2014 Outlook - Gilts to follow, Bunds to lag
The rest of 2013 will be used to focus on key themes and trades for 2014. We remain of the view that the portfolio should have a long vol but also a long risk bias in the New Year.
For bond markets it’s about a controlled adjustment higher in yields with much depending on the Fed’s tapering journey eventually give way to the much more important question of when ZIRP will come to an end. The stronger focus on inflation in the December FOMC statement will not preclude an end to tapering during 2014 as the Fed shifts to the fuel of forward guidance/ZIRP and away from QE.
Bund and Gilt yields will also move higher taking their lead from Treasuries. We expect Bunds to lag with the ECB in easing mode and eurozone banks concerned about their LTRO related peripheral exposure. The safety and liquidity demand for Bunds is going to be a lot more difficult to shake off compared to Treasuries and Gilts. As a result Treasury/Bund and Gilt/Bund spreads are expected to widen.
For risk markets the higher volatility on safe haven bonds and less concern over the inflation outlook should continue to help the flow of money into equities. 2013 has seen record highs on the S&P500 and Dax and the tail end of the year has also witnessed the Nikkei breaking through 16k and the highest level since October 2008. Yen weakness has certainly helped and with the BoJ likely to deliver a further burst of QE in April the trends of higher Nikkei and USD/JPY should continue.
In addition to yen weakness there will be much focus on the euro as a funding currency. It will not be easy to choose what to put on the asset side of the ledger beyond the US dollar and GBP should be at the top of the list. A test of the 7% threshold in Q1 2014 will make communication difficult for the BoE especially as the economic and housing data continue to surprise to the upside. Volatility on GBP assets is expected to be higher than that on the dollar, yen and euro.