Short US duration

The Fed, worried by the international developments (fall in the oil prices, Ukrainian, Crimean conflict, etc.) that could drive inflation even lower, has adopted a less hawkish tone. However, the US economy is still vigorous, with solid labour data (Non-Farm Payrolls above consensus for the third month in a row). We consequently believe that the Fed is planning to hike its key rate before year-end and normalise the rate environment. We are at the same time confident that long-term rate expectations will be driven lower with the decrease in inflation expectations. For these reasons, we keep our negative bias on the 5Y segment and our flattening strategy (short 5Y / long 30Y). We also initiated a short on the 10-year part.

Long Euro duration

Duration-wise, we currently have a long stance, implemented via Italy. The sovereign QE expected for March should continue to support EMU sovereign debt. The recent inflation data (-0.6% YoY - January Eurostat CPI estimate) confirmed the disinflation trend in the euro area. On a short-term horizon, inflation dynamics should be kept under pressure by the recent decrease in oil prices and weakness in food inflation. The main risk factors are, however, the improving economic cycle in the US and the long investors’ positioning.

We increased our positive bias on linkers: despite mixed carry dynamics and spot inflation that should stay negative over the first half of the year. Linkers should benefit from the ECB’s accommodative stance (purchases of linkers, Chart 2) which should improve inflation dynamics before year-end.

We keep playing the euro-rate convergence card

Once again, the ECB stance is a key driver of European sovereign debt and, even more, of debt with an attractive yield pick-up. The ECB’s monthly purchases will exhaust the supply of this debt, creating a strong “hunt-for-yield” environment. We are therefore keeping our overweight on non-core sovereign debts (Italy, Spain, Ireland and Portugal). Moreover, the political risk from Greece has faded, temporarily at least, with the 4-month extension of the Greek bail-out: EU officials are maintaining their efforts to preserve the integrity of the euro zone. Ratings dynamics could be also supportive in 2015 (Portugal, Spain). Macro prospects are also improving: Irish growth numbers were strong and even Greece should publish a positive growth figure and primary budget surplus this year.

Short EUR

We continue to underweight the euro but, after a massive retracement, the EUR/USD cross has reverted closer to its fair value (according to long-term indicators such as the Trade Weighted and Purchase Power Parity indices, Chart 3). At this stage, we prefer to reduce our overweight on the USD versus EUR. As a result, our long-term strategic negative bias on the EUR is also taken the GBP. The GBP continues to be supported by positive capital flows as well as strong macro results. The monetary divergence between the BoE and the ECB also favours the British pound.