2013 was marked by a reduction in systemic risks in the Eurozone, falling inflation and gradually improving growth at low levels in Europe and the US. As we move into 2014, systemic risks promise to remain low, real growth is set to increase substantially and inflation should bottom out. While fiscal policy was very restrictive in recent years – thereby forcing monetary policy to adopt an increasingly accommodative stance - it will become much less so in the quarters ahead. This will force some of the major central banks to limit their monetary accommodation. As European and US growth improve and the Fed winds down its asset purchase programmes, the first half of next year promises to see a continuation of recent trends – bear-steepening of US, UK and EUR curves with an outperformance of the Eurozone and an ongoing tightening in Eurozone sovereign bond spreads. However, significant above-trend growth, slowly rising core inflation and wage pressures on the back of falling unemployment will push the US Fed into further action towards the end of the year. In line with the FOMC’s forward guidance, rate hikes will not yet be on the agenda but an outright reduction in USD liquidity will become increasingly likely via the introduction of reverse repo operations. This, however, promises to cause a renewed wave of selling across Emerging Markets and in commodity dependent assets and currencies while also propelling risk aversion and realized volatility higher across developed markets. The upward pressure on EUR, USD and GBP vs. a broad basket of currencies should be maintained in 2014 but as the year progresses, the USD should increasingly become the outperformer within this group.
- Short UST, Gilts, Bunds and JGBs. US-EUR and UK-EUR spread wideners.
- Long break-even wideners.
- Overweight higher-yielding semi-core and peripheral bonds.
- Long USD, GBP and EUR vs. a broad basket of EM and DM currencies. Short CAD, NOK, AUD & JPY.
- The second half is likely to be dominated by increasing prospects of monetary tightening in the US and the UK.