The Daily Prophet: Draghi Shows How to Taper Without a Tantrum

Connecting the dots in global markets.

Not many investors thought he could pull it off, but European Central Bank President Mario Draghi managed to avoid roiling markets when he detailed the central bank's plan to cut its monthly bond purchases in half. In fact, bonds and stocks soared while the euro weakened -- a perfect outcome for Draghi.

With just a touch of Italian flair, Draghi added a bit of a surprise to the plan to pull back from the markets. Yes, the ECB will halve its monthly bond purchases to 30 billion euros from 60 billion euros starting in January, but the bank's president also indicated that zero percent interest rates could remain at current levels until “well past” whenever it finally decides to end its quantitative easing measures. Some economists said that won't be until sometime in 2020. Bonds across Europe rallied hard, with yields on 10-year German bunds tumbling almost 7 basis points to 0.42 percent, the biggest drop since December. Although the Bloomberg Euro Index tumbled the most this year, that was welcomed because the currency's strength in recent months had become a drag on the economy and corporate earnings. As such, the STOXX Europe 600 Index promptly rose the most since August.

"The 'lower for longer' scenario appears to be a victory for the doves on the ECB, and is consistent with Draghi's call for 'patience and persistence'," the strategists at Brown Brothers Harriman wrote in a research note. "Draghi seemed intent (on) encouraging the market to push out in time when the first hike may be delivered." The reaction may help alleviate the biggest fear among global investors, which is that markets will fall apart as central banks stop injecting cash into financial assets. That's been the concern since the infamous "taper tantrum" of 2013 that roiled markets when then Federal Reserve Chairman Ben S. Bernanke said the central bank was considering slowing its bond purchases.

China has too much debt? Not according to international bond investors, who couldn't get enough of the $2 billion in sovereign dollar-denominated bonds offered by the Asian nation. The Ministry of Finance sold five-year bonds to yield a super tight 15 basis points more than similar-maturity U.S. Treasuries, down from the initial guidance of 30 to 40 basis points, according to Bloomberg News's Carrie Hong. It sold 10-year notes at a yield spread of 25 basis points, below the initial guidance there of 40-50 basis points. For an economy the size of China's, the amount of bonds sold is negligible, but the results are very symbolic as a show of confidence in the nation's leadership from the international investment community. In fact, the offering came just a few days after the ruling Communist Party approved a revised charter that enshrined President Xi Jinping's name under its guiding principles, elevating him to a special status enjoyed only by Mao Zedong and Deng Xiaoping. Oh, and China didn't bother to have the securities rated by any of the credit assessment firms. Now that's power. 

The biggest exchange-traded fund tracking the biotech industry is headed toward its longest losing streak since September 2015, falling for seven days in a row. The $9.5 billion iShares Nasdaq Biotechnology ETF tumbled as much as 2.9 percent Thursday as Celgene and Amgen joined Biogen in reporting disappointing results, according to Bloomberg News. The slide has investors worried that we could be seeing a repeat of two years ago, when biotech stocks were the main culprits in a market selloff. Besides some disappointing earnings, President Donald Trump is again taking jabs at the industry, saying two days ago that drugmakers are “getting away with murder” with their prices. Equity investors are already on edge waiting for earnings from tech giants such as and Microsoft. Add to that the uncertainty about who Trump will name to lead the Fed. “People are anxious, you can’t deny it,” said Donald Selkin, the chief market strategist at Newbridge Securities Corp. The last time biotech suffered such a prolonged decline, it fueled a broad selloff that sent the S&P 500 Index to its biggest decline in four years.

Speaking of anxiety, gold investors are loading up on the haven asset, sensing the dip in the price of the precious metal from about $1,362 in early September to $1,268 recently is a buying opportunity. Despite the price decline, investors have boosted their holdings of gold through exchange-traded funds to the highest since November 2016, or 2,163.4 tons, according to Eddie van der Walt and Ranjeetha Pakiam. The drop in gold has a lot to do with the rebound in the dollar. That's because the gold is priced in the U.S. currency, so any gain in the greenback means it's more expensive to buy gold. Although gold may be suffering a rough patch, it does have some high-profile backers. Billionaire Ray Dalio, the founder of Bridgewater Associates, has recommended investors consider placing 5 to 10 percent of assets in gold as a hedge against political and economic risks. Pakiam reports that big money management firm BlackRock says in a world where economic or geopolitical perils abound, investors should hold bullion in their portfolio to balance equity and credit risks, adding that the prospects for real interest rates staying low are positive for gold.

Investors are not very optimistic about the chances that Venezuela will meet some big bond payments due starting Friday. Dollar-denominated bonds issued by the government-run oil giant PDVSA tumbled more than four cents, as yields on notes due in 2020 jumped more than 2 percentage points to 17.3 percent, according to Bloomberg News's Christine Jenkins and Ben Bartenstein. Venezuela is already two weeks late on coupons payments for other bonds. Those payments had a grace period -- a buffer of sorts that gives the country an additional 30 days to work out the technical glitches and deliver the cash. The principal portions of the payments owed over the next week contain no such language. Although Venezuela has been in fiscal straits for some time now, any missed payments are still likely to further erode the investor sentiment toward emerging markets. After soaring for much of the year, emerging-market assets have slumped of late amid fresh political and economic turbulence in places such as Brazil, Turkey, South Africa and Mexico.

What is the impact on the economy of natural-disasters such as Hurricanes Harvey and Irma, which inflicted heavy damage on Texas and Florida? Economists may find out Friday when the U.S. Commerce Department releases its first look at gross domestic product for the third quarter. The consensus is that the economy likely expanded at a 2.6 percent annualized rate in the three months ended Sept. 30, which isn't out of the ordinary based on recent history. Harvey and Irma depressed investment in the energy sector and to a lesser extent, housing, according to Bloomberg News's Shobhana Chandra. While storm-related disruptions also probably hurt consumer outlays on services, other purchases, as well as government spending, may have been boosted by disaster relief and rebuilding that will further aid fourth-quarter growth. Excluding the temporary distortions, Chandra reports that the rest of the economy was humming along heading into the home stretch of 2017, thanks in part to stronger-than-anticipated business spending on equipment.

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