Buy SGBi3107 outright @ -1.55% or against SGB1051 in an BEI spread @ 122.5bp.
The Riksbank is determined to make progress in reaching its inflation rate target. The sooner the better is clearly their stance. One way of achieving this is by further weakening the currency and thereby impacting inflation and inflation expectations. On top of this, later in the year there will be base effects from oil and mortgage rate costs. Together with an aggressive monetary policy, it is not totally impossible that an inverted BEI curve will develop, in our view.
Long term, we think global developments and domestic wage growth will play a greater role in determining Swedish inflation. It is not certain that wage growth will be enough to establish a long-term base level (above say 1-1.5%) for Swedish ‘core inflation’ that is closer to the inflation target than the current level. Swedish wages and inflation are unlikely to deviate too much from the rest of the world (mainly Europe) in our view. In the short term, say over the next three to five years, we see current monetary policy as having an impact. Long term, global developments will be more decisive, in our view. We cannot exclude the possibility of an inverted BEI curve between 3-5y and 10-15y.
This year we have been long in linkers in BEI rates in various combinations. We still believe this positioning is correct, as we think inflation has most likely passed its trough in this cycle. At least in the short term, BEI rates, despite the recent move higher, trade cheap, in our view. The recent rise in BEI rates should be interpreted with some caution as a big part of it is an effect of a carry adjustment. The rise in the BEI3107 rate in March has been 65bp, of which 45bp is a carry effect. Hence, inflation expectations reflected in BEI3107 have risen some 20bp in March and not 65bp as the change in the BEI rate suggests. On a carry and seasonally adjusted basis, BEI3107 now trades at 0.95%.
Assuming that our forecast is correct up to March 2016, then the average inflation during the bond’s (SGBi3107, 1 June 2017) last year before maturity (meaning CPI between March 2016 and March 2017) needs to be 0.6% on average in order to justify current market pricing (see table below). This is, of course, very low. According to our forecast, the average inflation rate in 2016 will be 1.25% (to set current pricing in perspective).
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