What is the trade when ECB start QE?

QE is here and we've got to live with it at least until inflation hits target, or we hit September 2016. What we don't really know is what will pan out when they start buying bonds.

What do we know?

We know that European bonds have been bought up like they are going out of fashion. It's a pure front run but what's going to happen when the ECB step in to start buying those bonds?

First off there's been a constant little niggle at the back of my mind that comes from Constancio's comments at an event last month. He remarked that one of the factors the ECB is still unsure about is whether there are enough people willing to sell bonds in large enough amounts to enable QE to work. It's a pretty big deal if there's not.

There's talk that sellers in the European bond market are drying up as buyers are hoarding in readiness to flog it all to the ECB. This has been highlighted by FT Alphaville today

It's official, there are no more sellers of bonds." An investor told us yesterday, and he's not alone. Bond buying on ECB QE, the Greek loan extension and recent growth data in the periphery has transformed itself into bond hoarding.- RBS' Alberto Gallo and team

We therefore face a scenario whereby bond longs could hold out on the ECB causing a big squeeze on bond prices. There may be plenty who will take profit on positions as soon as the ECB start buying but there may be some big players who will want to squeeze the ECB for every cent they can get.

So part one of the big QE trade is ready to go, when the ECB pull the trigger. At some point there's going to be a rush to the bond exit door which is going to lead to part two of the QE trade, more on that in a bit.

There is a big potential risk and that's to underestimate the ECB. They will know all this is happening and could well choose to upset the apple cart a little bit. If they want to do that they could simply push back their purchase start date (expected this month) and spin it to the rise in inflation, saying they want to see if it develops into a trend. That's a very short term play but it will be one that will open up some of the floodgates from bond longs, thus relieving some pressure in the bond market and potentially giving them better levels and better liquidity to buy into.

Where's all the bond money going to go after?

Once all these bondholders have sold up to the ECB where are they going to take their buckets of profits?

The path of least resistance is stocks and higher yields. That means that we could be at the bottom of an 18 month bull market in European stocks and/or see a flood of funds coming out of Europe looking for higher yields elsewhere. That's a big negative for the euro first of all. Conversely it's a potential big plus for other currencies, whether the money flows into other stocks or bonds.

It's already thought that the move is already underway. The euro is falling, bond yields are holding the lows and stocks sit on their highs as we head to the ECB meeting. The dollar has seen some buying, even on the back of less than impressive data. US stocks are back to their bullish best while there's been an exit from Treasuries. It looks like stocks are going to be the weapon of choice and again, this looks like a typical front run.

What's in it for little old Mr & Mrs Retail Trader like you and me?

We know the bond trade is about to happen (when the ECB announce their first buying date) so we've got a chance to do something now. The easiest trade would be to get into European stocks and sit back and wait. If the ECB do squeeze the bond market, stocks will likely be the first place the bond money runs to anyway. Any quick run into European stocks will lessen the currency impact. This is one of the factors that's got me torn over the euro trade as I explained yesterday.

So, for me the trade is getting long European stocks and I think it's going to have plenty of legs in it, even if it means buying in at these current highs. Timing is everything and also who to buy. Germany has to be at the top but I think spreading trades around is the safer option and gives greater coverage. Timing wise, starting now isn't a problem and I think we'll also get a small window of opportunity after the ECB meeting, to get the lay of the land from anything that gets announced, so there's no immediate rush.

That's my trade idea for QE and I'm going to be thinking about pulling the trigger between now and Thursday. That aside, I'm more than open to other thoughts, ideas and suggestions you may have. This could be a very good trading opportunity and it's not often you get one where you can definitively mark, and trade on the individual trigger events before they happen, if you can formulate a plan.

Draghi's ready to trade, are you?