JP Morgan View - Can Q2 survive IP sticker shock?

Apr 1, 2011 -JP Morgan View 

Fixed income

• Bonds fell for the second week in a row, driven by another upside surprise in Euro area inflation, and generally more hawkish commentary from the Fed. Government yields have now largely retraced the March flight to safety. Inflation risks and impending central bank tightening are the main forces bearing down on bonds. Against that, the coming slowing in activity data as a result of the Japanese earthquake may provide near-term support. We keep our shorts where central bank hikes are on the horizon, in the UK and Euro area, looking for a modest further selloff. But we cover our duration short in the US, with yields towards the higher end of their recent range.

• Another eventful week for Euro area peripherals saw Portugal underperform heavily. Ireland's decision not to seek haircuts on senior bank debt bolsters the value argument for short-dated peripherals: 1yr Greece yielding 13% is the pick here, though it is not a position for the faint-hearted. Portugal's shortdated issuance programme postpones the day when it will need EU/IMF funding. That still seems the most likely outcome though, especially after Portugal's upward deficit revision widened the credibility gap between Spain (which has been delivering on its fiscal targets) and the rest. We still look for the semi peripherals (Spain and Italy) to outperform the high yielders (Greece, Ireland and Portugal) for a little longer.

Credit

• This week's release of the Irish bank stress test reduces the likelihood of bailins of existing senior bank bond holders. The announcement yesterday is supportive of senior versus subordinated Irish bank bonds as the threat of burden sharing remains off the table for senior bonds, but not for subordinated bonds. The announcement is also positive for Euro area senior bank bonds more generally, which were under threat from a potential bail-in. Stay OW bank bonds within European HG credit.