Bond markets: the effects of size and duration of QE

The size and duration of QE is currently the single most important driver of euro rates and government bond yields. It's the conviction of UBS chief investment office Wealth Management. "If the ECB considered enlarging or prolonging purchases, government bonds would inevitably have to provide the main share", the analysts say.

In their opinion, with only moderate program adjustments, the ECB could carry out 15 more months of QE in its current form, if needed. Raising monthly purchase volumes is more likely than an extension, and would push yields and spreads down further, but would also enhance the risk of a correction later. But a failure of the ECB to meet the high market expectations for more easing in March can trigger a sharp correction in European high grade bonds.

Between the European government bonds, UBS thinks that Bunds will likely outperform most highly rated Eurozone government bonds: "at best some will achieve small excess returns, but only a few basis points of widening can wipe these out". Portuguese bonds recently underperformed strongly due to political risk, and promise 5–8% of excess return if the new government agrees on a reasonable budget plan. Downside risk is also high, though (a possible exclusion from QE could cost 5–6% in underperformance). In conclusion: "in a broader context, we confirm our preference for European corporate bonds over high grade bonds".