As is the case for most things in life, I would have been better off had I listened to Yoda.
Even Bart has learned his lesson and has not been suckered into trying to pick a top in the bund market during this latest move higher.
I am not quite as smart as Bart, and my short from a couple of days ago has quickly turned into a disaster.
Yesterday’s ECB’s announcement has certainly proved to be far from a fully “all baked in” affair. Even though much of Draghi’s plan was telegraphed weeks in advance, the reaction has proved that the market had remained skeptical right until the last minute.
Since Draghi unveiled the details of his plan, the EUR especially, has in technical terms, shit the bed.
And with the currency debasement, the European stock market has exploded higher.
Although the ECB’s QE plan exceeded expectations, it is difficult to argue that it was this far above expectations. My guess is that many market participants had been badly burned by Draghi’s promises over the last six months, and had remained in a “show me the money” stance. Combine that with the fact that the really big long term money needs to wait for the actual change in policy before executing portfolio changes, you have a situation where the markets are surprisingly inefficient at quickly discounting the policy.
It might take a day or two still before things settle down.
As is often the case, Martin Enlund from Nordea Markets has the best chart which compares the ECB’s QE to the Fed’s last two programs.
You can see that the markets took a few days to fully price in the US QE programs.
The fact that it is Friday also leads me to believe that this morning’s rout is one final “just get me into the trade” push. I have often seen these sorts of emotional moves end Friday at lunch. The final capitulation happens in the morning as traders can’t imagine anything but the trend continuing over the week-end. By lunch time everyone who had to put it on (or get out) has done so, and it marks the end of the move. If I had to guess, we will see the low in the Euro sometime this morning.
Now don’t get me wrong, I wouldn’t be trading Euros from the long side for anything more than a short term trade. Nor would I be shorting Eurostoxx. Draghi has indeed come through with a QE program that is big enough to stop the deflationary spiral in Europe.
There are plenty of different analysts that have gone through the program’s numbers, so I won’t bother regurgitating them here. I would say that the only thing that was a disappointment was the fact that the ECB seems to have done the bare minimum when it came to the sharing of the risk. My guess is that Draghi realized that if the ECB did not share any risk, the market would view that very negatively. He therefore convinced the Germans that zero risk sharing was not an option as it would send a terrible message. The 20% risk sharing from the ECB was the Germans acquiescing to the smallest amount possible as to not roil the markets. I think it sends a very poor message about the future of the EU, but that is probably a story for another day as today, the markets have taken the ECB’s QE program as unambiguously great news.
This lack of risk sharing has probably hurt my short bund a little more than would have otherwise been the case. At the margin it makes bunds more attractive as the Germans are limiting their exposure to the other nations to 20%.
But I am hanging tough with my bund short. I still contend that QE programs are bearish for the long end of the yield curve, and now that the ECB has fully stepped up to the plate, it is time to fade the bid in the long end. I would be more worried about my bund short had Draghi under delivered. As it is, the market is saying that he definitely has put the pedal to the metal enough to stimulate. If he is as successful as the FX and stock market are signalling, then the long end of the bond market should be a sell.
Something to think about
I will write this up further on Monday, but I want to leave you with one idea. Over the past few years the Bank of Japan has been the most aggressive Central Bank out there. The BoJ has managed to move the EURJPY form 95 to 150. They have stolen export growth from the Europeans, and have been one of major contributing factors to the EU’s deflationary morass. I have always contended that eventually the Europeans would be forced to respond. It looks like that day was yesterday.
But if the trend of Japan stealing growth from the EU is over, what does this mean for the Japanese stock market? I think it is worth a shot on the dark side…