Managers warn unwinding European QE could burst 'the mother of all bubbles'

Inflation has overshot ECB target of 2%

Tom Eckett
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Managers warn unwinding European QE could burst 'the mother of all bubbles'

The European fixed income market is facing systemic risks as the European Central Bank (ECB) prepares to unwind its quantitative easing (QE) programme, according to managers.

Back in December 2016, ECB President Mario Draghi announced the central bank, which has already bought some €1.5trn in bond assets, would be scaling purchases back from €80bn to €60bn a month. However, it said the scheme would be extended until at least December 2017.

But managers expect proper tapering to accelerate in the second half of this year and are concerned about the impact this could have on the European bond market, fearing increased volatility and significant redemptions.

Market risk

Matt Eagan, vice president and portfolio manager at Loomis Sayles, said any action by the ECB carries risks for fixed income markets.

"Central banks are in uncharted territory when it comes to removing QE. The proposed playbook suggest central banks first taper purchases and then raise policy rates gradually, followed by an eventual reduction in the stock of debt owned by stopping reinvestment. Each stage carries risks for the bond market," he said.

Eurozone inflation overshoots ECB target to hit 2% in February

Meanwhile, James Butterfill, head of research and investment strategy at ETF Securities, said European fixed income is in bubble territory, having been supported by easy monetary policy.

"As a result of QE cash, bonds and bond proxies such as telecoms have become very expensive. 

"This is potentially the mother of all bubbles, as we have had a 35-year bond bull market which has been propped up by QE," he said.

"Many managers have sleep-walked into large government bond positions simply because they have appeared the safer assets."

James de Bunsen, multi-asset fund manager at Henderson, is among those avoiding European fixed income, arguing investor behaviour in reaction to the end of the bull run is difficult to predict.

Euro sovereign bond performance has been strong over the past three years, with the Citi European Government Bond index returning 18.4% (in sterling terms), but the past six months have seen the index fall 3.4%, according to FE Trustnet.

European vs US government bond returns over five years (%)

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