EU RATES ROUNDUP: Bearish Duration, Short Bias on U.K. Front-End
(Bloomberg) -- Most analysts are bearish duration, skew of ECB purchases toward short-dated Germany expected to continue to support the sector. Deutsche Bank adds long 5y vs eonia, Morgan Stanley holds 3s30s real-yield steepeners.
- Prospects for limited tightening in OAT/bund after Macron’s second-round election success as residual risks dissipate, underweight buyers emerge
- Mixed views on U.K. rates: short bias on the front-end of the curve given dovish BOE pricing
- JPMorgan recommends adding downside via options, turns bearish gilts; Morgan Stanley likes long-duration trades, recommends 2s10s flatteners
- Barclays (strategists including Cagdas Aksu)
- A lot already priced in for Macron victory in EGB spreads, bearish sentiment in duration likely has further room to go in medium term depending on data, ECB reaction function, macro backdrop
- Medium-term projection for OAT/bund spreads on a Macron win is 45-55bp, given ECB is more likely to reduce accommodation down the line in this scenario
- A decisive Macron win could squeeze shorts further pushing spreads toward 40bps area in short term with hope that Macron may do also better in parliamentary elections in June
- Maintain short bias via reds/greens (1y1y/1y2y fwd), ECB Sept. 2017/Jan. 2018 steepeners, short 10y France outright
- Citigroup (strategists including Jamie Searle)
- Schatz yields likely to remain deeply negative; record lows may be retested if the wall of ECB buying finally starts to add to long-term scarcity drivers
- April QE data show buying of Germany below capital key for only the second time; may be a sign of scarcity or sign ECB is trying to eke out purchases in Germany, highlighting difficulty in QE implementation; something may have to give to extend QE into 2018
- Longer-term, beware the periphery; ECB tapering may be happening as the next political risk in Italy begins to escalate; forecast 300bps in BTP/bund spread by 1Q 2018 vs around 186bps currently
- Constructive on OATs; may benefit from evaporation of Le Pen risk, spreads around 45bp still much wider than 20bps-40bps pre-election range seen for much of last year, correlations to other risk metrics such as iTraxx also suggest some scope for ongoing performance
- Deutsche Bank (strategists including Francis Yared)
- OAT/bund spread below 50bps no longer prices any idiosyncratic French risk; exit short 3Y France which was intended as a hedge against adverse market outcomes following the elections
- Maintain year-end bund target of 75bps predicated on upward core inflation trend, ECB taper in late 2017
- Comparing pre-QE levels with the maximum QE pricing period, German 5s10s is too flat vs 10s30, which can also be seen in the richness of 5s10s30s fly relative to 10y yield; recommend going short the belly of the 5s10s30s fly to express a bearish view on German 10Y yields
- Estimate that 45% of remaining eligible German bonds to be purchased in the 1Y-5Y sector; given the shape of the German ASW term structure, look for 5y to richen, recommend going long 5y Germany vs Eonia
- In the U.K., current pricing remains rich vs BOE guidance; prefer front-end shorts to steepeners; hold shorts in the front end into the Inflation Report, maintain short Feb. 2018 MPC-dated sonia
- JPMorgan (strategists including Fabio Bassi)
- Macron victory will have modest impact; hold 30Y shorts and 7s15s bund steepener as markets underestimate ECB and Fed actions over the next few years, near term pick- up in 10Y+ issuance, ECB’s low average maturity of QE purchases of German bonds
- In EGB spreads, hold underweight France vs 10Y Germany, 8Y Belgium and 8Y Ireland; turn neutral on other spreads as end of 2Q 2017 targets have been broadly reached
- Underweight 10Y+ sector across Austria, France, Italy, Portugal, Spain given expectations of a pick- up in long-dated issuance; recommend 10s30s credit- curve steepeners targeting the countries most likely to launch new deals
- In the U.K., move to a bearish bias on duration; 10Y gilt yields remain rich vs fundamentals, 10y sector also rich on the curve; yields toward bottom end of 6-month ranges, forwards remain low; expect some concession ahead of upcoming syndicated supply
- Go short 30Y fwd 10Y gilt ahead of 2057 gilt syndication supply (sell 2057 gilt vs 2047 gilt on cash-for-cash basis)
- BOE likely to remain patient at May inflation report, risks are skewed to a hawkish stance; initiate June 2017 2-year mid-curve 99.375/99.125 1x2 put spread at cost of 7 tick ahead of the May Inflation Report; also hold reds/greens Sonia curve steepener and Sept. 2017/June 2018 Short Sterling curve steepener
- Morgan Stanley (strategists including Anton Heese)
- Bond market indicators turn bearish on bunds but the reading is weak; business cycle surprises and equity market performance have been arguing most strongly for being short, momentum in bunds has turned bearish as well
- Prefer steepeners to outright shorts as expect short-dated rates to remain anchored by low funding costs, making it difficult for 5y or shorter yields to rise; prefer real yields given forward long-dated DBRi real yields are barely positive, richness of 10s30s breakeven curve, very positive carry in May, 04/2046 is being auctioned this week and typically sees concession
- Recommend 04/2020 vs 04/2046 DBRi real yield steepeners
- Recommend 2s10s gilt flatteners weighted 2:1; like long duration trades, considerable short base still persists in 10y sector, see this as being source of support going forward; flattener preferred to outright long because there is significantly less priced in for MPC rate hikes than there was in late January
- SocGen (strategists including Vincent Chaigneau)
- With key tail risks diminishing and the global economy charging ahead, bond yields are adjusting higher; 10y bund is likely on its way for yet another test, this time of the upper end of the range (0.50%); soaring bank stocks will feed the recovery for now and make central banks more comfortable in normalizing policy
- Add to existing G4 duration short, hold 2y3m/3y3m Eonia steepener
- Belly of the EUR rates curve is exposed because the forward guidance, though reaffirmed for now, looks increasingly conditional with more warnings from ECB members;
- In OATs, Japanese investors still underweight, don’t fade spread narrowing; like owning the 15y sector of the OAT curve, which has lagged in the rally; continue to like SPGBs, which have lagged OATs despite a higher beta, recently recommend long position in SPGB 2021 vs OAT
Alert:
HALISTER1Source: BFW (Bloomberg First Word)
Tickers 2539Z GR (European Central Bank)
People Anton Heese (Morgan Stanley & Co International PLC)
Cagdas Aksu (Barclays PLC)
Fabio Bassi (JPMorgan Chase & Co)
Francis Yared (Deutsche Bank AG)
Jamie Searle (Citigroup Inc)
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