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The Governing Council of the European Central Bank (ECB) did not make any changes today to the main refi rate, which remains at 0.05%, or to the deposit and marginal lending facilities rates which are still at -0.2% and 0.3% respectively.
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Yields on German Bunds are now negative out to a maturity of 7 years, suggesting that the market has priced in the QE programme, which President Draghi announced will to start on 9th March with the purchase of €60bn of bonds per month, as well as the very low CPI inflation rate in the eurozone. Draghi made it clear today that the QE programme will include the purchase of bonds with negative yields up to the deposit rate (-0.2%).
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In the press conference, which took place in Cyprus, Draghi revealed that the ECB predict an annual real GDP growth rate of 1.5% in 2015, rising to 2.1% in 2017[1]. He also pointed out that the fall in oil prices was a contributing factor to reduced downside risks to the single currency bloc’s macroeconomic outlook. It is interesting to note that the staff forecasts all assume that QE will end in 2016.
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There has been a lot of noise around Greece in the media over the last few weeks and this was reflected in the huge number of questions concerning Greece in the Q&A. Draghi said that ECB liquidity provision to Greece is 68% of Greek GDP and that the ECB could not currently buy Greek government bonds, however, once holdings fall to 33% the ECB could purchase them.
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We believe that the growing dispersion in the fundamental economic conditions and the monetary policy stances of the major economies and central banks will be important drivers of returns in both the bond and currency markets this year.
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We retain our thesis that we will see increasing monetary policy divergence as the year progresses. Thus far, all of the central bank action in 2015 has been on the loosening side, which has been reflected recently in the bond markets, such as the widening spreads between German Bunds and US Treasuries or UK Gilts[2]. However, our base scenario is that the US Federal Reserve (Fed) and Bank of England (BoE), which had both previously pursued QE programmes, will tighten their monetary policy stances this year.
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This view is reflected in our positioning in UK rates, which is still one of short duration. While the BoE today maintained the benchmark interest rate at the record low of 0.5%, we believe that they will raise rates in 2015, compared to the market which is now pricing for the first rate rise in 2016.
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We believe that the improved growth forecasts outlined today by the ECB for the eurozone negate any drag that weak growth in the region could pose to the first tightening actions by the Fed or BoE. The timing between the first rate hikes from these two central banks will, in our view, be relatively close as the fundamentals remain on a positive trajectory in both economies. However, it is now most likely that the Fed will move first.
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This week the Reserve Bank of Australia (RBA) kept the cash rate unchanged at 2.25%. Nevertheless, we expect the RBA to maintain an easing bias. As such, we remain long Australian government bonds and are short the AUD as the demand for commodities and commodity prices remain weak.
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Holding local currency Indian bonds has been one of our favourite positions in emerging markets for some time. The Reserve Bank of India surprised many market participants with an inter-meeting cut of 25bp this week, taking the repo rate down to 7.5%.
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Regarding Japan, we are positioned with a Japanese government bond curve flattener and we remain short the yen. It is very interesting to note that volatility in the JGB market has increased significantly in recent weeks.
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Indeed, volatility has increased overall in bond and currency markets over the last few weeks. We see the potential for further volatility as liquidity issues arise once markets begin to focus on the large imbalances and crowding in certain sectors that formed during the protracted era of very loose monetary policy and when the divergence of monetary policies does become more pronounced.
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In such an environment of raised volatility we believe that maintaining a focus on fundamentals through the noise will be key, along with diversification and a strong focus on risk management.
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