Review
The initial reaction in the European fixed income market to the ECB QE launch has been significant. The long end has led the move and we have seen an aggressive curve flattening with 30Y German sovereign bonds as low as 0.70%. U.S. 30-Year have moved higher despite weaker-than-expected data at the beginning of the year, as the market increasingly believes the Fed will start hiking in Q3/Q4 15.
In Denmark, the pressure on DKK has abated compared with a month ago. The lower risk of further Danish cuts has led to underperformance in Danish fixed income markets.
International rates
We believe the move lower in EUR rates is a bit overdone and we do not expect long-end yields (10y) to move lower. We expect the EUR curve to steepen gradually from the very long end going forward, as we believe higher growth and inflation expectations will outweigh the direct effect on prices of QE purchases.
Although US rates have moved higher over the past month, the market is not prepared for the Fed starting to hike rates in the middle of this year. Therefore, we still project a significant rise in US swap rates, mainly in the 2-Year-5-Year segment as we get close to lift-off in the Fed funds rate. We expect the long end of the US curve to be more capped due to aggressive monetary easing in Europe and Japan.
Scandi rates
We expect Danmarks Nationalbank to leave interest rates unchanged over 12M. We expect some of the recent underperformance in Danish fixed income markets to reverse and the spreads to narrow somewhat versus the EUR. Despite the possibility of another small rate cut in Sweden, it is clear that for many real-money investors bonds with negative yields are not a viable long-term investment. Recently, 10-Year bonds have underperformed significantly against Bunds. Given that the risk of increased central bank bond purchases cannot be disregarded, we believe there is room for the Swedish long end to perform further.
In Norway, the market is pricing in two additional cuts in 2015. We believe this aggressive pricing will continue for the next six months but eventually we believe we will see a correction if rates are cut only once as we expect. Ten-year swaps have tightened versus EUR swaps over the past six months, though we have seen some reversal of this trend recently. We believe this tightening will continue on a three- to six-month horizon and then reverse again.
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