EU RATES ROUNDUP: Mixed Views on Curves Driven by ECB Sequencing
(Bloomberg) -- Analysts are split on ECB sequencing, whether QE ends or rates rise first, as a result views on the curves are mixed.
- Morgan Stanley and Credit Agricole doubt any imminent ECB hike and maintain steepeners, Citigroup holds paid positions in the belly, while Barclays and Deutsche Bank like front- end steepeners
- Post-TLTRO, there are mixed views on whether there is any follow-through carry demand. Danske Bank recommendings buying belly of SPGB curve vs swaps, while Credit Agricole likes selling the belly vs wings, Morgan Stanley recommends fading steepening of 5s10s BTP vs bund
- Barclays (strategists including Cagdas Aksu)
- As long as the outcome of the French elections is not disruptive, ECB is likely to change forward guidance in its policy statement starting in June; expect the ECB to hike the deposit rate in 2018 before net asset purchases end
- ECB moves are likely to be less dovish than presumed by investors until recently
- If the ECB does signal balance sheet normalization, expect higher rates in Europe, led by the back end, driven by an unwind of term premia from depressed levels; for Q2, preferred trade expressions are for a further steepening of the EUR reds/greens and 10s30s curve
- In EGBs, recent moves in the 10y France vs Germany spread have been highly correlated with the probability of a Le Pen win in the second round; regardless of the election outcome, EGB spreads are unlikely to compress substantially from current levels, maintain short 10y France and Spain vs Germany view
- In the U.K., long-term trend growth estimates, neutral rate, is not that far from U.S., convergence trades therefore look attractive, prefer being long 10y Treasuries vs gilts and buying U.S. 6m30y receivers vs 6m30y U.K. receivers
- BofAML (strategists including Sphia Salim)
- 10s30s has flattened by over 10bps since mid-February, affected by an unexpected shift in the perceived ECB reaction function early March
- Curve has also been flattening on rallies, surprising those who assumed a new dynamic would emerge, where rate moves would be belly driven
- U.S. front-end rates are partly to do with this, in that they are a representation of the reflation trade, which has been expressed via steepeners in Europe
- Three key risks to further flattening in the short/medium term; Trump administration may deliver a tax reform by early April, ESM may begin its swaps program before mid-year and surprise with large notional paying from the start, and sovereigns may increase their long-dated issuance with a few syndications
- The start of the bear-flattening move has seen a large cheapening in implied vols on the 30y tails relative to those on shorter tails, as market participants priced in a new dynamic whereby the curve would start to be driven by ECB rate expectations, with the belly leading the move
- This is not yet the exact dynamic in place at this stage, and see the potential for new episodes of bull flattening, recommend buying vol on 30y tails vs 5-10y tails
- Citigroup (strategists including Harvinder Sian)
- The sell off in Bunds has taken the valuations to fair value, around 0.42% in 10y, as the ECB reworks its policy sequencing in the face of better growth
- ECB move has nothing to do with higher inflation but is a compromise between hawks and doves; key macro forecast is that Bunds rally as inflation risk premia declines, target 5y5y breakeven inflation at 1.4%, which infers Bunds at 0.15%
- Investors are short German bonds the most globally, with positioning skewed to bear flatteners; shorts are concentrated at Schatz and Bobl bucket, based on analysis of futures and cash flows
- String of ECB comments suggesting more flexibility in policy sequencing shows more consensus on the issue, raises risk of some message in this direction from Draghi at the April ECB press conference Q&A
- In terms of positioning, remain paid in Sep ECB OIS, long Euribor mid-curve puts and are short EUR 2y fwd 1y vs NZD, on the idea the market will price out negative rates much more quickly, and now that the final TLTRO-II has been seen, expect the market to move again
- Recommending reloading Bobl ASW wideners; risk of possible quarter-end stress in repo should support widening; ECB data on April 3 to confirm a drop in German average maturity to below 4y; receiving flows related to TLTRO-II are now absent
- Technicals likely to be supportive for OAT/Bunds as net supply profile turns decisively negative for France (est. -EU33b in April); continue to see OATs as cheap, especially vs supras and Ireland; start to scale in long as the first round of elections approaches
- Credit Agricole (strategists including Mohit Kumar)
- Recent sell off has been led by the front end, driven in part by the repricing of ECB rate-hike expectations; don’t expect to see ECB raise rates and view the shift in sentiment and move in front end of the German curve as premature, look to fade the move
- Drop in headline inflation as the base effects fall off, supply–demand dynamics such as ECB shortening of QE purchases, should also support bullish view on intermediary rates, steepening of the curve
- Maintain 5s30s steepener trades in Bunds; on the German curve, like going long 4Y vs 1Y and 8Y as a proxy for long 5Y bucket
- Expectation for increased take-up in TLTRO-II supported front-end of peripheral curves, driving steepening in recent weeks; richening of the 4Y bucket in peripheries is overdone, fade via selling 4Y SPGBs on the 2s4s6s fly, and sell 5Y SPGBs on the 3s5s8s fly
- Danske Bank (strategists including Arne Lohmann Rasmussen)
- Lower inflation, uncertain political picture both in the U.S., where investors seem to be losing their patience with Trump, and in Europe, ahead of the first round of the French presidential election on April 23, should be supportive for Bunds
- May also still see some last-minute support for Bunds ahead of quarter end; Euro-zone headline inflation likely peaked in February, expect CPI to be 1.6% y/y in March down from 2.0% y/y in February; which supports positive view on duration in the EGB market in the coming week
- Large take-up at the TLTRO-II should result in further performance in 4Y-5Y Spain and Ireland as well as covered bonds; recommend buying 4-5y Spain vs swaps
- Deutsche Bank (strategists including Francis Yared)
- Continue to prefer shorts in the periphery largely on account of expectations of further tapering of ECB QE
- Recommend switching short position in Italy 10Y into a 5s30s steepener as a more carry-efficient bearish trade
- Held some concern recently about the ECB’s ability to communicate a one-off depo hike in a manner which prevents the market from pricing in more hikes on a cumulative basis; while it is still relatively early it would appear that the ECB has had some success in achieving this
- Looking at various possible ECB-hike scenarios, including the worst-case scenario, where there is a one-off depo hike followed by a very slow pace of hikes, recommend a 2Y fwd 1Y vs 4Y fwd 1Y steepener as this offers the greatest risk/reward
- Take-up at the last of the 4Y TLTROs was larger than expected, though market impact has been limited, suggests some segments of the market were already anticipating a large take-up; most lasting impact of the large take up should be seen via reduced issuance of bank debt
- JPMorgan (strategists including Fabio Bassi)
- Outlook for 2nd quarter; anticipate receding political risk in France in a baseline scenario of Macron presidency, while the ECB is likely to turn to a neutral stance but still keep the QE tapering/rate hike sequencing unchanged
- German yield curve is biased steeper, while French and peripheral credit curves are expected to flatten
- Growth is improving and warrants higher yields European, but continue to believe in the old ECB sequencing, ending QE first before hiking rates, therefore keep 7s15s Germany steepening exposure; broadly neutral on the short end, continue to see higher yields at the long end
- Le Pen’s chances are slim, but not zero; recommend going long a basket of 10Y France, Italy and Spain vs Germany, but keep cheap hedges via underweighting short-end Belgium and Netherlands, add France and Spain 3s10s credit curve flatteners, and own low- coupon bonds vs high-coupon
- In the central scenario of a Macron presidency, project 10Y Bund yields at 60bp, 10Y France-Germany as low as 40bp and 10Y Italy-Germany at 170bps
- Morgan Stanley (strategists including Anton Heese)
- Continue to favor 5s30s Bund curve steepeners; realized volatility in the Schatz and Bobl has risen, while long- end rate vol remains higher, meaning the curve continues to trade with a bull-flattening/bear-steepening dynamic
- Not implausible that ECB raises rates before ending its QE purchases, although would go against its current explicit forward guidance; with 10bps-12bps of rate hikes now expected by next March’s meeting, risks are skewed toward the ECB normalizing rates slower than the market currently expects
- Perceived political risk premium has fallen in the euro sovereign bond market, partly helped by the TLTRO-driven buying flows; TLTRO-fueled rally could fade in the near term and the risk of spread re-widening into the French election is not trivial
- Recommend holding hedges against Le Pen risks by keeping the 10s30s OAT/Bund flattener
- TLTRO-fueled buying has compressed front-end BTP/Bund spreads and led the 5s10s BTP/Bund curve to steepen; the effect is likely to fade post the event, while political risk in Italy will likely overshadow the BTP/Bund spreads, on top of the French election risk, which imposes widening risk from the recent rally; entering a BTP/Bund 5s10s flattener
- In the U.K., after the cheapening of front-end sterling rates, take off 2s5s gilt flattener and instead go long Dec. 17 short sterling; sell off in the front end means there is once again upside to owning the U.K. front end
- NatWest Markets (strategists including Giles Gale)
- OATs are set to outperform Bunds, particularly in 30y, as Le Pen has failed to gain momentum and polls are not close enough to believe Le Pen has a significant chance of victory: MORE
- Banking sector risks are under control, while downsizing of QE buying is still distant enough; recommend extending from long 4y BTP to 7y, and buying 7y BTPei; 4s7s peripheral flatteners also attractive
- SocGen (strategists including Ciaran O’Hagan)
- No immediate threats to EGB credit spreads, with yields proving stable so far in 2017; mood turning toward adding yield, more in credit than in duration
- Overweight 4y maturities in OATs, Bonos in the aftermath of the TLTRO; 2024 Bonos also offer attractive carry and roll (7bp/3m)
- In EUR rates, bear steepeners are still appealing at the front end; shifting curve regime impacts the directionality of flies, as well as vol-relative value in the gamma space. Even after the recent repricing, prefer buying EUR 3m5y payers vs 3m2y and 3m10y
Alert:
HALISTER1Source: BFW (Bloomberg First Word)
Tickers 2539Z GR (European Central Bank)
People Anton Heese (Morgan Stanley)
Arne Rasmussen (Danske Bank A/S)
Cagdas Aksu (Barclays PLC)
Ciaran Ohagan (Societe Generale SA)
Fabio Bassi (JPMorgan Chase & Co)
To de-activate this alert, click
hereTo modify this alert, click
hereUUID: 7947283