The European Central Bank's aggressive plan to increase both the scale and scope of its asset purchases shows that President Draghi is serious about keeping his promise to do "whatever it takes". But investors are still nervous about whether the liquidity being created will have a positive impact on the real economy. We are more sanguine than most about the growth backdrop, both internationally and within the euro area. The fundamental drivers for the single current bloc are very positive; fiscal policy, euro depreciation, banks' appetite to lend and a falling oil price are all moving in the right direction. European earnings momentum is stabilising and earnings growth looks set to significantly exceed the US in 2015. The big question for allocation is: when will markets adjust to a more constructive view?
Earlier US rate rises?
While central bank policy measures, in aggregate, offer support for bonds, we continue to be wary about our exposure, particularly to expensive government and investment grade bonds. Fixed income markets appear to be focused on the short-term disinflationary impact of the fall in oil prices. We believe they have yet to factor in the positive impact on growth that should emerge as the year progresses. Investors may be happy to accept falling bond yields so long as economic conditions remain tepid, but this picture could quickly reverse if macro momentum continues to improve in Europe.
Furthermore, the US labour market is clearly tightening and data is signalling that wage growth is finally picking up. This increases the chances that US rate rises are brought forward which will ultimately pressure areas of the fixed income markets.
UK - trouble beneath the surface
Much has been made of the remarkable turnaround in the UK economy. Surface appearances can be deceptive, however: the housing market is beginning to cool and cannot be relied on indefinitely to support the household wealth effect. Most importantly, years of necessary fiscal consolidation lie ahead to reduce the budget deficit and pay down debt - and this coincides with a period of heightened political uncertainty. The 2015 general election is creeping closer and Britain's political landscape is more fragmented now than at any time since WWII. All indications point to some form of coalition, which could struggle to obtain consensus on the details of fiscal consolidation. In this environment, markets could face an extended period of anxiety.