The consensus risk that I highlighted in my last article materialised with the sell-off in bonds during the second half of April. In my view this sell-off was the result of trading in derivatives markets from hedge fund managers. The sell-off was technical in nature and does not take the consequences of the ECB’s decisions sufficently into account. While it’s true that German 30-year rates at less than 0.50% made little sense, low yields in short and medium term maturities did find some justification on account of the abundance of liquidity and the risks of deflation. Some market participants have suggested that improvements in the economic outlook and the prospect of rising inflation could lead the ECB to cut short its quantitative easing programme. We don’t agree with this analysis: all the measures envisaged reduce the cost of funding for governments and corporates and should weaken the euro. These effects will be beneficial only if they are sustainable. So, we expect the market to revert to its previous trend of grinding down sovereign rates on the short to intermediate part of the curve (up to seven years of maturity) until yields are barely positive. The ECB’s bond purchases could lead to a scarity of government bonds. It’s true that sovereign issuance in the eurozone was strong early this year but it will shrink from June onwards to the point that they are not sufficient to meet the demands of purchases by the ECB. The deficit in eurozone government debt instruments will reach € 230 billion in the second half of the year!
CIO Core Fixed Income, Sovereign & Aggregate management team, Portfolio Manager