While it is largely accepted as a done deal that the ECB will, over the next year, fully phase out its QE, what there is far less agreement on, is what impact this tapering will have on risk assets, and linked to that, when it will happen. However, whether it takes place in 8 months or 18, the market has already been able to observe first hand what will happen when one of the last 2 central banks to inject trillions into the market, calls it a day.
As Bank of America's Chief Investment Strategist Micheal Hartnett shows in his latest Flow Show, the marginal impact of the ECB's direct monetization of private, corporate sector bonds has been declining less and less with every passing year, and in 2018, spreads have actually blown out by 67bps YTD, despite the ECB having injected a near record €70BN in the private sector (much of which in the primary market, i.e. paying corporate issuers directly).
There is a word for this lack of return on central bank intervention: "Quantitative Failure."
This is, of course, a problem, for both the markets and the feedback loop that has been at the basis of risk asset price formation for the past decade: if and when the market realizes that central banks are pushing on a string and both their actions and words are no longer able to serve as a backstop, it's game over, and it manifests itself in a run for the exits.
Which, incidentally, is precisely what is happening.
According to Hartnett, "Europe’s cyclical capitulation" has started to unfold and in just the past 7 weeks, investors have unwound a 1/3 of inflows that have taken place into EU equities over the 15 months as "ECB QE failing to reduce credit spreads."
What happens next?
While it is distinctly possible that nothing changes, the downside risk is that if European outflows persist, and if the idea that the ECB is now powerless spreads to other markets, that could well mark the end of the great equity bull market that has been built entirely on the altar of central banks; because once the faith goes away, it's over. The question then becomes will the flight from equities lead to a bid for stocks, or - with faith in conventional monetary policy fading - also lead to a liquidation of fixed income, something Jeff Gundlach presented as the all too possible endgame to this grand experiment back in January.