Thursday, 05 January, 2017
2017 Year ahead outlooks
BAML: Global Rates Outlook ( December 9): Rates- US duration to underperform: BAML maintains a bearish view on the belly of the US curve. From this perspective fiscal stimulus should clear the path for expectations of faster Fed hikes, giving the US 5y sector more room to underperform. Meanwhile the ECB did confirm their bullish bias in 5y and therefore expect EUR duration outperforming the US. The bank remains mildly bearish duration in the UK on back of supply and risks to BoE QE. Lastly expect the AUD curve to retain a steepening bias.
– Front end: EUR front-end is cheap: BAML does not expect ECB to raise rates until well after QE ends unlike what is being priced in eonia forwards. While in the US, the onshore money fund story settles down post reform, repatriation flows may threaten bank funding costs through reduced corporate cash holdings in offshore funds.
– Spreads: policy dependent – fin reg in USD, QE in EUR: BAML has a bias towards tighter USD 2y-5y spreads (lower reg demand) and wider 10y- 30y spreads (higher pension demand). They consider GSE debt to remain vulnerable if new administration ends status quo. In euro area without QE, 10y BTP-Bund spread would rise well above 240bp. Considers 30s50s BTP flatteners as a cheap hedge to wider periphery spreads. Clean positioning and reduced ECB uncertainty should support carry trades in the front-end.
– Vol: buy belly vol in US, sell belly vol in EUR: BAML sees USD vol as cheap in short to medium tails, relative to the level and shape of the curve. In EUR, vol could reprice lower in gamma on short and medium tails. While vol in long tails could on the other hand increase, as the long-end is most vulnerable to a selloff.
– Inflation: pay real rates in USD and GBP, short b/e in EUR: BAML recommends paying USD 10y real rates on back of their fair value model.Also considers EUR break evens a bit too rich and prefers to remain short. Lastly they like paying GBP 5y real rates and being short 8y cash breakevens.
Citi European rates outlook 2017
How does the field look after the December ECB policy shift and second FOMC rate hike? The FOMC was an outright bearish signal. It points to the FOMC fighting the clumsy timing of fiscal boosts. That has dragged global yields higher but this effect should fade as US financial conditions tighten and on the blow-back for the global economy.
The blow-back that matters is China CNY depreciation risk as one-way USDCNY price action accelerates outflows against a backdrop of a Reserves position that is more fragile than the consensus recognizes. A North Atlantic deflation shock beckons.
As for the ECB, the cash-for-collateral facility is unlikely to solve Bund scarcity and portends even richer 2yr Schatz yields as 2017 progresses. On the fundamentals, low core HICP looks embedded as German wage deals reference inflation compensation near 1%. The scarcity and low-flation combination works towards lower Bund yields with the curve flattening on a repeat reach for yield.
The ECB drivers change into H2-17 because the 33% issuer limit looks like being hard-coded for legal reasons. That means a taper to zero on EGBs as extension space into 2018 is limited. The unwinding of Bund scarcity is bearish but the effect is more critical for the stability of the periphery. Citi have a low conviction on which dominates immediately but medium term this is a critical danger for periphery risk.
Politics is a big driver in 2017. A French lean towards Marine Le Pen is an existential crisis for the EU/Euro. The more likely outcome is a François Fillon victory and that means competitive disinflation reaches across most of the Euro area in Citi’s view. Perversely, more populism in German could herald a left-wing coalition as the AfD takes votes from the CDU.
In periphery, Citi see three key 2017 drivers for steeper spread curves: shifting PSPP demand; the return of (long-dated) supply; and political event risk/ratings. Current spreads to Bunds are good entry points for wideners. As mentioned, periphery markets can be destabilized in H2-17 on ECB hard taper expectations.
In Gilts, Citi are bullish duration versus the bearish consensus. The front end prices hikes into a potential cliff edge GDP risk in 2019 while the long end should see correlation to Bunds rather than Treasuries.
In Linkers, Citi are sellers of € breakevens (5y5y) where rolldown looks attractive once more and premised on the HICP outlook above. They are also short 5y5y RPI because of the end of BOE QE and because Brexit is not autarky.
Socgen : FI outlook 2017 (November 28): The slow improvement in economic conditions, the turn in global inflation trends as well as the policy rotation should see yields ending higher in 2017. Socgen expects fiscal policies to gain more traction and should be supportive of near-term growth– enough to reduce the need for super easy monetary policy (Fed path will be re-priced higher, ECB will taper etc). Overall, coming year should see further normalisation in the rates space. From this perspective, the theme of rebuilding term premia in longer maturity rates as seen post-US elections should continue . Especially with CBs shifting away from rate cuts and even larger QE, growing appetite for budgetary stimulus and risk of more anti-establishment votes. Socgen recommends positioning for steeper curves relative to the level of rates in USD and GBP, long-end JPY steepeners and sticking to conditional bear steepeners or curve caps in EUR.
Key trading themes include:
-Enter the year with a strategic short duration bias- prefer treasuries among G4 but only on an unhedged-currency basis.
-Prefer steepeners in GBP, JPY and EUR – particularly vs USD.
-Receive USD cross-currency bases over coming months, if less so vs EUR.
-Buy 10y OAT vs Bund if/when at 75bp; prefer carry and rolldown in non-core front end.
-EUR rates: Medium-term ECB rate expectations will continue to fluctuate with rates market direction, but should no increase significantly on a two year horizon, given the ECB’s forward guidance. This would suggest that the belly of the EUR curve, rather than the 2y sector, should be more impacted by shifts in market’s expectations for ECB rates normalisation. Furthermore, independent of the near-term ECB decisions, there will be no escape from the ultimate slowdown in asset purchases. Within the EGB space, Socgen prefers holdings core rates over 2017. Idiosyncratic risks, ECB tapering and rising yields will prove challenging for sovereign spreads, though there should be selected opportunities as political risk gets overpriced, e.g. in OATs. In peripheral space suggests carry strategies in short-end of the curve and continues to prefer SPGBs over BTPs.
-UK rates: UK yields still remain at extremely low levels from a historic basis. Coming year could see inflation premiums further rising and a less favourable supply/demand trade-off can justify steeper curves. In particular, sees risks in the belly of the curve given the degree of flatness out to 10y. In terms of trades Socgen looks at 2s10s steepeners in swaps and 5s10s30s fly, short the bell.
Dankse: 2017 Fixed income top trades ( December 1) : Fixed Income Top Trades overview : 1) 10Y-30Y 5Y forward EUR swap steepener 2) Lower 1Y1Y real rate (rec 1Y1Y eonia vs higher 1Y1Y inflation) 3) Steeper EUR swap curve 3Y10Y 6M forward 4) Long France vs swaps/the Netherlands 5) Long only recommendations – Danish covered bonds 6) Relative value trade DK mortgages – buy 2.5’47 against 10Y EUR swaps 7) Relative value trade DK mortgages – buy 1.5’37 against 10Y EUR swaps 8) Exploit steep money-market curve and receive SEK 3Y1Y 9) Receive 1Y1Y EURSEK CCS 10) Long 6Y NGB vs Germany with an open FX exposure
-US rates : Expects Fed to hike rates in December and looks for two more hikes in 2017 (slightly below consensus). In rates pace, US could see further increase in yields in 2017. In terms of trades suggest steeper EUR 3Y10Y6M forward given the expected spill-over to 10Y EUR rates from higher USD rates in 2017.
-Euro rates: Expects the ECB to extend QE purchases by at least six months. Also thinks that QE could last longer than generally expected in the market. From this perspective, the low core inflation suggest that ECB should not hike in the foreseeable future –keeping the front-end of the EUR curve anchored. Dankse suggest positioning for a lower real rate 1Y1Yand a steeper EUR swap curve 3Y10Y6M forward.
-SEK rates: Expects the Riksbank to announce an extension of government bond purchases for another six months and by SEK30bn combined with a 10bp rate cut in December. In rates space, recommends trades using the steepness of the curve and exploiting favourable roll-down via receiving SEK 3Y1Yswap and receive 1Y1YEURSEK CCS.
-Danish rates: Believes Denmark will need deposit rate to be lower than that of eurozone on back of Danish economy’s strong fundamentals . From this perspective, the European elections should support safe haven lows
-NOK rates: Expects Norges Bank to keep the target rate on hold at the upcoming board meeting 15 December. Also expect see an unchanged target interest rates at 0.50% in 2017. In terms of trades recommends long 6Y NGB versus Germany or alternatively against swaps.
MS 2017- Sparkle and Fade (November 27): MS position for reflation to continue through 1Q17, supported by inflecting EPS growth, higher inflation and hope for fiscal policy. Investors, however, will need to be nimble. By 2Q, tighter financial conditions, slower China growth and elevated policy expectations loom large. The End of (DM) Easing: They remove their expectation for ECB rate cuts, and now expect six Fed rate hikes through YE18. Policy easing in ’17 is an EM story, with rate cuts likely in Brazil, Korea and Russia. In a Late-Cycle Market, both ‘Boom’ and ‘Bust’ Are More Likely: Higher odds of looser US fiscal policy raise the likelihood of better growth and a more rapid end to the cycle. This view leads us to sell credit to buy equities, and position for higher volatility in equities, credit and rates. EMFX volatility is the exception – we think it overstates risks. The Best ‘Reflation’ Trades Aren’t in America: Japan and Europe should see better equity returns, more inflation (vs. expectations), and more curve steepening (vs. forwards) than the US. EM Isn’t Dead. It’s Just Resting: With fundamentals improving, valuations reset higher and a better cushion against Fed tightening than in 2013, MS see a strategic opportunity to allocate from DM to EM credit in 1H17.
– Where MS Differs: Relative to consensus, MS are more bullish on USD and bearish on JPY and KRW. They are also more bullish on Japanese equities and more positive on ROW vs. US equities, see less US curve steepening, worse US credit returns and lower UK yields.
– What’s Changed: MS downgrade credit to EW and upgrade equities to OW. MS double-upgrade Japanese equities to OW, add to EU stocks and reduce US and EM equities. They expect the worst government bond returns in the eurozone, and believe investors should favour both EM and securitized credit over corporate bonds. We expect broad USD strength, weaker JPY, KRW, AUD and CNH, and we turn more balanced on the GBP. MS list our top trades for the year-ahead.
Key Investment Ideas:
– Over the coming year, MS suggest investors underweight German Bunds and JGBs, overweight UK Gilts, and adopt a neutral stance toward US Treasuries. The Treasury market is mostly priced for the rate hikes MS expect the Fed to deliver, but the Bund, Gilt and JGB markets are not priced for our expectations for related central bank policy.
– Their economists expect the Fed to deliver two hikes in 2017; the ECB to announce a six-month extension of its PSPP in December 2016 followed by potential preparation for tapering in 2H17; the BoE to end its QE programme, but cut rates by the middle of 2017; and the BoJ to hike the 10y target rate around year-end 2017.
– MS like 5s30s steepeners in the US, UK and Japan, and 2s10s steepeners in Germany over the first six months of 2017. They see the Treasury, Bund and JGB curves bear-steepening relative to the forwards, but the Gilt curve bull-steepening. However, MS would see the 1H steepening of the Bund and Treasury curves as an opportunity to enter bear-flatteners for the back half of the year.
– Top trades for 2017: Long Gilts vs. Bunds and long JGBi breakevens.
RBS: European Rates Year Ahead 2017 (November 24)- Monetary & fiscal policy. Who’s hired, who’s fired? Regarding the ECB meeting in December, they expect the ECB to dissipate fears of tapering in December, and nod to low core CPI as the main reason for extending QE. They see extension until December 2017. They see the market having difficulty in driving yields higher from here given their lower forecast for CPI and they believe the ECB is recognising the core CPI problem. With monetary policy likely full steam ahead in 2017, they recommend to Buy 10y bunds, with new target of 0%. On periphery, they recommend 5y Spain vs 5y France , which they have seen converging for some months. They also like 10s30s French steepeners versus 10s30s German flatteners (they believe the largest political risk next year being the election of Ms Le Pen in France). They expect a relief rally in December after the Italian referendum (4 December) across all periphery, mainly BTPs, which trade at their spread highs to other periphery. Even on a ‘no’ result, they believe 10y BTPs would likely rally, though by a lot less (perhaps ~30bp including a favourable ECB) than if it is a ‘yes’ vote (which would likely see a ~60bp rally if the ECB comes as we see it as well, taking back much of the ~90bp sell-off). However, they are not buying ahead of the referendum. In they UK, they see a likely trigger of Article 50 in H1 2017. As such they see some uncertainty creeping into the economy, contributing to muted growth in 2017. Fiscal policy will also make a return, but again not enough to be labled a ‘bazooka’, more in a thoroughly British-style understated fashion. They therefore believe, pressure will remain on long end UK, where QE is unlikely renewed post January, especially given the BoE forecasts CPI well above target; and with another £109bn funding (over 4 years) being announced in the Autumn Statement. Markets will speculate in Q1, into the March Budget, for a larger increase in funding coming, and the UK curve should steepen (and market underperform) relative to Europe. They therefore recommend 5s30s Gilt steepeners.
BNP: Global Rates Plus: G10 yield forecasts: Higher and steeper (November 23– BNP believes 10y core yields bottomed in July and EGBs will face a series of headwinds in 2017. The headwinds include a likely change in the ECB’s asset purchase programme (APP) parameters and a reduction in the monthly amount of purchases, higher US long-term rates, and the end of the ECB deposit rate easing cycle. BNP therefore expect a rise in yields from the 5y bucket onwards, and a steepening of the curve in 2017. They also expect curve dynamics will change in 2018, with a bear flattening ahead of the ECB’s normalisation of the deposit rate in 2019. On peripherals spreads they believe these are capped and should edge lower in H1 before rising back gradually in H2 2017 with a further reduction in the APP monthly size. In the UK, they expect the Bank of England to adopt a neutral stance in a context of rising inflation. With the end of quantitative easing in January and an overshoot on its inflation target,they believe bear steepening pressure will prevail with the 2y/10y Gilt segment to be much steeper than the levels implied by forwards. Their views and recommendations are therefore to keep a short duration in 10y swap rates for a target of 1%, keep their 10y/30y Bund steepener and pay 10y10y swap vs 5y5y and stay short Buxl ASW targetting 20bp. They also recommend to keep the short Schatz/Bobl Eonia box and 3y/10y BTP/Bono box. In the UK, they recommend to keep 2s10s GBP swap steepener and stay outright short in 10y Gilts for a target of 1.9%. They also expect gilts to underperform vs swap and therefore favor a 10y+ short position
Barclays Global Rates Weekly (November 17):The US elections have changed the backdrop for global rates markets, and rates have likely bottomed. Barclays maintain their recommendation to short 2y US rates. Yield curves are likely to diverge at the front end, although inter-market developed economy spreads should stay contained at the long end.
– Duration: Donald Trump’s victory in the US presidential election marks a regime shift in rates markets and should lead to elevated term premia globally. Barx think the Fed will react to any fiscal stimulus-related overshoot in the economy by hiking rates, and markets are not yet appropriately priced for this. They maintain their short recommendation on US 2y rates. They look for a range of 2-2.5% in US10s in Q1.
– Curve: Barclays are neutral on the curve in the US, given the massive steepening so far in 5s30s, and maintain their recommendation to sell 10s against 5s and 30s. In Europe, they maintain a steepener through the Irish 10s/30s curve and maintain a steepening bias on the JGB curve.
– Cross-market: Although yield curves have room to diverge at the front end given differing prospects for monetary policy, the drift is likely to be limited in longer tenors. Barx view a spread level of 190-200bp between 10y Treasuries and bunds as sufficient cushion; they would look to go long Bunds as a favoured sector to fade the rate sell-off.
– Spreads: Barclays are neutral on swap spreads in the US as they believe they are appropriately priced for any potential worsening in the fiscal outlook. They maintain their long 7y French ASW and long March-17 Bund ASW against EONIA recommendations. They continue to like being long 5y5y Italy vs Spain and the 10y CTD sector vs the wings in Italy and France.
– Volatility: Rate volatility rose after the US elections, primarily on the rate sell-off. We like selling 3m*5y straddles in the US, protected for higher rates through high strike payers. Mid-expiry vols in Europe still look cheap to Barclays and they maintain long 2y*5y vega structures. They also maintain their UK bear-steepener recommendation.
– US agency MBS: Given their substantial underperformance following the election, mortgages currently look attractive and they have a positive view on the basis, though they may still be vulnerable to volatility in the rates market and the potential for continued convexity-related sales.
– Money markets: Barclays expect US 3m LOIS to hold steady around 35bp, but believe that elevated government-only fund balances will likely tip bill and repo rates lower. In Europe, their view is that the ECB is unlikely to reduce the liquidity surplus in the next two years, making market pricing of forward EONIA aggressive.
– Inflation-linked: US breakevens have surged following the US election but remain structurally attractive, in their view. EUR 10y core breakevens are already above 1, and they do not expect much upside momentum. They continue to favour shorting 5y5y UK RPI swaps.
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