Other than the unflappability of Indiana Governor Mike Pence, and that The Donald could learn something from his running mate’s performance at last night’s vice presidential debate, everyone is talking about the prospect of the European Central Bank (ECB) tapering.
Normally, I would find talk of ECB tapering―in other words, gradually winding down its bond purchases before ending its quantitative easing (QE) program―hilarious if it wasn’t for the fact that it’s having a profound impact on the markets, which are reacting quite negatively to that prospect.
A few comments on why I believe ECB tapering is a non-starter:
First, the talk of tapering is really nothing more than a thought experiment at this point, as opposed to becoming a reality any time soon. These tapering statements are really more to the effect that if and when the ECB is done with its QE program―and the key words are if and when ―it will not cut off its bond purchases in one go. Instead it would gradually taper purchases over time. That is quite prudent for a large central bank, and is precisely what the Federal Reserve (Fed) did when it turned off its asset purchase program. And that thought experiment could be a quid pro quo for the northern Europeans as the ECB gets down to actually extending the QE program.
More ECB Easing, Not Tapering, on Tap
Second, I, for one, still firmly believe that the ECB―and the Bank of Japan, for that matter―is going to be easing rather than tightening or tapering any time soon. Europe’s structural headwinds were already quite heavy without Brexit. With the Brexit timeline now better defined, the likelihood that the ECB could gain anything by tightening or tapering, at least right now, is just not realistic. A strengthening euro, which would be the direct consequence of ECB tapering, as was the case with the Fed and the dollar, is the last thing Europe and the ECB need.
Third, the markets certainly are overreacting to the tapering speculation but are taking their cues from the German bund market. Bunds, from a valuation perspective, have been overextended, and a correction in bunds is neither unexpected nor uncalled for. However, for equity investors to conclude that this is the end of QE in Europe because front-end bunds are selling off is an overreaction, in my judgment. This too shall pass.
Finally, the current episode, like several previous ones, sadly but surely proves once again that central bank policy expectations are the first principal component of market returns, asset class notwithstanding.
As an investor if you get that call right, the rest may not matter. It is still a macro world.
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Below-investment-grade (“high yield” or “junk”) bonds are more at risk of default and are subject to liquidity risk. Eurozone investments may be subject to volatility and liquidity issues.
These views represent the opinions of OppenheimerFunds, Inc. and are not intended as investment advice or to predict or depict the performance of any investment. These views are as of the publication date, and are subject to change based on subsequent developments.