RESEARCH ROUNDUP: Brexit Fallout for USD Rates; FOMC on Hold
(Bloomberg) -- Brexit impact on financial conditions, U.S. inflation expectations (via USD strength), potential easing from BOE, ECB will make it much more difficult for Fed to hike rates, analysts say.
- Bias toward long positions in USD rates duration, curve flatteners; both TD Securities and Deutsche bank revise down forecast for 10Y rates
- BofAML (strategists including Shyam Rajan)
- Aside from risk-off, see two key drivers of USTs
- Flight out of Gilts by risk-averse foreign investors to benefit Treasuries, similar dynamic seen for European bonds in 2011
- Attracting global liquidity putting pressure on inflation expectations at a time when real rates are constrained, monetary policy seen as ineffective
- 5s30s curve to flatten from current levels, rate hikes pushed out, don’t see cuts on the table just yet
- Large flattening in 10s30s Germany, 30y JGBs lower by 6bps vs U.S. 10s30s steepening by 5bps seems like an unstable equilibrium
- Citi (strategists including Jabaz Mathai)
- EU referendum has delivered uncertainty; recommend unwinding long rate, long vol trades; opportunistically start setting through options for tactical bounce; medium term remains bullish
- BOE, ECB braced for further easing, Fed is trapped in a global central bank easing cycle, will not allow for rate increases near term as would cause further destabilization
- Risk markets will normalize as central banks provide a safety net to risk assets through more QE, this is where opportunities exist in rates markets
- Recommend buying EDZ6 99.50/99.375 1x2 call spreads and 1x2 6m2y ATMF/ATMF -20bps receiver spreads, monetizes richness of volatility, fades extremely dovish Fed policy expectation
- Medium term, July provides a good backdrop for bunds, USTs, as net supply dynamics look favorable, sell-offs to be muted
- Deutsche Bank (strategists including Dominic Konstam)
- Revise down rate outlook, see 10s trading around a midpoint of 1.25% through 2H 2016; forecast change down to stagnating growth, not any particular exogenous shock
- Brexit presents challenges for U.K. economy, European political integration; will be difficult for market rates to rise, let alone Fed to hike
- Real money, speculator positioning has moved to broadly flat in duration; if U.S. data disappoints, investors will seek to enter long duration positions
- Recent developments should reinforce data dependence for remainder of the year, supportive for vol, mostly at the back end of the curve; absence of Fed hikes would cause further pressure on upper left vol
- Morgan Stanley (strategists including Matthew Hornbach)
- Continue to recommend long duration; best value in belly of curve due to the potential for further central bank easing, attractive carry & roll; recommend long 5Y USTs
- Treasuries stand to benefit from tightening in financial conditions, weaker growth outlook (driven by a drag on U.S. exports), should result in lowered path of rates
- Notable that Fed’s recent statement mentioned willingness to act if a scenario leads to “adverse implications for the U.S. economy”; given low rates, bar for the Fed to act will be lower
- SocGen (strategists including Bruno Braizinha)
- Don’t fade recent rally; Brexit shock presents difficulties for FOMC given tightening financial conditions, renewed downward pressure on inflation expectations, significant reduction in visibility around U.S. outlook
- Recommend holding costless 5y5y receiver ladder, or enter 4y5y costless receiver ladder, offers downside breakeven of -3bps for the terminal 5y rate; hold costless 3m forward 5s10s bull flattener
- TD Securities (strategists including Priya Misra)
- 10Y year-end forecast falls to 1.40%, incorporates risk of political, economic, financial contagion from U.K. Referendum
- Fed concerns with tighter financial conditions should push hikes further out; front end yields are floored, further rally to be felt further out the curve, 5s30s should flatten
- 10Y may break below historical lows of 1.38% as knee- jerk reaction to weakness in risk assets, strength of the dollar in a classic flight to quality move
- Expect flatter 10s30s swap spread curve due to variable annuity hedging needs, which should result in receiving pressure in long-end
- Expectations of higher libor may widen front-end spreads
Alert:
HALISTER1Source: BFW (Bloomberg First Word)
People Bruno Braizinha (Societe Generale SA)
Dominic Konstam (Deutsche Bank AG)
Jabaz Mathai (Citigroup Inc)
Matthew Hornbach (Morgan Stanley)
Priya Misra (TD Securities USA LLC)
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