And within that asset class, most market participants have rebalanced their portfolios towards US Treasuries and government agency bonds. This confirms that the portfolio rebalancing channel has been instrumental in delivering the intended benefits of our quantitative easing. Slide 4 shows the extent of this rebalancing more clearly. Since the start of our asset purchase programme (APP), euro area investors alone accounted for more than half of foreign purchases of US debt securities. History suggests that these shares are highly unusual for the euro area. Only recently has the share started to decline again. Now, according to conventional models of the term structure, such capital flows should play no direct role in determining yields.4 In these models, the term premium reflects the covariance between expected bond returns and the representative investor’s stochastic discount factor. However, the conditions under which the supply of and demand for bonds are entirely neutral on yields are very restrictive and unlikely to hold in practice. Indeed, it is now widely accepted that arbitrageurs are often risk-averse and that many investors have so-called preferred habitats for certain assets or segments of the yield curve.5 Pension funds, for example, typically need to invest a significant portion of their assets in safe long-dated bonds to match the liability side of their balance sheet. With arbitrageurs capital-constrained, changes in the demand from preferred habitat investors can then affect the price of duration risk and hence term premia.
Incidentally, as oil prices moved higher in recent weeks, the inflation risk premia also rose amid an increasing willingness on the part of investors to hedge against inflation in an environment of strongly declining deflation probabilities. This is also consistent with survey-based evidence. For example, a recent survey of 62 fund managers by Bank of America Merrill Lynch revealed that a rise in inflation is thought to be the most underestimated tail risk for global financial markets in 2018. One fund manager in two considers a rise in inflation as a risk to current market prices. Now, whether or not this risk is real, or how much we should worry about it, is an entirely different question. I will pass no judgment on the US. In the euro area, however, we see no such inflation tail risks at the current juncture. Inflation is expected to converge only very gradually to levels closer to 2%. For this reason, an ample degree of monetary stimulus remains necessary for underlying inflation pressures to continue to build up, and we expect the ECB’s key interest rates to remain at their present levels for an extended period of time, and well past the horizon of our net asset purchases. At the same time, we currently see no reason to believe that the distribution of future inflation risks has moved permanently lower. 13 It is true that it is taking longer than usual for inflationary pressure to emerge.