HALISTER1: EU RATES ROUNDUP: Turning Short EUR Front-End Heading Into ECB

EU RATES ROUNDUP: Turning Short EUR Front-End Heading Into ECB

(Bloomberg) -- Analysts focus on the ECB, with many highlighting risks for the front-end.
  • Citigroup recommend hedging via Euribor options, Barclays prefer reds/greens EONIA steepeners, while Deutsche Bank enter short 3Y fwd 2Y eonia
  • Citigroup (strategists including Harvinder Sian)
    • Strategic view is that the peak in Euro HICP for this year has been seen, expect core HICP to flat-line near 1%, motivating a trend decline in 5y5y breakevens (target 1.40%)
      • Risk is that staff HICP projections get less benign on sharper output gap narrowing
      • Already look for wind-down of QE in 2018, perhaps the compromise in 2017 will be to tweak the depo rate marginally higher given it will help bank profitability, prevent deeper losses on PSPP buying
    • Recommend buying Euribor Sept. 2017 1y mid-curve 99.875 puts paying 2.5c (delta 13%) to hedge risk of election upset in France, possible ECB changes to HICP forecast: MORE
    • Remain long Bobl spreads, see risk that ECB will get more generous on the cash-for-collateral facility, though unlikely to happen in near term as the ECB will be aware of SNB buying as well as other factors responsible for driving 2y yields
  • Barclays (strategists including Cagdas Aksu)
    • ECB is likely to keep its dovish bias with the risk that it tones it down; recommend closing long Bund ASW vs EONIA, with ASW close to all-time wides, no longer fundamentally cheap
      • Scope for tightening, possibly a less-dovish ECB tone, capital ratio deviation, or a mention around repo issues
    • Initiate reds/greens EONIA steepeners; curve has little term premium at around 11.5bps given the improving backdrop for the euro-area economy
      • Longer-dated EONIA can build more relative term premium associated with better growth and inflation outlook, end of Draghi’s term in late 2019 and Fed policy outlook
    • Holding onto our short 10y Spain and Austria vs Germany trades; keep long-end periphery curve steepening in 10s30s Ireland based on macro backdrop and credit risk premium arguments
  • Morgan Stanley (strategists including Anton Heese)
    • The implication of higher UST yields, with the Fed now expected to hike in March, is for a steeper euro curve
      • Expect collateral scarcity issues, exacerbated by euro political risk concerns, to keep 5y and shorter-maturity German paper well-anchored; continue to recommend bund 5s30s steepeners
    • In the U.K., growth data has come in weaker than expected, reducing the likelihood of the MPC raising rates for the foreseeable future
      • Continue to hold 2s5s gilt flatteners, which has a very clear long duration bias; recommend the trade as a way to reflect expectation that the MPC is likely to keep rates lower than the market currently prices
  • BofAML (strategists including Ralf Preusser)
    • Any change to the ECB’s statement on rates remaining “at present or lower levels” would see the 1-3y part of the OIS curve most susceptible to a sell-off; don’t believe the ECB will extend their TLTROs next week
    • Clarification from the ECB that this will be the final TLTRO should imply a very large take-up at the March 23 operation, as this will be the banks’ last opportunity to obtain cheap 4y funding at rates
      • As a result, ahead of LTRO look for outperformance of 4-5y point on the swap curve, widening in 3s6s basis (4-5y sector), after LTRO look for widening in FRA-OIS, some support for the periphery
    • In the U.K., budget to result in reduced supply relative to expectations, would be most beneficial for long-dated conventional Gilts; budget will be perceived as less austere, which may have a mildly bearish impact on the front-end
      • Taken together, this suggests broad curve flattening
  • Deutsche Bank (strategists including Francis Yared)
    • Market pricing of the Fed remains too benign, both the terminal rate and the term premium remain too low
      • As political risk is receding, the ECB should slowly but surely acknowledge that the data is supportive of a reduction in the stimulus later this year
      • Don’t expect any significant changes from the ECB at its meeting next week; greater chance of a removal of the “lower” element in the forward guidance on policy rates rather than removing the bias for increasing the pace of QE
      • Enter a new short 3Y fwd 2Y eonia as the market has scope to reprice the money market curve
      • Maintain bearish bias on the front-end of France (3Y) and Italy (5Y)
  • JPMorgan (strategists including Gianluca Salford)
    • Bias for higher German yields in the short and long term given continued decline in maturity of purchases, risk ECB tweaks forward guidance bearishly, continued tightening of intra-EMU spreads, which may prompt more unwinds of long Bund hedges, developments in U.S. rates
      • Wait for a pullback to re-enter shorts at the long end; bias for steeper 2s10s and 10s30s curves but currently unattractive entry levels
      • Stopped out of longs in Schatz last week; barring dramatically new information on the ECB reaction function, consider re-entering longs in Schatz in the -80/-75bps area, targeting a move toward -90bps
    • Intra-EMU spreads are reacting to reduced political risk; template of Brexit and Italian vote and fair value models suggest there is room for further tightening
      • Recommend 10s30s France steepeners vs Germany as a cheap way to position for a continuation of tightening
Alert: HALISTER1
Source: BFW (Bloomberg First Word)

Tickers
2539Z GR (European Central Bank)

People
Harvinder Sian (Citigroup Inc)
Anton Heese (Morgan Stanley)
Cagdas Aksu (Barclays PLC)
Francis Yared (Deutsche Bank AG)
Gianluca Salford (JPMorgan Chase & Co)

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