HALISTER1: EU RATES ROUNDUP: Consensus Long-End Steepener View Under Fire

EU RATES ROUNDUP: Consensus Long-End Steepener View Under Fire

(Bloomberg) -- Consensus long-end curve steepener view in EUR rates comes under threat after latest perceived shift from the ECB opens up potential for a depo-rate increase.
  • BofAML unwinds 3m30y payers and removes steepener views, SocGen suggests long-end steepeners no longer an obvious choice, while Morgan Stanley reaffirms its 5s30s steepener view, as it see ECB rate pricing as too aggressive
    • Bias toward front-end shorts remain; EGB spreads still seen as vulnerable into French elections, ECB accommodation removal; Barclays enters short 10y France vs Germany
  • BofAML (strategists including Ralf Preusser)
    • ECB policy tightening could be considered over in coming year given the inflation outlook, but it would be a mistake; rate hikes could be used as a technical adjustment to alleviate the downside pressure on front- end German yields
      • Remove steepener bias on EUR rates and close 6m30y payer spreads
    • Expect first French election TV debate on March 20 to result in significant interest in the following polls, particularly with the proportion of undecided voters still relatively high
      • Increase for Le Pen would see return of flight-to- quality flows, while a gain for Fillon could also be viewed as increasing risks
      • Recommend going long 04/2022 Bobl vs paying 1y1y swaps; the trade would benefit from increased risk aversion, repo squeeze and/or greater buying from the Bundesbank in the 5y part of the curve relative to the shorter end
    • Expect large participation at next week’s 4y T-LTRO, with some banks swapping it into floating, driving an outperformance of the 4y relative to the wings; recommend going long the belly of the PCA-weighted 2s4s7s fly
    • Language in the BOE minutes justifies front-end repricing on shift in risks; reaction suggests pricing out of further QE expectations, supporting cross-market shorts
  • Barclays (strategists including Cagdas Aksu)
    • Dutch election results undershot worst fears from a populism perspective; uncertainty associated with the French elections unlikely to disappear until second round
      • Maintain short 10y Spain vs Germany trade and initiate a short 10y France vs Germany trade: MORE
  • Morgan Stanley (strategists including Anton Heese)
    • Recent media reports that the ECB discussed the possibility of raising rates before the end of QE has stirred up market expectation on rate hikes, prompting a shift in the front end
    • Even in the tail-risk scenario of a hike before QE ends, highly unlikely the ECB can go with a full blown 25bps hike, given the last four rate cuts have been 10bps and underlying inflation pressure remains subdued
      • 10bp hike would be more likely, although still an unlikely scenario, and would be a very dovish hike, suggesting a slow tightening path thereafter
      • Maintain bunds 5s30s steepeners as market pricing of a 10-15bps of hikes by March 2018 is too aggressive
    • Re-pricing of the front end has led the 5y to cheapen on 2s5s10 to the cheapest level since mid-2015; 5y should also perform better on the curve compared to previous hiking cycles as it still embeds the QE premium, given the average Bund duration purchased by the PSPP is much closer to 5y than 10y
  • Deutsche Bank (strategists including Francis Yared)
    • Latest ECB press conference, subsequent press reports and Nowotny’s comments have opened up the door to a potential change in the sequencing of policy normalization
      • Markets are now pricing a significant probability of a one-off hike in the depo rate, with 10bps priced by Jan. 2018, 15bps by May 2018 and 20bps by Aug. 2018
    • Maintain short position in France 3Y but move short position in Italy 5Y to the 10Y sector given the lower negative carry of 10Y, recent bear-steepening dynamic is set to persist given to the front-end support from the TLTROs, longer-dated issuance
    • BOE dialled up the hawkish message in March; investors expecting resilience in upcoming data could therefore find shorts in the very front-end meeting dates attractive from a risk/reward perspective
      • Money-market curves price too little risk premium given upcoming inflation pressure, maintain the 1y1y/3y1y Sonia steepener
  • Citigroup (strategists including Harvinder Sian)
    • U.S./Euro rate differentials give the ECB more space to recalibrate policy on the basis of higher growth; the inflation backdrop by contrast is benign, and inflation expectations should start supporting richer long-end valuations
      • Continue to look for ECB depo-rate hike this year, most likely in Sept. 17; expect ECB speakers to diverge on where policy goes next, but more open- mindedness on the policy sequencing has to be on the table
      • Maintain paid positions in the belly of the curve (and owning downside in Euribor mid-curves) with economic data likely to be the main support for these trades
    • Despite the expectation for an ECB rate move this year, believe headline inflation has peaked, should see breakevens drift lower. Expect little movement in core HICP ahead
      • Inflation has peaked and expect 5y5y breakeven to move to 1.4% from 1.7%, and that will bring down Bund valuation from near 0.6% at present towards 0.2%
    • Poor reaction by periphery to Dutch election outcome is a warning sign that confidence in ECB policy is already being eroded. Expect a relief rally in periphery after Le Pen fails to win French elections, but this should give way quickly to renewed widening with 10y BTP/Bund back toward 200bps as investors anticipate ECB tapering in 2018
    • Hawkish episodes from BOE should be faded as actual risk of a policy error is far too great ahead of potential cliff-edge risk; MPC might tactically sound hawkish while remaining firmly on hold; 10y gilt target remains 1%
  • Credit Agricole (strategists including Mohit Kumar)
    • Long the front end of EUR rates curve with market pricing in more than 50% chance of ECB hike by mid 2018; see the ECB as some way off from reducing the stimulus
      • Market-price distortions and asset scarcity will have to be addressed; ECB might take view that hiking rates before ending QE could to address some cross-market distortion, weakness of the EUR
    • EGB spreads tighten given the favorable Dutch election, reflation theme of the Eurozone has weakened (helped by falling oil prices), and the Fed’s dovish hike
    • See risks on EGB spreads as asymmetric risk, with renewed political noise to support widening; OAT-Bund can hit 80bps, while BTP-Bund can revisit 200bps
  • SocGen (strategists including Vincent Chaigneau)
    • EUR curve dynamics at inflexion point with bear steepeners in 5s10s, 10s30s no longer “no-brainers,” though they remain appealing in 2s5s as rising uncertainty on ECB policy is consistent with a rebuilding of term premiums
      • Medium-term strategic view on the EUR front end is best expressed via trades that do not suffer from overly penalizing time decay, such as buying EUR 1y2y payer ladders, or buying 1y2y ATM fwd payers vs selling 1y1y
    • With sentiment toward sovereign risk stabilizing, surprised that 5s15s SPGB curve has steepened so much, contrasting with strength in 15y core and soft core
      • 15y Spanish paper offers an opportunity to capture a large pick-up with limited duration extension, buy the SPGB 07/2030 versus the SPGB 01/2022 at 81bps in ASW
    • Term premia rebuilding is an ongoing global phenomenon; based on regressing the slope of the curve vs level of short rates, prefer expressing term premium trade via paying EUR 10y vs receiving 0.76x the PV01-weighted amount of EUR 2y

Alert: HALISTER1
Source: 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)
Mohit Kumar (Credit Agricole SA)

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