Photo: Bloomberg TV
Market volatility is at record lows right now, but experts are expecting an uptick in event risk over the next few weeks.The European Central Bank (ECB) meets September 6, and everyone is expecting them to unveil a bond-buying plan that will stem government borrowing costs in countries like Italy and Spain.
Of course, if the ECB is expected to unveil such a plan, one would also expect Spanish and Italian bond yields to fall as investors bid up peripheral bonds in anticipation of ECB intervention.
However, PIMCO CEO Mohamed El-Erian made the point on Bloomberg TV this morning that just by hinting at future plans, the ECB really just “froze everybody,” and the trades have become too expensive for hedge funds to bet against Italy and Spain right now.
El-Erian told Bloomberg TV that bond yields in Spain and Italy have fallen recently due to hedge funds and others covering short positions:
Why have we had that tranquility? Because Draghi on July 26 – and then the ECB a week later – froze everybody by striking that very delicate balance in words – not in actions, in words – between conditionality and financing. So, the Germans love the conditionality element, and the Spaniards and the Italians love the financing elements.
So, it froze everybody. And remember, in this market, when you freeze everybody, it will go up, because the cost of remaining short is high. That’s particularly true for European peripheral bonds. It is expensive for hedge funds to remain short.
So, if you can freeze everybody for a while, the markets will go up. However, words are not sufficient. Now we need actions. Starting next week, we have a full calendar, and this market is going to tip one way or another. It’s either going to tip toward consolidating its gains because the ECB will be able to deliver or it is going to give up its gain because the ECB will find it very difficult to deliver without other policymakers.
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