QE by the ECB would follow similar programmes by the US Federal Reserve, the Bank of England and the Bank of Japan, However, a case can be made for yields rising or falling. If ECB bids more aggressively for bonds, prices would rise and yields would fall as in the US. Simple economics suggests a central bank purchasing programme should drive bond prices higher and therefore yields lower. What happens to yields, which move inversely with prices, matters a lot.
Moreover, government bonds are used to price assets across financial markets. The experience of the three rounds of US QE since 2008 shows that yields may rise. Just the anticipation of ECB program prompted bond prices to plunge and the euro to drop in value. Yeildes which move inversely with prices, are now negative on German bonds.
Similar quantitative easing by central banks have helped economic growth in the United States and Britain, although their programs did not result in negative interest rates. How the ECB manages its bond buying will largely determine where yields head next.
Upcoming meetings in Cyprus will set the stage for ECB’s QE implementation. If QE is expected to lift growth and inflation, bond yields would logically increase as investors take profits. The fact is that investors assume that it would lead to stronger economic growth and inflation, all factors that usually drive bond yields higher.
During each of the three rounds of Fed QE, rates rose and then fell when they stopped buying bonds. As it happen Shrewd investorys bought US government bonds and drove yields lower in anticipation of the Fed stepping in as a buyer, and then got out when it did. In other words, the biggest effects of QE comes before it is announced. Markets are forward looking and that is the natural.
One explanation is that investors buy the rumour and sell the fact. The risk in bonds has gone up: That all sounds pretty bad already. And in fairness, it may be premature or just wrong, with yields staying stable and low for longer than most analysts are predicting.” London-based co-head of macro and markets research at Goldman Sachs Group Inc.,Francesco Garzarelli, said in a Bloomberg Television interview Thursday.
Unexpected moves might create considerable volatility and Garzarelli think that makes fixed income a very dangerous asset class. One sensible thing to do when the central banks start buying is to sell bonds. Cypure could mak a turning point.