Weston is concerned, the ECB taper talk fits with a changing tide among central banks that’s seen the Fed start tightening, the BoJ add “yield curve control” to its monetary policy — apparently to reduce the strain of bank earnings from negative interest rates, and the RBA shift to a more explicit “neutral” policy bias.

“I think most people realise that if there is a major shock to financial markets again that central banks probably aren’t going to be the calming mechanism they’ve been over the past five or six years,” Weston says.