The first week of May was pretty much characterised by the sharp sell-off in bonds, particularly bunds and high-rated (Investment Grade) bonds, and despite showing some signs of slowing down over recent trading sessions, the trend has persisted.

The decline is considered to be more technical (rather than fundamental) in nature and is hence not driven by inflationary expectations. The equity market has also had it fair share of weakness during this period whilst the euro has strengthened against the US dollar and the price of oil is well over 30 per cent above its mid-March 2015 lows.

So what do recent moves signify in the wake of a rather bleak economic recovery in the Eurozone, just two to three months into the ECB’s 19-month (at least) QE programme?

I would tend to say that the recent moves within the European IG space were rather exacerbated, to say the least, and to state that the Eurozone economic recovery has begun a positive trajectory after just a handful of randomly positively encouraging data would be premature.

By following the markets in great detail, we can devise that market moves go hand in hand with either loss of momentum in activity data or perhaps the unfolding of macro-economic events. For example, it can be argued that the recent correction may be in part due to easing of market jitters over Greece, which are expected to fade if progress continues to be made towards a resolution.

However on the other hand, we are well aware that indicators which used to be at the forefront of market direction, such as the composite PMI and economic sentiment index, which lost ground in May, were overseen as developments in the periphery were encouraging and took centre stage, such as the PMI data in Spain and Italy which surpassed expectations.

Despite this, we feel that the recent reversal in trends has provided those participants who believe that the QE trade will eventually prevail and that the ECB will continue to dry up liquidity, with an optimal trading opportunity to get in at ‘relatively’ attractive prices. This argument can be further supported by the supply/demand dynamic, which is expected to turn bullish once again for bonds towards the end of the month of May.

It is therefore important not to undermine the importance of the pressures that QE will exert on supply/demand during the remainder of the programme. Supply/demand has supported the fundamental story in the past couple of weeks, as supply has turned from negative (lack of) to positive (increase in supply) by about €90 billion between April and May.

However, for the remainder of the year, after accounting for QE, net supply is expected to go back into negative territory, with July being a key outlier, where this is expected to reach a negative €80bn print.

Also, we must highlight the fact that rates should not be viewed in isolation but within the context of other market levels and indicators.

And by this we put particular emphasis on the five year- five year inflation swap rate (a measure of the five year inflationary figures five years from now), a measure which ECB’s Draghi makes continued reference to in his periodical committee press conferences, which indicates that the market still doubts whether ECB QE will be successful or not, given that is remains below the ECB’s target of two per cent.

Disclaimer:

This article was issued by Mark Vella, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.