EU RATES ROUNDUP: BofAML Joins Deutsche in Long OAT on Spread
(Bloomberg) -- French election risks rumble on; BofAML joins Deutsche Bank in recommending long France on a spread basis.
- Duration bias is mixed, with Morgan Stanley recommending long Bobl as flight-to-quality boosts front-end; bias toward steepeners softens further as JPMorgan tactically close their 10s30s recommendation
- Deutsche Bank (strategists including Francis Yared)
- Last week recommended going long France (100%) vs Italy (20%) and Germany (80%)
- See potential for further OAT selling from non- residents, modify the weights on Italy, Germany to 50% each; in a repeat of the 2011-12 euro-zone stresses, Italian spreads have a lot more room to widen compared to French spreads
- Japanese investors’ increased allocation to France within their holdings of euro-zone debt securities since 2011 amounts to ~EU95b, equivalent to ~6% of outstanding French govt debt
- IMF and ECB studies suggest that a 1% decline in the share of non-domestic holdings could increase yields by 6bps to 13bps, this compares with around 30bps of widening in France relative to other semi-core markets since November
- Current French election polls show the concern should be less about the outcome of a second round between Le Pen and either Macron or Fillon; the polls suggest Le Pen would lose with a margin several multiples of the Brexit polling error
- JPMorgan (strategists including Mika Inkinen)
- Expect further declines in average maturity of PSPP purchases to support the short-end, push long-dated yields higher; 10y bunds are expensive at current levels, expect higher yields but given political risk, don’t recommend outright shorts yet
- Recommend tactically closing 10s30s Bund steepeners on valuations, expectations of declining 10Y+ issuance, but still like the trade from a medium term point of view
- 10y France-Germany spread is approaching fair value based on political analysis; stay short 10y OAT vs Bund with a stop 5bps tighter than current levels
- Close Spain underweight, relative richness vs comparables has corrected as the threat from early elections in Italy has diminished; see room for further 10y+ DSL-Bund widening on politics; close supply-related 30Y underweight in Belgium and Finland
- Stay long in 2Y Germany, expect the short end to be supported by further removal of tightening expectations, richening of general collateral repo rates vs EONIA OIS, increase in purchases below the depo rate, possible increase in fears about some members leaving the Euro
- Oct. 18 ECB OIS is still pricing about 2/3 probability of 15bps rate hike; keep receiving Oct. 18 ECB OIS
- Morgan Stanley (strategists including Anton Heese)
- BTP, OAT spreads reached new highs, seeing 5-10bps daily spread movements during last week; volatility caused by concerns around political risks in Italy and France, expect this to continue
- German curve has potential to steepen further, even if duration remains well supported due to political risk concerns; room for the front-end to rally further, and long-end valuations, especially on real yield, remain unattractive
- Potential for further rally in Bobl, given safe-haven gains have been more pronounced in front-end; 5y yield is above German general collateral, repo term structure remains inverted, showing markets don’t price in any easing in German funding markets
- Recommend 5s30s German curve steepeners both in nominals and real yields
- Ongoing uncertainty around political risk, lack of obvious buyer support for France and Italy going into the French election, the coupon effect will likely have minimal effect in the midst of the macro environment
- Recommend investors to hold OAT-Bund 10s30s flattener as a way to protect against further widening in OAT spreads, and also hold on to the low vs high-coupon bonds in Italy to hedge against rising credit premium
- BofAML (strategists including Ralf Preusser)
- Position for a widening in peripheral spreads, going long France vs short Spain in 10y at 63bps, target at 120bps
- End of ECB QE is far from being fully priced in; markets will substitute political risks with monetary policy risk, with periphery to lag even if French elections to prove a non-event
- Positioning of Japanese life and pension funds in the French long-end remains long; choose Spain to express short peripheral position due to the large outperformance of the 10y SPGB-Bund relative to its traditional relationship vs other spreads
- 10y5y GBP swap rate vs EUR turned negative last week; think opposing this move poses a good opportunity to express cross-market bearishness in U.K. rates and recommend paying 10y5y in GBP swaps vs. EUR, entering the trade at a spread of -2bp with a target of 60bp and a stop of -30bp
- Barclays (strategists including Cagdas Aksu)
- Risks skewed to further ECB-speak widening in short term; markets are too complacent despite elevated policy uncertainty, continue to hold defensive trade in EGBs, namely: short 10y Spain and Austria vs Germany
- Now also attractive to add wideners conditionally, recommend buying RXM7 calls vs selling matched- maturity swaption receivers
- Path of least resistance for further steepening given potential improvement in data, which can lead to higher taper risk; change in German leadership can result in more stimulative policy
- Recent bull-flattening of the U.K. money market curve has led to the first rate hike being pushed out to mid-2019
- Beyond the next 18 months, the flattening of the curve seems an aggressive assumption, given the underlying inflationary pressure; can best be faded via paying GBP 1y fwd 2s5s
- Citigroup (strategists including Harvinder Sian)
- OATs beginning to look cheap as outlook for sovereign cohesion becomes more favorable with reformist Macron favorite to win
- Not buyers yet, given headline and polling risks, expect short covering to begin into the second round of the French election
- Recommend selling EUR 4m30y payer to a receiver spread; see the curve as already steep and expect HICP to peak in February, resulting in a fair value drop for rates
- This motivated by extreme correlations between front-end and 5y5y HICP; expect 5yy5y breakevens to fall to 1.40%, see 10yr Bunds down to the 0.1% region
- Front-end SPGBei breakevens continued to rally last week while euro breakevens softened; consistent outperformance might be partly driven by a lack of short-dated sub-7y SPGBei supply; supply pressure returns soon, negative carry approaching, recommend selling SPGBei 2019 breakevens vs HICPx
Alert:
HALISTER1Source: BFW (Bloomberg First Word)
Tickers 2539Z GR (European Central Bank)
People Anton Heese (Morgan Stanley)
Cagdas Aksu (Barclays PLC)
Francis Yared (Deutsche Bank AG)
Harvinder Sian (Citigroup Inc)
Mika Inkinen (JPMorgan Chase Bank NA)
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