Front end slips on oil
Brent’s slide to $80 today from above $89 last week took the future to its lowest levels since January and weighed heavily on the front end of the inflation curve, with EUR 1y down 12bps to 4.79% while 2y dropped 11bps to 3.60%.
The fall in crude oil prices was blamed variously on the new EU price cap, rising US interest rates, oil market illiquidity, softer Saudi pricing and/or broad-based risk-off, with the S&P 500 down 1% today and TIPS breakevens 10bps lower in 2y and 6bps in 10y.
Euro nominals bull-steepened and a modest rise in Dutch gas futures of around 3% on the day was insufficient to support inflation, with long end swaps 6-7bps weaker and EUR 5y5y 5bps lower at 2.34%, versus a high point on Monday of almost 2.42%. Similarly, core real yields rose out to about 10y despite a 7-8bps rally at the front of the nominal EGB curve.
Real yield steepeners and shorts: BofA and Barclays
Banks this week favour a mixture of trades but a couple are wary of long end euro real yields and suggest looking at spread trades against TIPS, steepeners or outright shorts.
- BofA: “The consensus might accept that inflation is not transitory, but a market that has consistently underestimated inflation pressures nevertheless clings to a fairly swift return to target (or at least close to target). We continue to favour 10y BTPei breakeven longs, with prospective carry pricing a slide to 204bp by July.”
“The long-end of the euro linker curve is a different story, and we have already expressed a preference for long TIPS over long Euro linkers. The 10y20y real rate difference to the US has reached unprecedented levels, while the forward inversion in the Euro real yield curve has also struck new records (and is priced to invert a lot farther over the next twelve months). We think technical complications have aggravated this curve stress, and see it moderating next year.”
“We would consider cash-and-duration butterflies (long centre) in either OATei or BTPei issues, as a way to express forward starting real steepeners in these curves.”
“Forward flattening has been a feature of curves generally this year. But one of the reasons we believe it has been particularly acute in the Euro real curve is the fact that there are five 2023 issues, all of which exited the Euro linker index this year, delivering a large cumulative index extension and resulting in €87bn of bonds departing the index in market value terms (substantially in excess of the issuance entering indices). Two of the five departing issues were Italy's, while Italy has not tapped its 30y linker this year, perhaps explaining why Italy's forward inversion appears especially stretched.”
“Next year will see three issues departing the index, with a current combined market value of €56bn, which seems more in balance with the €60bn Euro linker supply we expect.”
“We recommend a BTPei 2028/33/51 butterfly with (-39.5%/+100%/-60.5% cash-and-duration neutral risk weights at 43bp (equivalent to a forward curve inversion of 87bp), setting a target of 15bp and a stop-loss at 58bp. Risk to the trade is heavy pension demand for long linkers.”
- Barclays: “Short OAT€i53 in real yield. We believe the demand backdrop for core linkers is set to be much less supportive at current real yield levels. We see value in opposing the rally in long-end core real yields to position for a correction in long-end breakeven levels, but also some retracement of the recent duration rally.”
“Positive core real yields alongside high breakeven levels a couple of months ago was often cited as a combination that could prompt core issuers to ramp up linker issuance in early 2023 ie high breakevens make linker issuance more ‘cost-effective’ relative to nominals, while positive real yields attract real money demand.”
“After the real yield rally, the demand argument is certainly less strong. However, we think that euro linker issuers are, in general, committed to their linker programmes. While there seems to have been increased political scrutiny of issuance this year as high inflation pushed up the debt-servicing cost of linker programmes, we do not think this will lead to any meaningful step back, especially from established issuers like France and Italy. Ultimately, we think that issuers will be driven to take advantage of high breakeven levels, while they last, especially in the long end.”
“Admittedly, for Germany, it is less clear as there seems to have been a willingness to keep inflation-linked issuance low there over the past few years. On the other hand, high forwards in the long-end could prompt Spain to finally extend its SPGB€i curve beyond the 33s.”
- Deutsche Bank last week launched a €50m (max) inflation-linked note due 31 Jan 2029 with coupon linked to euro HICPx inflation +100bps floored at 0%. Priced at 102.00 and self-led.
- Deutsche Bank last week launched a €25m (max) inflation-linked note due 10 Feb 2027 with coupon linked to euro HICPx inflation floored at 0%. Priced at par and self-led.
- Credit Agricole last week sold a €10m EMTN 0.76% due 19 Dec 2034 with redemption linked to euro HICPx. Priced at par and self-led.