HALISTER1: EU RATES ROUNDUP: Bearish EUR Rates Duration Bias into ECB

EU RATES ROUNDUP: Bearish EUR Rates Duration Bias into ECB

(Bloomberg) -- Most analysts continue to hold a short bias in EUR rates duration with those who aren’t still recommending hedges such as steepeners, buying downside protection for ECB meeting.
  • RBS (strategists including Oriane Parmentier)
    • Remain bullish 10Y bunds, targeting -0.40%; pressure remains on fiscal tightening instead of easing, given PSPP buying, balanced budgets, negative supply of duration to the market
    • Believe the market remains underweight bunds, reinforces bullish bund view; uncertainty around U.K., slowing growth, lackluster inflation also supportive
    • Long bund positions may also benefit from relaxation of QE rules at this week’s meeting; continue to expect ECB to cut rates further, starting with 10bps in Dec. meeting
  • Deutsche Bank (strategists including Francis Yared)
    • Given relatively resilient data, the ECB may stay on hold this week; any further policy accommodation a close call; should limit itself to an extension of QE (which is priced, announcement likely to have minimal impact), technical changes to the program
      • Market is pricing 1bp rate cut at this month’s ECB meeting, 12bps of cuts on a cumulative basis by 1Q 2018; shape of the Eonia curve, excess flatness of 5s10s and 10s30s curves indicates the market is pricing an eventual extension of ECB QE
    • Volatility, payer skew are at levels very similar to that seen in April 2015 before the sell-off; given limited positioning, benign inflation outlook, weakening global growth, any sell-off should be muted compared to Apr-Jun 2015; recommend 1x1.5 3M 10Y ATMF/ATMF + 25bps payer spreads
    • In the U.K., maintain short gilts 5Y5Y as the amount of QE priced-in remains excessive; also hold short EUR 5Y as it is unlikely that the ECB delivers the 13bps of cumulative rate cuts currently being priced in
  • JPMorgan (strategists including Fabio Bassi)
    • Expect ECB to disappoint modestly with no rate cut, no QE extension, no scarcity measures; risk-reward still favors shorts in 10Y bunds, move to 10s30s steepening bias; keep reds/greens steepener outright, initiate level-adjusted greens/blues EONIA steepens
      • Hedges against ECB disappointment include 2s/10s weighted bear steepener, paying belly of 5s10s20s EUR swap fly
    • Hold short gamma bias at front-end of the curve; tactically, take profit on short 3Mx2Y gamma and instead sell Dec. 16 schatz gamma; stay short Oct. 16 unhedged Bobl strangles (131.75/131.50, Dec16 Bobl futures at 131.61), which was primarily initiated as a carry trade
    • Further out the curve, stay long 10Y gamma; lack of action by the ECB and BOJ later this month has potential to push yields higher, especially if markets start to interpret a lack of action as a reluctance to provide further stimulus
    • In U.K., stay long Nov16 MPC OIS; remove bullish bias on gilts, turn neutral on duration given improving data, fading negative net supply impact, rich valuations; take profit on both 2s10s and 10s/30s gilt curve flatteners; enter 30Y swap spread narrower given upcoming gilt supply, potential increase in swapped issuance, short term valuations
  • Citi (strategists including Harvinder Sian)
    • Data, financial conditions don’t warrant a bazooka response from ECB, but low inflation points to an extension of QE by 6-months
    • PSPP parameters may be altered, baseline is lift in 33% limit on non-CAC bonds, which infers a sharp flattening rally but buys just a handful of extra months
    • Adjustments to capital key or depo floor removal may mean an end of PSPP driven negative convexity effect, infer curve steepeners with bearish long end momentum
      • EUR spread options attractive to set-up for curve steepening: MORE
    • Growing more concerned about effects of negative rates on bank profitability, ultimately the transmission mechanism; hold short EUR 1y1y OIS, selling 2y1y receivers, long 2y 2s5s floors
    • Cautious on PGB spreads, not significantly bearish given the ECB; domestic politics, headline risk can weigh on tone over near-term, keeping spreads in check
    • In U.K., gilt yields are fairly valued despite “bubble- like gains”, remain low yield believers; see 10s30s flattening a further 10bps-15bps
  • Morgan Stanley (strategists including Anton Heese)
    • Inflation data will matter more to ECB than growth data, expect other G4 markets to drive bunds
      • Pushed back expectations of further ECB easing to Sept. to Dec. meeting: MORE
    • Technical changes to ECB PSPP program may ease some scarcity issues; however don’t expect this to cause 10y bunds to sell off more than 5-10bps, 30y bunds 10-15bps
    • In U.K., rally in the long-end has potential to become self-reinforcing; 30y gilts outperformed dramatically cross-market in August, can continue to richen; go long 30Y gilts vs bunds
    • Turn bearish on peripheral spreads in near as ECB not likely to ease further in near term, supply due to restart
      • Suggest German 10s30s steepeners vs France as a way to fade bund scarcity premium; In the U.K., look at supply picture, net of QE, which is the lowest since 2012
    • EONIA curve poised to steepen if ECB rate cut arrives sooner or rate cut is taken off the table; continue to recommend paying 2y1y vs 1y (whites/greens) steepener to express steepening risk
Alert: HALISTER1
Source: BFW (Bloomberg First Word)

Tickers
2539Z GR (European Central Bank)

People
Oriane Parmentier (Royal Bank of Scotland Group PLC)
Anton Heese (Morgan Stanley)
Fabio Bassi (JPMorgan Chase & Co)
Francis Yared (Deutsche Bank AG)
Harvinder Sian (Citigroup Inc)

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