HALISTER1: EU RATES ROUNDUP: Long-End Steepeners, Mixed View on Front End

EU RATES ROUNDUP: Long-End Steepeners, Mixed View on Front End

(Bloomberg) -- ECB meeting autopsy. Duration bias remains the same, with shorts and steepeners favored. NatWest Markets rotate paid position in 30y swap into short 30y Germany. JPMorgan opens 7s15s steepeners.
  • Mixed views on front end; Citigroup looks for continued repricing of EUR belly, recommends paying 2y1y cross-market, Barclays hold their reds/greens EONIA steepeners. Deutsche unwinds short 3y2y EONIA and JPMorgan recommends fading the front-end repricing via Euribor call fly.
  • Citigroup (strategists including Harvinder Sian)
    • ECB forward guidance quasi-weakened as ‘lower rates’ no longer believed; Draghi doesn’t want to speculate on rate hikes before QE ends, but is keeping options open to do exactly that
    • See good arguments for the depo hike to aid bank profitability, protect the periphery via undisturbed QE; could see a rate rise as early as June, but more likely in September
    • Markets need to rethink the timeline of how long rates remain negative; look for more cheapening in forward swaps around the belly of the curve (e.g. 4y fwd 1y), also expect to see ongoing hard squeeze in German short end, driven by ECB buying as well as purchases from the SNB, Czech central bank
      • Recommend paying the belly of the euro curve on expectation ECB exit from negative rates well ahead of the current pricing of the Jan. 2020 ECB meeting; pay EUR 2y fwd 1y vs receiving NZD 2y fwd 1y
  • Deutsche Bank (strategists including Francis Yared)
    • ECB opened the door for a one-off adjustment to the deposit rate; given the significant repricing in eonia, exit short 3Y2Y EONIA as it is now at levels consistent with the outlook
      • Hold short 3Y France, which will capture a potential one-off adjustment to the deposit facility as well as provide a convex hedge against increased political risk in France
      • Maintain the short BTP 5Y; even without immediate political risk, the prospects of an ECB taper should put medium term pressure on BTPs
      • In the U.K., the Budget saw a sharp decline in T- bill issuance, which should richen very front-end spreads; recommend adding long 2Y ASW boxed vs existing short 5Y spreads recommendation
    • Historical analysis of the polling errors in French election shows current lead of Macron over Fillon (~6%) is within the average polling error at this stage of the race, while the lead of Macron, Fillon over Le Pen in the second round is greater than the largest polling error at this stage of the race
      • This suggests that the greatest uncertainty at this stage is about who would qualify for the second round
  • BofAML (strategists including Sphia Salim)
    • Draghi’s comments exacerbated the steepening of EUR curves triggered by QE purchase data; the optimistic tone drove swap rates, long-dated yields higher, while remarks on the German front end suggested no imminent action is to be expected, at least not before another sharp rally
    • Significant increase in the beta of OIS forwards to Bund yields suggests a change in the perceived reaction function of the ECB; rate hikes are likely even as Bund yields remain supported by a continuation of QE
      • Maintain steepening bias on the Bund curve, don’t fade the selloff in front-end swap rates at this stage
    • ECB’s average maturity data for Germany, shows 4.3y for February, which along with non-EUR CB interventions (e.g. SNB, CNB, Danish CB) were likely responsible for over 50% of the richening in Schatz & Bobl vs OIS in Feb.
  • Barclays (strategists including Cagdas Aksu)
    • Theoretically, no reason why the ECB cannot hike the depo rate, manipulate net asset purchases simultaneously, combining the two might not be smooth and could pose communication and short-rate dispersion challenges
      • Now expect the deposit rate to be increased in 2018 by a cumulative 20bps, with the balance of policy risks skewed towards a scenario in which the deposit rate is at zero by the end of 2018
    • See a continuation of the rise in term and credit premiums in the EUR rate and EGB market and, therefore, maintain an EONIA reds/greens steepener, a 10s30s Ireland steepener and EGB spread wideners
      • Maintain recommendation to go long a June 2017 FRA/Eonia contract as it offers attractive risk/reward in case of increase in political risks ahead of French elections
  • NatWest Markets (strategists including Giles Gale)
    • Expect a six-month QE extension in December 2017; if inflation dips as expected, the ECB will be much chastened this time next year
      • Ahead of this, expect the taper theme to build, before it eventually fades; markets are bound to consider tapering from December and a rate hike by September or December 2018 as base case
      • Hold short duration view; PSPP data shows Feb. German purchases weighted at 4.3y, markets begin to focus on ECB QE tapering, evidence that the theme of reduced PSPP support is taking hold with the asset- liability industries in Europe, which would be significant for long-dated Bunds
      • Recommended paying 30y swap to express short last week because of ESM steepening theme, but now look for proportionally less paying and more sales of cash bonds at the long end from the ESM/EFSF; rotate this into short 30y bund, target 1.49%, stop 1.19%
    • Confident ECB sets a low hurdle for tapering in 2018, PSPP shortening by Bundesbank, sovereign risks reducing still argues for steepener curve
  • Morgan Stanley (strategists including Anton Heese)
    • Continue to like holding 5s30s steepeners in Bunds, despite recent headlines about ECB rate hikes preceding the end of QE, and remain short 5y Treasury notes outright
    • The decision to buy bonds below the depo rate made in December effectively decoupled the decision on bond purchases from the setting of interest rates, leading to speculation the ECB might raise rates before ending QE
      • This would make sense if negative front-end rates were seen to be harming the financial sector but doing little to boost the economy, but QE was still necessary to guarantee reflation
  • JPMorgan (strategists including Fabio Bassi)
    • ECB meeting saw a lower emphasis on its forward guidance, Draghi referred to it as an expectation, rather than a commitment, and subsequent press reports left open the question of sequencing of rate hikes and ending QE
      • Retain a bearish duration bias and steepening view and open 7s15s Bund steepener
      • Keep cheap hedges against French politics tail risk in country spreads, credit curves, high-coupon vs low-coupon, CDS; add 10s30s Italy steepener vs Spain
    • Think that current market pricing is too aggressive, especially the 15bps of ECB hikes priced by June 2018 and ascribe small probability to this outcome; continue to stay long June 2018 ECB OIS
      • Like fading front-end selloff via bullish Euribor structures; favour buying the 100/100.25/100.50 June 2017 1y mid-curve Euribor call fly which has attractive upside/cost ratio
    • Expect TLTRO take-up of around EU70b with upside risk, with moral suasion from the ECB to discourage their use for carry trades and/or liability management

Alert: HALISTER1
Source: BFW (Bloomberg First Word)

Tickers
2539Z GR (European Central Bank)

People
Anton Heese (Morgan Stanley)
Cagdas Aksu (Barclays PLC)
Fabio Bassi (JPMorgan Chase & Co)
Francis Yared (Deutsche Bank AG)
Giles Gale (Royal Bank of Scotland Group PLC)

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