Neutral on euro duration

For its first month of asset purchases under its PSPP, the ECB did not disappoint, reaching the target (EUR 60 bn.). That provided powerful support to the sovereign debt markets, with yields reaching new historical lows. By mid-April, German yields (up to 8 years) were in negative territory. The 10-year German yield decreased by up to 0.05% over April. Ignoring macro fundamentals and event risk (Greek funding issues), the market is currently flow-driven, with investors’ positioning currently very long on core and non-core countries’ debts.

We shall continue to play the reflation card until year-end

Indeed, the macroeconomic improvements are noteworthy: PMI for euro zone are on the upside, with France catching up. On the inflation front, the latest data came out at 0.0% YoY (April Eurostat estimate). Although still low, the data are nonetheless up from the previous 3-month releases (respectively -0.3% and -0.6%). Core inflation remained stable at 0.6%. Both elements should lead to a rise in yields (Chart 2). Strategically, we remain exposed to French inflation-linked bonds initiated in January and which outperformed their nominal peers.

Neutral on Portugal, more cautious on Spain & Italy

The main risk for non-core EMU debts is Greece. This tail risk is currently underestimated by the markets. We consider that the failure of negotiations between the Greek and European officials should be a powerful risk-off trigger which will spread to other non-core countries. Greece has recently honoured a debt payment to the IMF but upcoming repayments will be more sizeable and the country is running out of cash. We stand far from agreement so far while Greece is running out of cash. The latest treasury bill issuances have not been really successful, indicating increasing mistrust on the part of the remaining creditors. For that reason, after an impressive rally, we have gradually decreased our over-exposures to non-core areas, taking profit on Spain, Italy and Portugal.

Short USD

As expected, the Fed took note of the growth slowdown during the winter. However, it remains confident that the forward-looking outlook will remain positive. As a result, we do not expect a first rate hike in Q2. The normalisation of the rate environment should be slow and dependent on an improvement in labour figures and no further decrease in inflation pressures. Unfortunately, the slowdown has materialised, with disappointing Non-Farm payrolls and Q2 GDP figures well below expectations (at QoQ +0.2% vs. 1% expected and 2% in Q4 2014) As we consider the EUR/USD retracement to have been too fast too far, we have reversed our positioning, turning negative on the USD versus the EUR.