Few trades have been as consistently devastating as going against a central bank. Those who may have forgotten that lesson relearned it in spectacular fashion last week when the SNB removed its policy of buying Euro’s to artificially suppress the Swiss Franc. This was seen by many to be a signal in anticipation of massive QE from the ECB in their next meeting this Thursday. The current price action confirms our belief that financial markets uniformly expect the announcement of a large scale asset purchase program this week by Mario Draghi.
Central Banks have meddled with financial markets in unprecedented fashion over the last half-decade. Any of the times policymakers have intervened, their actions have left tell-tale fingerprints on markets. Whenever governments have expanded asset purchases it raises the value of both stocks and bonds. Normally these two assets move in opposite directions. But when Central Banks are actively meddling, the price of every risk asset becomes correlated.
However, it would seem that policymakers have been a little too effective in their suppression. Markets have now become conditioned to react in specific ways to even the hint of QE. Today we witnessed a rally in both long US Tsy bonds and S&P 500 futures. We haven’t heard much except rumors and anonymous leaks from the ECB regarding a concrete QE announcement. Last week’s SNB decision was the most definitive evidence we had until now: price action is providing positive confirmation of the market’s bias.
Like Pavlov’s dogs, markets are reacting to the prospect of a tasty treat. The SNB rang the dinner bell last week, and markets reacted accordingly. The expectation of QE from the ECB has placed a cap on volatility and erected floors under stocks and bonds. In the past, the ECB has preferred to use the threat of action, jawboning markets into submission. It will be interesting to see whether Draghi can deliver on the market’s inflated expectations. Thursday’s Q&A session will be one to watch.