EU RATES ROUNDUP: Strong Curve Steepener Bias Begins to Wane
(Bloomberg) -- Strong bias toward long-end steepeners remains, though begins to cool as Deutsche Bank exits EUR 5s30s steepeners, while Citi looks for some corrective flattening, both motivated by fair value estimates.
- Steepening risks remain with analysts on the look out for paying flows from the ESM, explained here
- JPMorgan (strategists including Antoine Gaveau)
- Recent ECB comments are supportive for the front end and negative for the long end; stay long 2Y Schatz, receive Oct. 18 OIS and greens EONIA, as markets appear to be pricing excessive tightening by the ECB from 2018 onward
- Keep steepeners in 10s30s on the German curve and 2Yx2Y/15Yx5Y on the swap curve; cross-market, hold shorts in 10Y bunds vs USTs
- EGB spreads were hit by a bout of risk aversion on negative headlines, hawkish ECB rhetoric and heavy supply; turn more defensive in the periphery, add short 15Y Spain vs. Germany, hedges in Italy; hold 10Y OAT- Bund and 7Y OAT-OLO wideners
- In Italy, if the date of the election is June of this year the proximity to the second round of the French Parliamentary vote can be quite negative for Italian bonds
- 10y sector on BTP curve has been under pressure, leaving curve distorted; recommend 3s10s Italy flattener vs Germany as expect concern to eventually hit the short end more than the long end
- Despite robust U.K. data, too early for the MPC to shift to a more hawkish bias; hold May 17/Nov. 17 OIS curve flatteners; enter 1Yx1Y/2Yx1Y weighted SONIA curve steepeners, continue to hold shorts in 10Y gilts
- NatWest Markets (strategists including Giles Gale)
- Early elections have become more likely in Italy, most likely in June; elections are not market friendly, so turn more defensive on BTP spreads
- Extend target on short 10y Bund/BTP spreads to 210bps, go short 30y Italy vs Spain
- Short-term debt relief measures were given the final green light by the Eurogroup, meaning the maturity extension from the EFSF/ESM is a go ahead
- Don’t expect recent steepening selloff to deter the ESM, expect the significant long-end paying flows to begin sooner rather than later, prefer to play this via 5s30s EUR steepeners in swaps
- Remain cautious on OATs; markets may not like the reduced chances of their first choice Mr Fillon after the recent political scandal, which introduces new uncertainty into the polls, which isn’t good for OATs in the near term
- In the U.K., expect a slightly hawkish BOE with higher CPI forecasts but no rate hike, recommend short-end steepeners such as 1y1y vs 2y1y
- Barclays (strategists including Cagdas Aksu)
- Early election risk is not a positive for Italian and peripheral spreads in the current environment, despite law changes reducing chances of 5-Star movement winning elections on its own
- Continue to expect a higher “taper” risk premium priced into EGB spreads this year; maintain short 10y Spain, Austria vs Germany as cheap options for higher credit risk in EGB spreads
- Continue to believe that higher “taper” risk premium is more likely to be reflected in the ultra long-end of the Bund curve; continue to hold 10s30s Ireland steepener, which offers good risk/reward both in a bull and bear rate-market environment
- Citi (strategists including Harvinder Sian)
- Bund selloff comes as core inflation, breakevens and PMIs rise; fair value for 10y has risen by ~30bps since start of Dec., now stands at 0.54%, with the rise driven largely by the inflation variables
- See no value in Bunds for now; expect fair value to fall towards 0.10% around 2Q/3Q on inflation inputs, core HICP to stabilize with unanchored 5y5y breakevens moving lower after headline base effects peak
- German 10s30s is now significantly over the fitted level of 68bps, pace of steepening unlikely to be maintained, corrective flattening is likely to emerge over time
- Following Italian Court ruling, probability of early elections has risen to over 50%; likely to be a factor that helps prevent a rally in BTPs rather than something bearish in itself
- In the U.K., don’t see BOE QE halt as bearish for gilts, expect markets to show resilience to higher net supply as overseas investors have remained loyal; bullish on gilts as widely held expectations of slower growth in 2017 will be validated
- Morgan Stanley (strategists including Anton Heese)
- Bond market indicators have turned uniformly negative on duration across the G4 rates markets; stock-market performance, negative momentum in bond markets are driving, higher positive correlations between equity and bond markets globally
- Suggest investors position by keeping a steepening bias in their portfolios, holding 5s30s steepeners in Bunds, and scaling into 5s30s in USTs
- Strange scenario is priced in EUR rate, with forward inflation-swap curve pricing Y/Y inflation rate not rising above 1.50% for another 5 years, while Eonia curve implies ECB to raise rates more than 100bps over the next 5 years
- Unusual that ECB priced to raise rates while inflation is well below target, suggests 5y real yields ought to be lower
- BOE ending QE purchases won’t be a negative shock to gilt market; repricing of rate expectations show investors have anticipated that QE would not be extended; continue to recommend short 10y gilt due to stronger data
- Deutsche Bank (strategists including Francis Yared)
- Move short position in 5Y Germany to Eonia steepener, 1Y1Y vs 3Y1Y
- Eonia pricing has moved the first 25bps ECB rate hike to mid-2019 from early 2020, see limited room for this to be brought closer, however there remains significant room for a further steepening of the money market curve
- Exit EUR 10s30s steepener trade as the spread is now close to fair value, based on simple regression models
- Some steepening risk remains on account of the continued issuance of long-dated paper, prospects for paying flows from the ESM
- Maintain short position in Italy 10Y, 10Y Bund ASW tightener and long 10Y EUR inflation breakeven
- In the U.K., go short 5Y GBP swap spreads following the richening of cash over the recent repricing, valuations now close to historical extremes; expect shorts to see an additional supply allocation at the next remit; hold short 30y gilt as long end remains rich
- TD Securities (strategists including Renuka Fernandez)
- In the U.K., no longer expect rate cut in 4Q 2017, see the BOE keeping rates on hold through 2017-2018
- No longer expect a pronounced fall in gilt yields in 2Q, continue to see a chance of a small fall as Brexit premia rises; maintain lower risk, long duration bias on 10y gilts via a pay position on swap spreads
- SocGen (strategists including Marc-Henri Thoumin)
- ECB’s hawkish voices are getting louder, this talk echoes the view that markets underestimate the risk of an ECB “taper II” around mid-year, which would send tremors around the bond markets
- Draghi for now refuses to talk about exit in order to anchor inflation expectations at a higher level; this supports 2s10s steepening in a bearish market
- Continue to recommend buying EUR 1y10y ATMF/+45bps payer spread vs 1y2y ATMF payer
- In peripherals, recommend opening 2025/2026 BTP steepeners into next week’s auction; beyond this, keen to take advantage of cheap valuations in the 10y area via steepeners involving longer-dated bonds or short- term long positions vs swaps
- In the U.K., ambiguity of Brexit process leaves BOE’s hands tied, despite rising inflation and still-strong growth; 10y sector is vulnerable given strong macro backdrop, while front end is too aggressively priced for rate hikes
- Recommend selling 10y gilts vs Bunds at a spread of 102bp
- BofAML (strategists including Ralf Preusser)
- Record corporate supply, significant increase in duration of SSAs and government bond sales have supported bear steepening
- Despite significant long-end supply, January’s index extensions are unlikely to provide much greater support than usual to the beleaguered EGB complex
- French index extension is just 0.10yrs, is simply in line with the 5y average, due to the absence of any BTANs rolling out of the index, while German index extensions are below average this month
- Risk that supply continues to surprise the market, could be the case due to the uncertain rates outlook beyond 1Q as the ECB is set to slow purchases
- In the U.K., expect an end to QE and the risk of a more hawkish tone from the BOE, this should support current preference to pay 5y real rates and be short belly breakevens
Alert:
HALISTER1Source: BFW (Bloomberg First Word)
Tickers 2539Z GR (European Central Bank)
People Antoine Gaveau (JPMorgan Chase & Co)
Anton Heese (Morgan Stanley)
Cagdas Aksu (Barclays PLC)
Francis Yared (Deutsche Bank AG)
Giles Gale (Royal Bank of Scotland Group PLC)
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