EU RATES ROUNDUP: Politics Dominates, Scope for More OATs Pain
(Bloomberg) -- French election risks rumble on, most analysts see scope for further weakening in OATs, spread wideners in DSLs, OATs and core steepeners remain in vogue; mixed views on the BOE outlook following its Inflation Report.
- NatWest Markets recommends going long 10y bunds; Deutsche Bank recommends fading OAT move by going long France vs Italy (20%) and Germany (80%)
- Citigroup (strategists including Harvinder Sian)
- Valuation metrics still point to 10y bund fair value yields above current levels (near 0.55%) as higher PMI, somewhat higher core inflation and especially higher breakevens impact
- The key to directional call is core inflation, expect no upward movement; confidence has risen on the fall back in core German CPI as base effects drop out from Feb. 17
- Election risks in France, Italy warrant wider spreads, but the main trends are more bearish than the market believes
- ECB’s legal limit at 33% of an issuer means PSPP ends in 2017, while moving away from the capital key buys only little extra time, meaning the periphery will be losing its lender of last resort function into late 2017
- Don’t rule out further softening in OAT spreads, but look to Irish yields as a potential cap; fundamentals remain healthy, rating outlooks are stable, while supply pressures are easing in February
- Deutsche Bank (strategists including Francis Yared)
- Growth momentum in Europe looks solid, growing above potential, reducing its unemployment gap, which should further support pipeline inflation
- Widening in French spreads is hard to explain, given no material change in the probability of Le Pen winning elections; go long France vs Italy (20%) and Germany (80%)
- Look to hedge this credit fly trade with a France 10s30s flattener, as the spread sits close to fair value on models and France had a significant increase in its duration supply in January
- Some evidence of Euro zone breakup trades in the government bond market despite broader momentum behind such trades remaining low; cheapening of low coupon vs high coupon bonds at the long end of the Italian curve
- BOE’s inflation forecasts were largely unchanged; continued growth resilience will strongly test their tolerance for above target inflation, add a short Nov. 2017 MPC Sonia
- Barclays (strategists including Cagdas Aksu)
- Political risk premium is still not overpriced in the EGB market, spreads are vulnerable to further widening; heavy Q1 EGB issuance, contagion from any potential macro risky asset correction could add further pressure
- With the closest European elections still two to three months away, too early for the market to fully price these risks given historical patterns; market unfriendly outcomes are not unlikely, particularly in France where it is not clear where votes would shift in the event Fillon left the race
- Maintain defensive trade ideas: short 10y Spain and Austria vs Germany, long bund ASW vs EONIA and Ireland 10s30s steepeners
- Euribor rates have been gradually falling, in line with the decline in commercial paper rates; expect downward pressure to continue and gradually pass through to the Euribor fixings, see 3m fix at -34bps by the end of this year
- In the U.K., Inflation Report revealed that MPC continues to tolerate prospects of higher inflation to protect growth, expect a steeper forward term structure out of the 2-3y sector as markets look to find the boundaries of inflation tolerance
- Morgan Stanley (strategists including Elaine Lin)
- Rate hike indicator for the ECB suggests the first 25bps rate hike is priced for April 2019, implying the ECB is likely to start tapering purchases in early 2018
- Given weak inflation data, risks are skewed toward the market pushing back out these expectations
- Continue to recommend 5s30s steepeners, in both real yield and nominal space, reiterate recommendation to receive 2y1y vs 1y Eonia flattener
- In the U.K., now recommend being short 10y U.K. real yields, instead of 10y gilt futures, given their worse valuations
- Despite aggressive widening in spreads in recent weeks, markets are far from the stressed period seen at the height of the sovereign crisis, when the BTP-bund spread reached beyond 500bps
- Sovereign or BTP markets unlikely to reach anywhere close to crisis-levels, given improving fundamentals, including a deficit surplus across peripherals and repaired banking sectors
- In addition, peripheral sovereign bond markets are now primarily held by domestic investors, making the bond markets less exposed to fire sale during stressed times
- BofAML (strategists including Ruairi Hourihane)
- DBRS downgrade, increasing political risk, has seen BTPs underperform PGBs over recent weeks; recommend closing short 5y BTP vs PGB position
- Concerned about the limited QE support for PGBs going forward, with the ECB already close to the 33% issue limit in the 2-5y sector
- DBRS are also set to review Portugal again on April 21, where a downgrade would see PGBs no longer eligible for QE
- JPMorgan (strategists including Fabio Bassi)
- Very short-end remains supported by dovish ECB rhetoric, expectations of purchases below depo rate; Monday’s data on ECB QE delivery in January will be key, expect a decent decrease in the average maturity of the purchases
- At the long end of the German curve, continue to favor 10s30s steepeners over shorts in 10y; after the latest leg of widening in France, advocate reducing the long standing French underweight and find the best risk- reward in shorting the ultra-long end of the Spanish curve
- In Spain, continue to warn about political risk at central and regional level, especially given that overweight Spain is a fairly popular trade in conversations with clients
- Keep shorts in 10Y+ Netherlands vs Germany on Dutch political uncertainty and short 30Y Finland vs Germany on new 30Y RFGB syndicate expectation
- Change of ECB call, now expect the first 15bps hike in deposit rate in Dec. 2018, two 25bps hikes of the deposit and refi rates in 2019, targeting refi and deposit rate at 50bps and 25bps, respectively by the end of 2019
- NatWest Markets (strategists including Giles Gale)
- Go long 10y Germany, fair value at 0.26%; conviction is not maximal but positioning and fundamentals support
- Continue to like steepeners, suggest changing up 5s30s for 10s30s, also like 10y on 5s10s30s and recommend a weighted barbell, remain short outside of core govies
- France’s latest political developments around Fillon are Macron-friendly, not market-friendly; OATs can still be hurt in the near-term, despite already elevated yield levels; stay short 30y France or 10s30s steepeners
- In Netherlands, expect a long coalition building process in the context of uncertainty in the rest of the EU, likelihood of a small leftward-shift in the governing coalition may be somewhat negative for DSLs; stay short 10y Netherlands vs Germany
- Dovish Inflation Report reinforced a neutral policy signal; inflationary impetus from higher GDP forecasts offset by the assumption of a lower NAIRU, high hurdle to policy action in either direction
- See potential for markets to price in a risk of the BOE becoming behind the curve, recommend holding GBP 1F1Y/2F1Y steepeners
Alert:
HALISTER1Source: BFW (Bloomberg First Word)
Tickers 2539Z GR (European Central Bank)
People Cagdas Aksu (Barclays PLC)
Elaine Lin (Morgan Stanley)
Fabio Bassi (JPMorgan Chase & Co)
Francis Yared (Deutsche Bank AG)
Giles Gale (Royal Bank of Scotland Group PLC)
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