European government bond yields have risen sharply across the board since November amid improving economic data and an uptick in inflation. This has led many investors to label 2017 the year of reflation. But Zahn begs to differ, at least as far as Europe is concerned.
“I believe that bonds will trade in a tight range this year,” said Zahn, who believes the ECB will continue to drive bond markets for a significant amount of time. “Draghi has signalled QE needs to be continued in the Eurozone. The fact that inflation in the Eurozone has now exceeded 1% for the first time in more than two years is not a game changer. It’s almost entirely due to energy inflation. There has been no movement in core inflation,” said Zahn.
The decision of the ECB to reduce its monthly asset purchases from €80bn to €60bn from April onwards was interpreted by many as a signal by the ECB that it believed monetary stimulus had run its course. Some investors, such as Blackrock, even went as far as to call the reduction in asset purchases ‘tapering’.
There are some risks to his outlook that are worthy of consideration, however. First, QE is highly controversial within the ECB’s board, and it’s likely Draghi has been pressured into agreeing to a reduction in asset purchases by his more hawkish northern European colleagues. Such pressure may increase over the course of the year if economic data and inflation continue to surprise to the upside.