Markets

Mark Gilbert is a Bloomberg Gadfly columnist covering asset management. He previously was a Bloomberg View columnist, and prior to that the London bureau chief for Bloomberg News. He is the author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”

Mario Draghi has one key task at the press conference after Thursday's European Central Bank meeting: Don't scare the horses.

Expectations are rising that the Frankfurt-based institution will soon explicitly announce plans to scale back quantitative easing. With the threat of deflation averted, that makes sense. The risk is that the bond market gets spooked, driving borrowing costs higher and faster than the euro zone's nascent economic recovery can cope with.

Taper Tantrum Redux?
The rise in the 10-year German bond yield this year echoes that of the 10-year Treasury in 2013 (albeit from a lower level)
Source: Bloomberg generic yields

Back in May 2013, the then Federal Reserve chairman Ben Bernanke sparked what became known as the taper tantrum. "If we see continued improvement, and we have confidence that is going to be sustained, we could in the next few meetings take a step down in our pace of purchases," Bernanke said. Ten-year Treasury yields began to ascend, reaching 3 percent by the end of the year from 2 percent before the taper talk.

Draghi's comments a few weeks ago have had a similar effect. "As the economy continues to recover, a constant policy stance will become more accommodative, and the central bank can accompany the recovery by adjusting the parameters of its policy instruments -- not in order to tighten the policy stance, but to keep it broadly unchanged," Draghi said on June 27.

German 10-year yields, which had tried and failed to breach the 0.5 percent level three times, took that as a signal that the days of easy money are ending. They started the year at 0.2 percent; they recently touched 0.6 percent.

That partly reflects an improved growth outlook for the region. Gross domestic product has expanded at an annual pace of between 1.6 percent and 2 percent every quarter since the start of 2015, a range that economists predict will prevail through the end of next year. In aggregate, euro zone data has been better than economists expected for the past several months.

Surprisingly Robust
Citigroup's economic surprise index for the euro zone
Source: Citigroup via Bloomberg
"A positive reading means that data releases have been stronger than expected and a negative reading means that data releases have been worse than expected."

That contrasts with the U.S., where economic releases began to surprise on the downside toward the end of April and have continued to be worse than expectations. And that, in turn, raises another problem for the ECB: the export-threatening strength of the euro against the dollar, even though it's as much a function of dollar weakness as single-currency strength.

On a Tear
The euro has gained against the dollar this year
Source: Bloomberg

A stronger currency also threatens to damp inflation, which is already slowing after briefly flirting with the ECB's target.

Heading in the Wrong Direction
Inflation has begun to decelerate again
Source: Eurostat via Bloomberg

The ECB itself forecasts inflation won't meet its target any time soon, predicting a 1.3 percent rate for next year and 1.6 percent in 2019. Moreover, Draghi's favorite measure of market expectations for inflation has also turned lower in recent months.

Stuck Below Target
Draghi's favored measure of inflation expectations -- the five-year forward rate on five-year inflation swaps
Source: Bloomberg

Draghi will almost certainly be asked during Thursday's press conference whether tapering was discussed. He needs to finesse the message by stressing that the ECB is close to the point of easing its foot off the gas, but not about to even contemplate tapping on the brakes. How well he conveys that nuance could be the difference between bund yields drifting back toward 1 percent by the end of the year -- or racing there this summer.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. The benchmark for the generic 10-year bund changed last week.

To contact the author of this story:
Mark Gilbert in London at magilbert@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net