The muted reaction of the market amid the Bank of England monetary policy meeting is eerie. The market was expecting some tapering, which the BOE delivered, but it didn’t exceed. Clearly, the market believes that ultra-low interest rates have priced whatever tapering will happen in the near future. It is also confident that central banks will announce any tapering well in advance, without provoking a taper tantrum such as we saw in 2013.
However, we believe that there are all the elements for the situation to get out of control.
1. There is no escaping from tapering
The Bank of England monetary policy meeting today was important because it confirmed one of the financial market’s most feared trends: central banks worldwide are about to reduce an unprecedented amount of stimulus.
It translates to the fact that if central banks do not taper today, they will taper later. The longer they wait to do that, the more fragile the financial market gets. Indeed as the economy recovers fast, there may be the need to tighten financial conditions more quickly than anticipated.
It is becoming a card game between central banks: who tapers first and who plays the tapering card at its best. Suppose the BOE was slightly more hawkish than the market wanted it to be today. Well, that could have provoked a selloff in Gilts that would have easily leaked to US Treasuries and European sovereigns as well. Indeed, a hawkish BOE implies that the Federal Reserve is behind the curve and that it should consider tapering earlier than what it has communicated to the market so far. If that were to happen, 10-year yields might break above the 1.75% resistance level to head towards the fear pivotal resistance f 2%.
It places the European Central Bank in an uncomfortable spot as Bund yields have risen for months. They are close to breaking above their resistance at -0.15% to head towards positive territory for the first time since 2019.
This week 10-year Bund yields broke their resistance at -0.20% to rise as much as 0.16%. If they break above this level, we might see them rising fast to 0%. Bund yields have been trading in a narrow ascending wedge while the RSI values have been falling, meaning that the uptrend is weakening and could reverse. If that were to happen, yields could fall to 0.40%.