FED, likely to err on side of caution

In 2015, the US growth has outstripped that of other Western countries and its unemployment rate has fallen rapidly. Now, there appears to be no constraints on raising its main funding rate during 2015. Yet, the overall economic environment is not so rosy with downside risks in many blocs (China, oil exporters, euro zone etc.), therefore the rate hikes led by the Fed should be small and implemented smoothly. In this context, the mid maturities could be penalised by the monetary stance while the very long-end of the curve should benefit from the care of the Fed and the lack of inflationist pressures. Thus, we maintain our flattening strategy (short 5Y / long 30Y).

Conversely, the ECB is launching its easing bazooka

After the recent disappointing inflation data (-0.2% YoY - December Eurostat CPI estimate), the ECB has decided to launch from March an important bond buying programme. It will buy euro denominated agencies and government bonds at a pace of EUR 60 bn per month up to September 2016, i.e. an injection of EUR 1.1tn of liquidities. It has shown to markets the ECB willingness to avoid the threat of the deflationist spiral.
On a short term horizon, inflation dynamics in the euro zone remain subdued and should be maintained under pressure by decreasing oil prices and weakness in food inflation. These are positive drivers for core EMU debts. However, the improving economic cycle in the US refrains us to adopt a long positioning on the expensive German curve (negative yield for short-term maturities and the 10-year maturity is yielding around 0.5%).
We initiated a small long bias on inflation linked bonds on the back of the downturn in inflation expectations and supportive monetary policy. We nevertheless remain prudent on the asset class as the carry dynamics are not supportive (Chart 2).

Strong overweight on EMU non-core countries

We kept a positive bias on non-core sovereign debts mainly via Spain and Portugal and reopened a long positioning on Italian debt. The ECB stance and the carry & roll down dynamics, well oriented, remain key drivers of the non-core debts performance. Moreover, the economic dynamics are improving. The recent labour data confirmed that Spanish, Irish and Portuguese unemployment rates are on a downside trend. Besides, industrial productions, especially in Spain and Ireland, are improving.
The prime source of concern for EMU peripheral sovereign markets comes from Greece: no consensus was finally reached after three tries to nominate a President triggering early parliamentary elections in January. The victory of Syriza, could bring volatility as the left wing party is in favour of a sizable alleviation of the debt burden (Chart 3) which is not acceptable for the Troika. The important long positioning of investors is another risk factor.

Despite short-term pressures, negative on CHF 

The Swiss National Bank surprised the markets by announcing the end of its peg EUR / CHF 1.2. In parallel, the policy rate was lowered to -0.75% from -0.25%. This triggered a strong appreciation of the CHF against other currencies as massive redemptions of "short" investors who thought that the SNB would protect its currency at all costs against an excessive overvaluation have pressured the CHF on the upside (Chart 4). In the short term, we do not exclude further pressures on the CHF. Nevertheless on a medium to long term perspective, we see the CHF depreciating as there is little or no driver to support the currency. First, bonds are at a very expensive level (the yield curve is in negative territory until the 10-year maturity). In macro terms, a substantial and sustained currency appreciation will strongly penalize exporters and add deflationary pressures which will at the end push growth lower (2015 forecast before the SNB move was about 1-1.5%). Finally, the SNB does not exclude to intervene differently in foreign exchange markets to protect its currency.

Bet for a lower Australian-US spread

The economic transition in the country (from a commoditylinked economy to a consumption-based economy) is still ongoing. As a result, Australia should continue to need an accommodative monetary policy in the coming months in a deteriorating macro environment (drop of commodities prices and signs of a slowing growth in China). Although US & Australian 10Y rates are strongly correlated, the spread should lower to 60 bps given the expected divergence in monetary policies.