How to Trade Mario Draghi’s ‘Taper Tantrum’

The world economy is overtaxed and swimming in debt. The combination offers little chance for growth.

With career politicians asleep at the wheel, central bankers have come to the rescue.

As we know, most central bankers don’t have any real world experience. OK, some do. But, they remain hopelessly detached from the real world. All central bankers believe that economic theory predicts how the real world works.

Unfortunately, that idea couldn’t be more wrong.

Economic theory has completely failed.

The world has remained trapped in a reckless monetary policy experiment. One that involves aggressive money printing, and near-zero or negative interest rates.

The experiment has blown the largest asset ‘bubble’ in history. What am I talking about? And how can you trade the next move?

I’ll explain…

The bull market is over

Central bankers have created a nightmare…

We know it.

They know it.

Unfortunately, central banks will never admit that they are wrong. There’s too much up for grabs. Aside from losing their power and high paying jobs, financial markets would melt down overnight.

Mario Draghi, President of the European Central Bank (ECB), is a great example of the status quo. Draghi keeps pretending that the monetary experiment is going to plan. He’s now ‘tightening’ the bond buying program. As CNBC reported on 8 December:

‘The European Central Bank (ECB) announced a continuation of the bank’s generous asset-buying program on Thursday, although a reduced pace of purchases is set to start from April next year.

‘Current asset purchases of 80 billion euros ($86 billion) a month were due to end in March 2017, but will now be extended until at least December 2017 and will be cut to 60 billion euros a month from April 2017, the bank said in a statement. Benchmark interest rates were left unchanged.’

Make no mistake: the decision confirms the bond bubble is over.

If you want to survive the future, I urge you to stay clear of government bonds. Government bonds have peaked. This is shown by the US 30-year bond on the chart below. Government bonds peaked on the letter ‘P’ in July.

Click to enlarge

Draghi’s decision surprised the market. Most economists thought he would extend the bond program by about six months at the current rate of €80 billion a month. The bond market didn’t know what to make of the mixed decision. Hence the continued bond selloff around the world. CNBC elaborated on the confusion…

“The ECB just surprised by announcing that they will extend their QE (quantitative easing) program by at least nine months, though at a smaller pace,” Carsten Brzeski, a chief economist at ING, said in a note.

“Even without calling this tapering, the ECB just announced tapering. It is the combination of extending and tapering that we thought would not yet happen as it could risk an unwarranted increase in bond yields.” 

Draghi spoke at a press conference after the announcement. He argued that the central bank wasn’t ‘tapering’ its bond purchases. CNBC noted:

“There is no question about tapering,” Draghi told the news conference. “Tapering was not discussed today,” he concluded, before adding that the concept of “tapering” has several meanings and depends on who was discussing the term.

As I said before, central bankers will always dismiss reality. This is definitely the start of tapering. However, the decision has been disguised. Draghi extended the bond buying program for another nine months. That should soften the blow…a bit.

What does that mean?

Bonds to rally?

Although the bond ‘bubble’ has peaked, we may see a decent bond rally soon. Remember, no market moves straight up or down forever.

In May 2013, former US Federal Reserve Chairman Ben Bernanke said he would no longer purchase bonds. Similar to the ECB decision, the money printing program didn’t stop overnight.

The decision was, however, a bit different to the ECB’s…

There was no major extension to the bond buying program by the Fed. It would gradually taper (reduce) the amount of bonds it was buying each month, until it bought no more bonds. Following that announcement, a short-lived global bond panic played out.

Bond prices plummeted and yields skyrocketed. Remember, bond yields and prices move inverse to each other. The panic lasted about five months, into September 2013. Once investors realised that there was no reason to panic, the bond market started to rally.

In my view, this current bond sell-off is the preview to the main event. Bonds have already declined for nearly five months, and are due for a bounce.

The real question is, when?

We have the US Fed interest rate decision this week. According to CME Group’s FedWatch, there’s a 94.9% chance of a rate hike. In other words, the hike is pretty much guaranteed. It has mostly been priced into this bond sell-off.

Bond punters now want to hear the Fed’s forward-looking plan.

Of course, the central bankers will come out with a bullish forecast for the world. But it’s all a show. That may result in more selling, as punters can prepare for the next few rate hikes.

The Bank of Japan also meets this Friday. Its decision should provide more clarity on their bond buying program.

The bond market should adjust to both decisions. That may see the sell-off continue into the New Year, before the next multi-month bond rally.


Jason Stevenson,
Resources Analyst

PS: Today, I’m off on a mine site visit to check out what could be the next big name in the resources business. I’ll be releasing the full story to my Resource Speculator readers on Thursday. Don’t miss out on the ‘hottest’ speculative punt going under the radar. Check out Resource Speculator here!

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Port Phillip Publishing, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.

Money Morning Australia