MBS Live Day Ahead: Bond Markets Debating Seriousness of ECB Tapering Risk

By: Matthew Graham •

Seemingly overnight (in fact, it WAS overnight yesterday), the notion of a European taper tantrum burst on the scene following comments from ECB President Draghi.  Those were as follows:

  • All signs now point to strengthening recovery in the EU
  • Deflationary forces replaced by reflationary ones
  • growth will be above trend and well-distributed among nations
  • inflation will still be muted due to temporary factors
  • still need a considerable amount of accommodation to get through those temporary factors
  • ECB will need to be gradual in adjusting parameters

Now this morning, the ECB is already trying to do damage control, saying Draghi intended the comments to balanced and that markets took him way out of context.  ECB sources further asserted that markets "failed to take note of caveats."  We can assume they're referring to the parts about still needing considerable accommodation and about the need to be gradual.

But the ECB fails to realize that the caveats are pretty worthless!  The need for considerable accommodation for TEMPORARY factors blatantly implies that considerable accommodation is itself temporary.  The need to be gradual in adjusting parameters is utterly insignificant next to the fact that the ECB is talking about adjusting parameters in the first place. 

This is a mistake that both the Fed and the ECB have reliably made when it comes time to pull back on accommodation.  They think markets can take these comments in stride because they're saying "hey guys!  We're still going to be really accommodative... just not as much as before."  In fact, markets are most interested in the big pivot--the big turning of the big corner--the big shift from "adding new bonds" to "holding steady."  That's what the Fed's taper tantrum was all about, and that's what Draghi's original comments hearkened just over 24 hours ago.  Bonds clearly didn't like it.

Today, then, will be all about deciding whether we're dealing with underlying truth in Draghi's original comments, or if he simply botched the delivery and is now honestly attempting to set the record straight.  Volatility in German bond markets (the EU benchmark) suggests it's still up for debate.