Earlier this morning we noted that the ECB’s Vitor Constancio tried to walk back Draghi’s “I’ll look through lackluster inflation” comment which, you’re reminded, sent the euro to a 1-year high.
Constancio’s remarks were initially brushed off but ultimately, EURUSD took a dive to a fresh low for the session under 1.1300 after it emerged that the ECB now thinks the market might have misjudged Draghi (imagine that). So we got this:
Attempts to walk things back aside, it’s abundantly clear that we’ve reached a tipping point.
You’re going to have to decide, once and for all, whether you’re buying into the idea that central banks are going to start rolling back accommodation.
Former FX trader Richard Breslow has some thoughts on that in his Tuesday missive.
A couple of things worth paying extra close attention to in what you’ll read below: the bit about Germany having to pay a price (higher yields) for normalization as the ECB will have to deviate materially from the capital key as they taper in order to keep periphery spreads from blowing out and the last bolded, underlined passage about how you should be watching for reactions to dovish comments more so than hawkish leans.
The question you need to be asking yourself right now is, “has the damage been done?” ECB President Mario Draghi’s comments were over-interpreted and the projected timeline greatly exaggerated, according to his vice president Vitor Constancio. The FOMC’s hawkish core is having to co-exist with a growing chorus of members backsliding on the pace of rate hikes. The BOE’s Mark Carney is plaintively imploring fellow committee members not to panic over recent inflation prints. But the fact of the matter is, after Tuesday’s news and price action, sovereign bond markets have done the seemingly impossible. They’ve technically broken their downtrends in yields.
- It was no small feat. And the fact that it was very much a global phenomenon makes it all the more significant. Investors should have been jolted into the realization that we just might be about to enjoy the healthy benefits of a two-way market
- Before you can get a true trend reversal, you need to break the sense that the extant move is inevitable. And we’ve done that on the charts. Now we wait for the fundamentals to catch up. And they will, if for no other reason that price action will need to be explained
- The market to watch more closely for confirmation or rejection of the latest moves will be in Europe. U.S. yields are certainly low, but make some sense in the global context. Those of the euro area border on the ridiculous. Unless you think ECB buying continues and all this talk of a strengthening economy is just more wishful thinking
- And make no mistake, in the big picture, yields everywhere have an inexorable tendency to rise or sink together. The same holds true for equities. Which is why it’s hard not to be just a teeny bit skeptical when central bankers talk about inflated asset prices — very much helped on their way by sovereign wealth funds and the like. But it probably makes some sense to either steel yourself to maintaining a buy-and-hold strategy or, proactively, reconsider your risk levels
- On a more fundamental level, become fixated on any mention of the ECB’s capital key for asset purchases. We know they already fudge with it, sometimes brazenly. But there won’t be a successful taper of any kind unless it’s pretty much thrown in the dust bin altogether. Unless they want to see peripheral spreads blow-out. It’s an interesting question just how much of a price are the Germans willing to pay to get monetary policy changed?
- Will yields begin to normalize or go back to business as usual? Pay attention to how they behave to dovish news and comments. It will be more telling than anything hawkish. If this is something more than a false break then traders will look at soft data and decide it’s actually become an opportunity to sell. If they go with it, it’s just back to the future