“We are near, very near, to an end to the eurozone crisis… The worst – in the sense of the fear of the eurozone breaking up – is over. But the best isn’t there yet.” – Francois Hollande
Stocks rallied as yields nudged higher following the prior week’s break in market internals as tensions “eased” in the Ukraine and markets continued to disregard any kind of warning signs that things could get more challenging. Investors and traders turned their focus on the Fed yet again, with the media reciting Yellen’s Jackson Hole comments. I suspect the word “slack” is going to be this year’s taper in terms of frequency of word use, as the Fed debates when to raise rates with wage reflation still nowhere to be found.
What happens in the U.S. may end up being a side show relative to Europe now. More and more traders and investors are convinced that Quantitative Easing in the Eurozone is inevitable, and that we may see bond buying by the European Central Bank by December. I do not disagree, largely because Germany’s economy is now contracting and there is less reason for pushback on large scale monetary action. Inflation expectations have been cratering in Europe, and it remains to be seen if the ECB can indeed reverse that trend.
I have noted before that I find the notion that QE can reverse deflationary pressure curious, given that QE failed to achieve its objectives in Japan and the US. However, if Draghi initiates QE and inflation expectations rise, then European yields likely rise and that could finally break the Treasury uptrend and high correlation over the last several months between stocks and bonds. This is much needed for alternative strategies like our primary inflation rotation approach. In a world where everything is correlated to the upside, the only way to be uncorrelated is to not participate to the same extent. Every time a central bank has initiated QE, yields rose. If this happens in Europe, it would take US Treasuries down and finally create a marginal rising rate environment so many have been wrong on for so long.
