EU RATES ROUNDUP: Analysts Turn Bearish on Front End Into ECB
(Bloomberg) -- Most strategists avoid new positions in research published ahead of the first round of the French vote, given the tightness of the race; Morgan Stanley recommends being long German 2y ASW.
- While expectations are low on the ECB meeting this week, bias toward shorts/steepeners exists in the EUR front end given the lack of term premium, with Barclays, Deutsche Bank, Citigroup and SocGen all favoring these positions.
- Morgan Stanley (strategists including Anton Heese)
- Bond-market indicators have turned increasingly bullish on 10y bunds and gilts, driven by downside economic data surprises and bond-market momentum; however, given the importance of the French election, remains neutral on duration instead
- Last few sessions ahead of the vote have shown hedges being unwound, OAT and BTP-bund and ASW have tightened aggressively and bunds have cheapened to a level close to fair value
- Recommends going long 2y ASW into the election as a way to hedge against re-denomination/capital-control risk in a market–unfriendly outcome but also based on ECB outlook
- In base-case scenario for French election, ECB should begin to normalize policy by weakening the forward guidance in the June meeting, tapering QE in Sept. 2017 and depo rate hike in Sept. 2018; swap curve would be more adversely affected than the cash bund curve
- In the U.K., combination of greater political stability and easier fiscal policy should be positive for growth; MPC is starting to lean toward a rate increase as a result of stronger growth and inflation above target
- Little is now priced into the front end of U.K. curve, risk of the market starting to re-price rate hikes once the French election risk diminishes isn’t trivial; recommends taking longs off in March 18 short sterling contract
- JPMorgan (strategists including Fabio Bassi)
- Enter the French vote with a risk-on portfolio but also hold some cheap hedges against tail risks; focus should shift back to fundamentals after election base case plays out; hold duration shorts in 30Y Germany and curve steepeners via 2s5s and 7s15s on the German curve
- Hold hedges against adverse election outcomes via 1Y/Bobl weighted bull flatteners, Sept. 2017 FRA/OIS and 2y2y EUR/USD cross-currency basis widener
- In spreads, hold intra-EMU tighteners combined with cheap hedges; maintains credit-curve steepeners and stays long a basket of 10Y France, Italy and Spain vs Germany
- Eonia market is now pricing low probability of deposit- rate cuts over the next few months and pricing only 12bps of hikes by the end of 2018, 28bps by the end of 2019; stay positioned for more policy rate normalization via June 2018/Sept. 2018 and Dec. 2017/Dec. 2018 ECB OIS curve steepener
- Citigroup (strategists including Harvinder Sian)
- Strategically, and heading into 4Q, expects spreads to be wider as the absence of the ECB lender-of-last resort brings a bearish regime shift in periphery and semi-core valuations
- German state election of NRW (most populated state) on May 14 is largely seen as a trial run for the Federal election in September; strong showing for the SPD would encourage looking to sell bunds on ASW given expectations of more fiscal activism and Eurobond chatter
- U.K. election on June 8 doesn’t change bargaining power with the EU, but probably means less cliff-edge risk; contours of the current Brexit strategy could wiggle toward a softer version; after hitting target of 1% for 10yr gilts, expect consolidation in a slightly higher range of 1-1.25%
- ECB meeting is widely expected to be a non-event; reward-risk favors bearish front/intermediate trades on the signals from the April meeting and eventually shift to forward guidance as staff projections near 2%
- Barclays (strategists including Cagdas Aksu)
- Given the likelihood of various election scenarios, the macro backdrop for the euro area economy and ECB’s reaction function down the line, keep short 10y France outright; short 10y Spain vs Germany
- Looking to the ECB, hold reds/greens Eonia steepeners and paying June FRA–Eonia as good risk/reward trades from a medium-term perspective
- In volatility, EUR vega has been supported from buying flows in the bottom right part of the surface, with callable note issuance having slowed down in EUR, long- dated options on long tenors could continue to perform well
- Consequently, like buying EUR 5y30y at-the-money payers vs 5y5y payers at-the-money +12bps at zero cost
- Deutsche Bank (strategists including Francis Yared)
- ECB meeting unlikely to be very eventful; however, market pricing has become reasonably extreme, recommends rotating out of our 2Y1Y/4Y1Y Eonia steepener into an outright short in 1Y fwd 2Y Eonia
- Despite a modest move higher in real yields, U.K. valuations remain “extremely rich”, and the reduction in cliff edge Brexit risk can act as a catalyst for normalization in currently depressed term premia; maintains gilt 5s10s steepener
- Ahead of May inflation report, BOE rate pricing is extremely rich relative to previous BOE communications, the MPC will struggle to validate the market’s very dovish expectations; front-end shorts are attractive given current valuations, recommend paying February 2018 MPC sonia
- Recommends going long German 5y Eonia-Spreads vs short 2y as the peak concerns ahead of French elections have likely passed and these spreads can begin to normalize
- Further, potential changes from the ECB either in their repo facilities, expansion of the deposit facility, the current term structure of Eonia spreads makes it attractive to implement the trade; both legs would roll positively
- SocGen (strategists including Vincent Chaigneau)
- As further rate cuts are excluded by the ECB, current relatively dovish market pricing is an opportunity to add to trades paying the front end, either outright or in conditional terms
- Expect to see rates re-direct higher if Draghi remains “fuzzy” on the intended policy sequence at this week’s meeting
- Surprise announcement of a general election has seen general belief is that this will reduce the risk of a hard Brexit, coupled with fears over the potential for a laxer approach to austerity, view this as negative for gilts
- Gilt cash flows over the coming months also unfavorable; holds short position in 10y gilt vs swap either outright or vs U.S. spread wideners
Alert:
HALISTER1Source: BFW (Bloomberg First Word)
Tickers 2539Z GR (European Central Bank)
People Anton Heese (Morgan Stanley)
Cagdas Aksu (Barclays PLC)
Fabio Bassi (JPMorgan Chase & Co)
Francis Yared (Deutsche Bank AG)
Harvinder Sian (Citigroup Inc)
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