MBS MID-DAY: Moderate Losses, but Ample Volatility as Markets Digest ECB

By the time this morning's ECB QE announcement hit, there was little doubt about it's existence.  Bond markets spent the overnight session continuing yesterday's anticipatory sell-off.  One of the key ingredients in that weakness was the fear of the unknown regarding the structure of the program.  With that structure now much more clearly-defined, the weakness dialed back significantly from early morning levels.

As expected, the European version of quantitative easing is significantly more complex than US QE, and that's made for a mixed reaction.  There are a few ways to look at it, and no way to know which way is best just yet.

On the one hand, we can look at it as being sufficient relative to expectations--especially considering German Bund yields are right in line with levels seen before yesterday's leak.  On the other hand, if European bond markets actually believed that QE would stoke inflation and help the economy, yields could be moving higher.  In that sense, we could also read this as markets deeming QE insufficient for the task at hand.

Case in point, Reuters surveyed 45 economists on the inflation topic following the QE announcement, and 24 of them said that it would not be sufficient.  36 of them agreed the ECB will need to extend QE beyond Sept 2016--even more of a consensus on the long term efficacy (or lack thereof).

The bottom line is that trading this out is a bit tricky.  With the efficacy in question, a bounce back in German Bunds was an easy call for markets to make.  Treasuries followed, fueled by forced buying among accounts who had bet on rates moving higher (i.e. "short covering").  After that snowball rally ran its course, the rest of the morning has had a very technical, mechanical feel to it--a hallmark of position-squaring and algorithmic trading that follows big moves and heavy/confusing information.

My personal thought is that while ECB QE may not have been as aggressive as will ultimately be needed, it's still something.  For the Eurozone, it's something that many market participants thought would never happen on Germany's watch (who knows... they may try to block this one just like they blocked OMT).  Assuming Eurozone yields are as low as they are due to inflation and growth expectations, even if this only helps a little, that would be bad for us.  We should be sensitive to that risk in the near term.