Weigh anchor – a key turning point for markets?

For most of the time global markets move at an incremental pace and the parable of the boiling frog applies. However, there are occasions that are key turning points to focus on and from the beautiful town of Sintra in Portugal, Mario Draghi, President of the European Central Bank (ECB) delivered a message from the ECB Forum on Tuesday 27 June that may well be one of them.

An immediate sell-off in bonds

Mr Draghi’s speech was markedly more upbeat on the outlook for the Eurozone economy, and he noted that the deflationary forces that had preoccupied the ECB were transitioning into inflationary pressures. He also said that “all the signs point to a strengthening and broadening in the euro area.”

The response in the markets was immediate, with a boost to the common currency and a significant sell-off in bonds across the euro area that in turn infected the UK and the US bond markets. German 10-year bund yields have risen a remarkable 15 basis points from 0.25 to 0.40 at the point of writing.

The improved euro area outlook

For some time now, we have been looking at the euro area data and wondering what the ECB was seeing that we were not. We have observed a strong rebound in economic activity and consumer confidence has significantly improved which was not being acknowledged. For us, it was a case of when – and not if – the tone would change.

Why has Draghi hesitated?

We suspect that the hesitation by Draghi has been justified by a valid concern that a signal turning markets away from ultra-low interest rates may have been the catalyst for a “Minsky moment” for some of the more fragile Italian banks. It is possible to be too cynical in this world, but is it too much of a coincidence that this policy shift comes immediately in the wake of the rescue of the Veneto banks and Monte die Paschi di Siena, not to mention Banco Popular’s altruistic bailout by Banco Santander?

A turning point for investors

Investors have been caught out many times since the financial crisis, trying to guess inflection points in bond yields, and the ECB’s rhetoric and the bond buying programme have been a heavy anchor on interest rates in the UK and the US. However, the speech in Sintra may be the turning point that we have been predicting and it definitely raises the stakes for investors holding expensive gilt positions.

We don’t believe that the pace of change will be rapid – there are still structural debt and deflationary issues in the euro area and the UK to contend with. However, the weight of evidence is increasingly in favour of caution in these historically “risk-free” assets.

For more information on our latest investment views please contact us on 020 7189 2400 or contact@tilney.co.uk