By Jon Sindreu
Investors are preparing for the European Central Bank to give them all the complex details of how it will end its massive bond-buying program. But there is one crucial piece of information they truly care about: When will interest rates start going up?
ECB policy makers have repeatedly said they won't start raising rates until "well past" the point when purchases have stopped -- even if inflation were to suddenly jump. That means divining the date of the last purchase is a big focus for money managers across the world.
Many analysts now forecast that the ECB will say Thursday that the purchases will end next September, an extension of around nine months from the current target. The central bank is expected to cut its purchases in half to EUR30 billion a month.
Yet if ECB President Mario Draghi says the speed of the taper is either faster or slower than expected, investors will adjust their rate projections to match, reshaping the entire bond market.
In the eurozone, rates have stayed pegged at minus 0.4% for a year and a half and, if Mr. Draghi says the speed of the taper is faster than expected, bonds could fall and the global rally propelling stocks to record highs could be derailed. If rates aren't so predictable anymore, analysts said, financial markets could leave behind years of historically subdued volatility.
In a speech in June, Mr. Draghi's hints about a faster-than-expected reduction of bond buying gave markets a jolt. Yields on the 10-year German government bond shot up to 0.570%, their highest in 18 months, and the euro gained around 2% against the U.S. dollar. German yields have since come back down to 0.474%.
The reaction was down to new expectations of future interest rates, market derivatives called overnight index swaps suggest. After his statement, those derivatives showed that investors brought forward their expectation of a rate rise to December 2018 or earlier.
They now suggest rates might stay where they are until around March 2019.
Once the ECB's taper calendar is clear, "I would expect the market to focus on the next step, which is the process towards rate normalization, " said Andrew Bosomworth, head of portfolio management for Pacific Investment Management Co. in Germany.
This means Mr. Draghi's carefully-chosen words will carry most of the ECB's policy might going forward, money managers said, potentially exposing bond markets to more volatility.
In the U.S., the Federal Reserve has already been down this road. In 2013, talk by policy makers about reversing QE sent yields on the 10-year Treasury note above 3% from around 1.9%.
By contrast, bond markets have remained mostly unruffled this month, as Fed officials started unwinding $10 billion of the massive $4.5 trillion asset portfolio they accumulated after the 2008 financial crisis -- a policy known as quantitative easing or QE -- in a bid to stoke growth and inflation. Money managers were initially jittery about the effects of this untested experiment, but most are now unconcerned.
"QE was much more impactful when it was implemented than when it will be undone," said Myles Bradshaw, head of global aggregate fixed income at Amundi, Europe's largest asset manager. "Because [the Fed's moves] have been so clearly disconnected from actual interest-rate policy, it's not as dramatic."
Bank of America Merrill Lynch strategist Athanasios Vamvakidis called the Fed's balance-sheet reduction "a sideshow to the hiking cycle," in a recent note to clients. Rates in the U.S. have been rising since 2015.
This issue gets to the core of a long-running hot button debate for economists: Did central bankers' bid to stimulate the economy by buying bonds work, and how? If it was central banks' demand for bonds that was successful in reducing borrowing costs, then surely reversing QE could suddenly push them up again.
But if QE's impact was just on market sentiment, as many investors now believe, the unwinding might have a much smaller effect.
A raft of research from economists and central banks estimates that QE lowered 10-year sovereign-bond yields by around 1 percentage point in the U.S. and U.K. and by half a percentage point in the eurozone. There is debate, though, on what exactly was pushing those yields lower. Was it the bond buying itself, or just the fact that such all-out policies are a way to convince investors that rates will stay low for very long?
"It's mostly about sentiment," said Charlie Diebel, head of rates at Aviva Investors.
The importance many investors are currently attaching to signals about the direction of interest rates, more than the size of central bank's balance sheets, could suggest the actual bond-buying had a smaller effect than once anticipated.
Write to Jon Sindreu at [email protected]