End of bond bubble?

From the 2nd half of April, sovereign yields from the euro zone have sharply risen. Technical and fundamental considerations can explain this movement. Technically, the supply & demand was less supportive in April-May (greater supply). The low volatility on futures markets combined with the very long investors’ positioning on EMU sovereign debts (especially on non-core countries) have also amplified the movement. Fundamentally, the inflation surprised to the upside in April and the Q1 growth was better than expected especially for the recent laggards (0.6% for France and 0.3% for Italy). From a valuation perspective, the valuation was excessive with more than 30% of the sovereign bond markets in negative territory. In this context, 10-year German and Italian yields increased by more than 60 bps in a couple of weeks up to 0.72% and 1.92% respectively. We decided to adopt a tactical flattening bias on the German curve (short 2-year / long 10-year).

Linkers remain attractive in a recovey context

The macroeconomic improvements are noteworthy: euro zone composite PMI came at 53.9 in April (from 54.0 in March) with Spain leading the trend. As already mentionned, the latest inflation data came on the positive side out at 0.0% YoY (April Eurostat estimate). The housing market in peripherals has probably bottomed in Spain while in Ireland and Portugal housing prices are moving upwards (Chart 2). Strategically, we remain exposed to French inflation-linked bonds initiated in January and which outperformed their nominal peers.

More cautious on EMU non-core debts

We reduced our exposures to peripheral debts over the first quarter and in April. We considered that valuation became stretched: Ireland and France traded almost flat on the 5-year segment while the 10-year Portuguese spread versus Italy reached only 20 to 30 bps. Thus, we decided to gradually take profit on these overweights. Moreover, the Greek funding issues remain an element of concerns. We consider that the possible failure of negotiations between the Greek and European officials will be a powerful risk-off trigger which will spread to other non-core countries. Beginning of May, Greece finally honoured an IMF repayment by emptying its IMF emergency cash account (EUR 650 million) and scraping EUR 100 million in cash reserves but this manoeuvre cannot be a viable option on the lon run.

We reinitiate a long bias on USD

We believe that the current macro environment in the US (disappointing NFP, retail sales, consumer confidence and growth data estimate – Chart 3) is now well priced in. Besides, we consider that the rebound of the EUR is overdone as, from a technical point of view, the ECB could accelerate its monthly asset purchases before the summer, a period with deteriorated liquidity conditions. We reinitiated a long bias on USD. However, in the current context, we expect a first rate hike in S2 and forecast a slow normalisation of the rate environment dependent on an improvement in labour figures and no further decrease in inflation pressures.