In this week’s Strategy we highlight three macro themes that we expect to shape global markets in 2015. These are 1) synchronised global recovery with low inflation, 2) historic divergence in monetary policy and 3) the biggest liquidity boost since 2011. Based on this we believe investors should position for the following key developments in 2015:
1. Outperformance of risk assets: The combination of synchronised recovery and another year with lots of liquidity will provide another strong base for risk assets (stocks, credit and peripheral bonds in the euro area). While some markets are expensive on a stand-alone basis, we believe they still offer value when viewed against extremely low bond yields. In an environment of renewed economic recovery, the hunt for yield is expected to get new tailwind.
2. Rise in US bond yields with short maturities: The markets are still only pricing in about one hike from the Fed next year, which is in sharp contrast with the Fed’s own projection of four or five hikes. It is not unusual, though, that the market is ‘mis-priced’ well ahead of the first hike. History suggests, however, that once we move to within three or four months of the first rate increase, a significant re-pricing can take place. In 2004, 2-year bond yields, for example, stayed low until March but then rose by close to 150bp up to the time of the rate hike in June. We are moving rapidly closer to the window where a re-pricing of Fed expectations is likely to take place.
3. Flattening of US yield curve: While yields in the short end are expected to go higher, the medium to long end of the bond spectrum will be better supported by the global liquidity glut. We thus look for a further significant flattening of the US yield curve. Again, a comparison with the 2004-2006 hiking cycle is useful. Over this period US 2-Year rose by 375bp whereas US 10-Year yields rose only 150bp. And most of the increase in 10-year yields came quite late in the hiking cycle – in early 2006. We could very well see a repeat of this ‘bond yield conundrum’ given the significant amount of liquidity that will continue to slush around amid a low appetite for real investments in the corporate sector. The low yield levels in Germany and Japan will also work to anchor US longer-term yields.
4. Outperformance of German versus US bonds: In the euro area we expect negative deposit rates and QE in government bonds to keep German bond yields at very low levels. While there could be some spill-over to Germany when US yields go up, at least yield levels out to five years should be well anchored by ECB policy. We thus look for further outperformance of Germany versus US in maturities from 0-5 years.
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