Good Morning,

Without a doubt, as 2014 progressed, sovereign (benchmark) bond yields declined more than forecast, with end of year forecasts being constantly revised lower as the year progressed. It is cumbersome to break it down to one particular episode but it is merely a sequence of events, and disappointing economic data to go with it, which has resulted in this downward trend in government bond yields. Not much fault can be placed on the lower than expected growth and inflation in the US, neither a more dovish policy than expected. Rather, the major reasons behind this is a concoction of persistently lower inflation in Europe coupled with the lacklustre growth in Japan, notwithstanding the continuous easing of financial conditions in both regions. In Japan, such easing actually materialised whilst in the EU, the intention for additional easing was made clear and is a foregone conclusion at this stage. It seems that the implications of such policies more than altering US expectations have resulted in a marked increase in risk aversion for the latter part of the year.

The subdued economic sentiment brought about by the geopolitical risks and financial turbulence as a direct result of the Ukrainian-Russian crisis could persist for the earlier stages of 2015. However, despite this, we expect negative economic drivers to bottom in H12015 as multiple growth drivers could begin to show signs of a recovery. So we will be closely looking into improving external conditions most notably in the US, the evolvement of central bank policy, the euro-dollar currency peg as well as the ramifications of the recently approved more growth-oriented fiscal policy, namely the €315bn plan announced by newly-elect European Commission President Juncker.

One possible catalyst to spur further discussion in 2015 is the EU Capital Markets Union that has been recently proposed by Juncker. It is still unclear what the exact reason behind this union really is, with a scheduled consultation process on the formation and operational aspect of the said union in the summer months. What is certain at this stage is that the union will strive to change corporate funding in Europe from the current (primarily) bank based system to the creation of new sources of funding for European companies, most notably SMEs.

Moreover, we believe that the union will strive to achieve a higher degree of efficiency and competiveness targeting a pro-growth stance, as European capital markets are not yet fully integrated, 20 years after the launch of the single market.

It is now an almost certainty that the ECB is to include government bonds in its expansionary programme in H12015. Towards the end of 2014, with the ECB becoming increasing slow, or rather unforthcoming, to adopt a full-scale quantitative easing programme, any sovereign QE from this point forth, despite the historically low levels of the Bund, should keep bond prices supported as the market comes to terms that the asset purchase programme will be a lengthy process.

Recent studies have highlighted key differences in spread movements after the announcement of QE by the Bank of England, US Federal Reserve and Bank of Japan. It is apparent so far, that the QE has had the desired effects on the UK and US economies as the announcement and subsequent auctioning of QE by the respective central banks was timely, with both central banks’ currently on the verge of unwinding their accommodative stance. On the other hand, the Bank of Japan took almost two years to formally announce QE after cutting its policy rate to zero. The ECB is pretty much on the same wavelength as the Bank of Japan; laggards in taking swift action, and the direction of Bunds is expected to be similar to that of JGBs following the announcement of QE by the ECB early on in 2015, that is maintaining their current. Bunds are also expected to benefit from an expected decline in overall net supply by the Bundesbank coupled with a persistently increase in demand from Asian investors. In fact, recent data shows that during the month of September 2014, Japanese investors became net buyers of the Bund for the first time in twelve months.

Have a nice day!