Where next for euro government bonds?

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As the European Central Bank (ECB) published its first-ever minutes of a policy meeting in which it revealed its plans to expand its Quantitative Easing (QE) programme. Tom Sartain, fixed income fund manager at Schroders, comments on what investors can expect from the euro government bond markets after the expanded QE begins:

“In January, the ECB announced a bold expansion of its asset purchase programme. Now that markets have had time to digest the news, investors want to know where eurozone government bonds will go next and where the opportunities lie in today’s low yield environment.

In summary, our views are that:

• The sheer size of the expanded stimulus plan and the quasi open-ended nature of the schedule came as a surprise to the market. We believe this will prove more impactful in raising inflation expectations than markets are anticipating.

• Markets are too pessimistic on the near-term growth outlook for the eurozone. Prior to January’s announcement data were already starting to turn. The asset purchases will act as a further boost to economic progress.

• The ECB’s decisive action could shift the supply-demand balance for certain parts of the European bond market; some assets will be clear beneficiaries from the programme.

• Although the monetary policies of the eurozone and stronger economies like the US and the UK are moving apart, key aspects of bond pricing will remain closely linked. Historically, inflation risk premium (the amount of return demanded by investors for offsetting inflation risk) and term premium (the return demanded for moving further along the yield curve) are highly correlated between these markets.

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