Open ½ position @ 152bp with an option to open next ½ position @ 118bp
Potential target @ 210bp, stop @ 97bp , Roll-down: 15bp in 3M, 54bp in 12M
Curve steepener to benefit from ECB forward guidance
The ECB guidance faced its first test on Friday after the NFP release and passed. While U.S. fixed income markets sold off briskly, European markets were more shielded and rates were stable relative to U.S. markets - especially in the short end of the curve. Down the road, the ECB will need to clarify its new way of communication, especially if data gradually improves from here. We are less certain that the ECB will introduce a more rules-based approach like the Fed and Bank of Japan, but there are other ways to maintain the downward bias in rates. The ECB could cut the refi rate and possibly combine it with long LTROs. These measures are currently being considered within the ECB, which seems more determined to anchor the short end as a Fed exit draws nearer.
Main view: short end anchored
We prefer a steepener trade to an outright receiver since the short end has come down significantly following the peak of the sell-off two weeks ago. The beta to outright is lowered somewhat and the roll-down is slightly better. Hence a steepener is likely to perform slightly better than a short-end receiver – a scenario where rates move higher.
Alternatives
There are several alternatives with similar characteristics for expressing the short end of the EUR curve being anchored. Below are a few of the alternatives: 2/10, 5/30 and 10/30, 1Y1Y/15Y15Y, or 2Y2Y/10Y10Y. Besides the 2/10 spot spread, all variations have negative correlation to outright 5Y and 10Y EUR swap levels:
- 2/10 variations are in general less correlated to outright, but roll-down and valuation is less attractive.
- 5/30 variations are slightly worse in the range, while outright sensitivity similar. Roll-down is less attractive.
- 10/30 variations are better in terms of valuation, whereas beta to outright is similar to the 2Y2Y/15Y15Y idea – roll-down is less attractive.
- A 2Y2Y/10Y10Y variation is in general slightly less sensitive to outright levels compared to 2Y2Y/15Y15Y and roll-down is similar. Valuation is slightly worse.
- A final alternative for those concerned about upside risks to 2Y2Y would be to enter a 1Y1Y/15Y15Y steepener, where a reduced roll-down is almost perfectly compensated by less outright risks. From a valuation perspective it looks slightly less attractive though.