Draghi Expected to Taper 2018 Bond Buying

While it definitely was dovish of Mario Draghi to say the ECB hadn’t discussed unwinding the balance sheet, it didn’t imply the ECB wouldn’t taper the 60 billion euro bond buying program in December. We got further clarification of the ECB’s tapering potential in December in the latest statement by Draghi which had a hawkish tone. Draghi explained how the political landscape has improved. The French elections went to the establishment candidate and Merkel is about to win the German elections. He also mentioned the expanding GDP growth rate in the context of potentially winding down the bond purchases in 2018.

I was expecting the dovishness Draghi had a few weeks ago to change over time, meaning I thought the reason for the dovishness a few weeks ago was the decision was too far in advance. Now it seems clear that Draghi wanted to calm the market for political reasons. Draghi said "Political winds are becoming tailwinds. There is newfound confidence in the reform process, and newfound support for European cohesion, which could help unleash pent-up demand and investment." Any positive description of the economy is hawkish. It’s a case of good news being bad news.

I wouldn’t get lulled into thinking the unwind of the Fed’s balance sheet isn’t a big deal for stocks if volatility doesn’t spike up in the fall. The key will be when the ECB tapers as it will cause the Fed’s unwind to start to have more of an effect on financial markets. In September, the Fed will unwind the balance sheet by $10 billion, but the ECB will be buying 60 billion euros in bonds. In January 2018, the Fed might be unwinding $15 billion and the ECB may taper buying to 30 billion euros. As you can see, the start of the unwind is only a $10 billion per month difference in policy, while January will see an over $35 billion difference. Economists expect the ECB to announce its policy decision in September or October. Currently market participants seem to have this unwind and tapering as their base case scenario, so the effects on the market may not start until January. The first bad string of economic news or earnings weakness could end the bull market if the GOP doesn’t pass fiscal stimulus.

Healthcare Delayed

Besides news on ECB policy, there was an update on the GOP healthcare policy. The Senate majority leader, Mitch McConnell had to delay the vote on the healthcare bill until after the 4th of July. This is going exactly according to my expectations. As I said, this will be a repeat of the House process. In the House, the bill failed to come for a vote initially even though leadership wanted it to be voted on. Senator Rand Paul met with President Trump to discuss the details of what he wants. Rand is grandstanding to get more of what he wants in the bill. I still think he and Mitch McConnell are on the same page as they have a good relationship. They have endorsed each other and are from the same state. Susan Collins is the main holdout on the moderate side of the spectrum of this debate. It will be important to follow Susan Collins and Rand to see the chances of it passing.

I can see a scenario where Susan Collins and Nevada Senator Dean Heller vote against the plan, but it passes because Vice President Pence breaks the tie. Dean Heller only won his election in 2012 by 1.26% so it would be tough to get him on board regardless of what the plan is. Dean is making a political calculation while the conservatives like Cruz, Paul, Johnson, and Lee are concerned more with principal. That’s why I think a small move to the right can get this passed.

The stock market sold off slightly on Tuesday after McConnell made the announcement. It shows that the market is realizing how much it will need to rely on fiscal stimulus to keep the bull market going in 2018. Tech sold off hard, not because healthcare legislation effects tech, but because tech is a ‘risk on’ trade.

The day was also bad for tech because Google was fined $2.7 billion buy the European Union for favoring Google’s shopping results over competitors. This is illogical because Amazon favors its own sellers on its website. In an ‘apples to apples’ comparison, Amazon exclusively makes money from sales on its website while Google allows other companies to make sales for an advertising fee. Google shouldn’t bear a burden because it is a web portal as it still should be able to control its own website. The points I am making are what Google would say in an appeal, but it looks like Google will probably have to pay the fine and redesign the website. Regulation is a growing risk for big tech stocks as last year the EU announced Apple owed $14.5 billion in back taxes for paying a 1% rate by taking a special deal to locate its headquarters in Ireland.

Finishing off the discussion on healthcare, it was announced the GOP’s plan would save $319 billion in deficits from 2017 to 2026 which is much more than the deficit reduction from the House plan which was $119 billion. This means if something close to the current plan passes, there will be plenty of savings for the tax cuts which are needed to keep the bull market alive.

Conclusion

Today the 137-day streak of the QQQ trading above its 50-day moving average ended as the $2.7 billion fine the ECB levied on Google and the delay of the healthcare plan vote cause tech stocks to selloff. Early 2018 could be an area of concern for the market as the Fed increases its unwind and the ECB continues its tapering. The potential volatility in the fall could come from the debt ceiling debate, the ECB’s tapering guidance, and the Fed’s beginning of its balance sheet reduction. My concerns are more focused on early 2018 than the fall of 2017 because I think the debt ceiling will be raised.