EU RATES ROUNDUP: U.S. Election EGB Trades, Gilts Short Squeeze
(Bloomberg) -- In focus this week are how to trade the U.S. election, the latest BTP spread widening and risks of a short squeeze in gilts; duration and curve biases are split with outlook hinging on analyst expectations for the ECB.
- Citi (strategists including Harvinder Sian)
- U.S. elections dominate trading risk near term; Clinton offers continuity with limited fiscal risk as the House is unlikely to swing to the Democrats; suggest adding to bear steepeners as EUR rates will see higher correlation to USD
- Trump win risks an initial flight-to-quality as risk assets sell-off, but strategically this is a sell for bond markets due to possible regime shift toward anti- globalization, global security reordering and higher uncertainty
- Continue to look for steeper EUR curves as markets move to pricing in ECB risks in December including on depo floor removal and taper, target for 10y bunds still at 0.3% with overshoot risk to 0.5%
- MPC turned neutral, but doubt the Inflation Report will add much impetus to the gilt sell-off; Article 50 ruling is arguably bullish for gilts, at the margin, though duration outlook is well balanced with non-domestic drivers likely to become more influential, starting with the U.S. election; maintain long 30y gilt vs bund, short 5y5y RPI
- BTP-bund spreads remain near the wide-end of ranges unlike many other EMU sovereigns; don’t recommend buying the dip and remain cautious due to a variety of fundamental factors such as PMI differentials, technicals such as heightened supply, bank selling, futures flows and event risk factors such as the referendum
- Scan of the EUR and USD vol cubes has located the EUR 2y2y and the USD 6m30y points as the most dislocated in terms of payer skew: MORE
- BofAML (strategists including Ralf Preusser)
- Cautious on the bund sell-off; pay close attention to the evolution of EUR breakevens; for a sustainable move higher in rates, market needs to reprice more than just real yields; repricing of breakevens in the euro area primarily reflects taking out the Brexit shock
- Other factors responsible for the bund sell-off include high issuance from sovereign, SSAs and corporates, selling from non-Euro zone investors as EUR weakened over October, last Wednesday’s break in the bund trend line and 200-DMA may have exacerbated the selloff, potential negative gamma hedging by options desks
- See outlook for the next few weeks as mixed; ECB will ultimately deliver a bond-bullish 6-month QE extension, maintaining purchases at the current EU80bn/month, though price action in the meantime may well depend on technicals, and any leaks from ‘ECB sources’
- See risks of some bear-steepening driven by the negative convexity of Bundesbank QE operations as a reduction in the maturity of purchases could start significantly exacerbating any bear steepening when 5y OBLs return above -40bp; PSPP data will give some insight as to whether the Bundesbank used last month’s selloff to reduce the weighted average maturity of their purchases
- Given the ECB outlook, ultimately expect 10s30s bunds flatteners to reassert themselves
- Barclays (strategists including Cagdas Aksu)
- Time to reshuffle trades; with Italian spreads not far from their post-Brexit levels vs Germany, at 2y wides versus Spain, as risk/reward no longer being favorable in being short Italy, close short 30y BTP vs bund trade
- Given the duration sell-off over the past few months and the risk events ahead, time to ease into bullish biased trades; recommend long March 17 bund ASW vs EONIA, maintain receiving 1y1y fwd EONIA
- Three reasons for this; Trump win should boost flight-to-quality flows which can be even more notable into bunds as a safe haven, should also setup for a more dovish ECB
- Clinton win would unlikely result in any large risk- on duration sell-off; while tapering risks cannot be ruled out from the ECB completely, the risk is already being reflected in the price
- Maintain long 7y French ASW, which has been held since late summer due to a favorable environment for front-end ASW on the back of GC–EONIA resilience and potential supportive ECB QE parameter changes
- Holding Ireland 10s30s steepeners; while the Irish curve trade can reverse some of its performance if duration rallies back, it should still perform well on a medium- term basis, given the higher credit risk in the 30y leg and 10y being cheap on the Irish curve, especially as a large size non-CAC bond
- Italy’s referendum has been driving BTP spreads wider, but populist parties and candidates are a wider concern; re-run of the Austrian presidential election on the same date seems to be being overlooked
- Political risk in Austria does not seem to be factored into Austrian bonds, which trade rich vs France and Finland, with yield pick-ups at or close to YTD wides, a valuation that may struggle to persist
- Deutsche Bank (strategists including Francis Yared)
- Rising political uncertainty in the U.S. is compensated by improving global growth; Trump victory would support the term premium, while a Clinton victory would lead to a repricing of Fed hikes
- Maintain overall bearish bias into U.S. election, expressed via short front reds, paying the term premium in the U.S., short real rates, breakevens and paying 10s30s in the U.K., long breakevens and paying 10s30s in Europe
- Hedges against risk off are expressed in the front- end of the Japanese curve and in BTPs
- In the U.K., the High Court ruling has temporarily reduced the risk of a hard Brexit; BOE has indicated that it will lean against an abrupt depreciation of the currency and increase in inflation expectations, taken together, the current dynamic should lead to lower breakevens and higher real rates
- Cheapening of some near-dated FRAs to levels above the spot 3-month fixing is inconsistent with the ECB’s commitment to keep policy rates at or below current levels well beyond the end of the ECB’s asset purchases; recommend receiving the EUR 6x9 FRA
- Underperformance of periphery in the sell-off suggests the market might be pricing in some risk of a tapering of ECB QE beyond March 2017; given the scarcity issues in core markets and to avoid a tightening of financing conditions the ECB might trade-off lower pace of monthly purchases for a longer extension
- RBS (strategists including Andrew Roberts)
- Remain constructive on fixed income but wary of choppy conditions until the ECB holds the markets’ hand post- December ECB; suspect yields have peaked, notwithstanding any post U.S. election spike
- As we moves toward fiscal policy shifts by central banks/governments, the best RV trades are cross market ones, selling countries where fiscal easing is likely vs buying those where fiscal easing is not
- Spain looks cheap anyway, coming off the back of long-term political uncertainty and shifting long- term toward trading closer to France; reiterate view of long 50y Spain vs 30y UST
- Long-dated convexity is too expensive in swaps; ultra- long dated issuance will continue strongly in 2017, pushing real-money to unwind receivers into cheaper cash positions, recommend paying 30s50s EUR swaps targeting move from -7.75bps to +5bps, stop at -12bps
- Sell-off in gilts has been futures-led, suggesting heavy involvement of leveraged funds; if the bearish themes that have encouraged this are not validated, bear- positioning in the 10y point may be weak as momentum sellers and global factors are risks to outright retracement; recommend 10s30s gilt curve steepeners at 66bps, target 76bps, stop 60bps
- Morgan Stanley (strategists including Anton Heese)
- Bond market indicators have become less bearish on G4 sovereign markets ahead of the U.S. presidential election; suggest investors take off shorts in 10y gilts, but remain long 10y USTs vs bunds; continue to like 5s30s TIPS breakeven inflation steepeners, and now like owning 5y Italian real yields
- Market still expects further significant easing from the ECB, suggests meaningful downside to euro rates if further accommodation is not forthcoming or guidance on future policy is hawkish; even as re-pricing that suggests less QE is now being priced in, any indication that the ECB plans to start tapering bond purchases through 2017 is likely to cause a bear steepening of the yield curve
- If ECB announces measures in December to address the scarcity issue, the potential sell-off in bunds is likely to be modest (less than 5bps in 10y), although it should still cause a bear steepening of the bund curve
- Turn neutral on gilts, exit short gilt recommendation; upside surprise on the PMI services indicator this week, still suggests bearish bias, however more hawkish stance from BOE is now fully in the price; also remain concerned that the surge in gilt futures’ open interest suggests there are many speculative short positions that are yet to be unwound
- BTP sell-off fueled by political risk, performance of other risk assets, general rising yields; exit short BTPs vs Spain as recent widening suggests it no longer makes sense to hold on to the trade; continue to hold short 30y BTP on 10s30s50s fly, which is a long convexity and long volatility trade, with decent carry & roll of 4.5bps/month
- Spain has begun to trade more like semi-core; investors now look beyond the political risk as the growth outlook appears favorable compared to other euro zone countries, while its better-shaped banking system and ongoing fiscal consolidation have added to investor confidence in Spain compared to other peripheral sovereigns
- JPMorgan (strategists including Fabio Bassi)
- U.S. election outcome poses asymmetric risks to bond markets, with the greater uncertainty regarding the outlook for trade and fiscal policy in the event of a Trump win likely seeing yields lower, while Clinton win would see modestly higher yields; don’t see compelling risk-reward on German yields or curve into next week, keep risk light
- Global data and central bank commentary favors higher yields and steeper curves over the medium term; EUR front end is cheap as EONIA curve now prices almost 100% probability of the first 10bp ECB hike by September 2019, which appears too early, but refrain from entering longs
- On the German curve, 2027-30 bunds are cheap, 2022 cheapness has corrected; in peripherals, keep periphery longs in short dated Ireland and Spain; stay neutral on Italy, though see 5y BTPs are the cheapest sector; add to core wideners via short Netherlands 25y vs Germany as risk-off hedge as valuations do not offer enough protection against a bund VaR shock
Alert:
HALISTER1Source: BFW (Bloomberg First Word)
People Harvinder Sian (Citigroup Inc)
Andrew Roberts (Royal Bank of Scotland Group PLC)
Anton Heese (Morgan Stanley)
Cagdas Aksu (Barclays PLC)
Fabio Bassi (JPMorgan Chase & Co)
To de-activate this alert, click
hereUUID: 7947283