EUR Swaps: NFPs boost post-ECB selloff; EURIBOR fallbacks
ECB spin backs Largarde's message; US data boosts selloff
Post-meeting ECB-speak backing Lagarde and hinting at more rate hikes, followed by a robust US jobs report (unemployment was lower-than-expected, average earnings growth was faster and non-farm payrolls also beat) ensured that Bunds remained mired at bottom of the day’s ranges heading towards the close, while a bounce in risk assets led by US regional bank shares added to the pressure.
EURIBORs fell by 1-8 ticks in the whites and reds, partially taking back yesterday’s 6-15 tick ECB rally. Similarly, €STR for the Sep23 ECB meeting has backed up by 5bps to 3.57%, implying around 43bps of additional tightening by then.
Euro 10y swaps rose 10bps to test 2.99% before edging back to 2.96%, and 2s/10s bear-steepened to -39.9bps (+3.6) even as 5s/10s and 10s/30s flattened back after yesterday’s big steepening moves, with 10s/30s at -35.0bps (-0.6). At the same time, swaps outperformed Bunds a touch with the Bobl spread at 76.4bps (-1.3) and the Bund at 71.3bps (-1.0).
Finally, euro vol is little-changed after falling modestly yesterday, with 1y1y at 123.3 nvol, while 3s6s basis is sharply better-offered led by the front end after rising yesterday with 5y 3s6s at 6.9bps (-1.0) and 10y at 2.2bps (-0.6).
Euro RFR Working Group on need for corporate EURIBOR fallbacks
ESMA’s Working Group on Euro Risk-Free Rates released a couple of reports this week. First, it issued a comparison of available term €STR rates from the EMMI ‘EFTERM’ (live) and Refinitiv ‘Term €STR’. Currently only the former is live and authorised by regulators (see link) and is based on a three level waterfall: OIS tradeable CLOB platform bid/offers and volumes; OIS D2C platform displayed bid/offers and volumes; and €STR futures and historical €STR rates.
More interestingly, the Working Group also published ‘guidance’ for €STR fallbacks for EURIBOR-based corporate lending products (see link), based on the Group’s May 2021 recommendations. The guidance concludes:
- “Corporate lending products now need to move to implement robust fallback provisions in new and refinanced EURIBOR referencing loans. Cost of funds and replacement of screen rate language are not workable permanent fallbacks and do not provide scalable options in the case of a possible permanent discontinuation of EURIBOR.
“Market participants are also reminded that they need to be operationally ready for EURIBOR fallbacks (be that compounded €STR in arrears or term €STR with a waterfall structure)….Now that term €STR rates are available alongside the already existing compounded €STR in arrears, there is no impediment to the full implementation of the May 2021 recommendations.”
ECB reactions - banks
Banks review the ECB meeting, Ahead, they look for 1-2 more hikes, most tend to broadly agree with front end pricing, expect QT to benefit EGB and/or IRS steepeners and wonder whether the combination of steady-higher ECB rates and Fed rate cuts in late 2023 will be sustainable.
- BofA: “The ECB used the bank lending survey (BLS) to buy optionality but continues to note that more ground needs to be covered to address the too high inflation. Our economists remain comfortable with their 25bp call for June & July and their baseline for the terminal ECB Depo shifts to 3.75% or more…We still believe it is too early to call the end of the EUR swaps curve flattening, or to expect significant widening in periphery spreads. However, we do not fade the asset swap curve widening, as Schatz richness could persist or even intensify.”
Commerzbank: “The ECB will pause rate hikes after June at 3.5%, which is still below forwards…We uphold our recommendation from last week, feeling increasingly comfortable scaling into long duration positions at 10y Bund yields near 2.5%. We hold on to our steepeners in 10-30y € IRS initiated in early March after the key -40bp had been taken out and see even more potential to scale into steepeners in shorter tenors, looking for 5-10y IRS to trade at positive levels by mid-year. In BTPs we maintain our short spread view, also taking into account the increasing headwinds from TLTROs and €QT.”
Citigroup: “The ECB plans to hike more than once and an eventual pause is more likely alongside fresh staff projections in September rather than in July. The rally in € rates looks a fade overall but is best expressed in the very front-end given external risk-off, in our view. We recommend paying July ECB €STR, especially with June not fully pricing +25bp, which helps to limit the downside risk.
“QT acceleration to stop all reinvestments from July implies a 4% reduction in balance sheet this year. It also risks markets pricing in an acceleration, with our most extreme scenario implying a 12% reduction next year. Academic/ECB research suggests this could further increase term premia and steepen EGB curves. We recommend PGB 10s30s steepener.”
NatWest: “We still look for another 25bp hike in June, and we maintain our view that then rates could stay at that level for a protracted period of time (i.e. until mid-24). We see the focus shifting on the duration of the tightening cycle, rather than on further hikes. We acknowledge that today’s ECB meeting provides bias for a little bit more (another 25bp hike in July)…But we expect that by then, it will be clear that the additional small increment is not needed…The front end can’t ignore that there is ~100bp cuts priced in for the Fed for the next five meetings (by January 2024)…The upward pressure on the euro this rates convergence might imply may put some pressure for (ECB) cuts.”
BNP Paribas: “The overall outcome supports our expectation of a terminal rate of 3.75%, around which we see the risks as balanced…The front-end rally makes sense to us, but we think it is overdone, to the extent that – although we have been calling the peak in rates – we may soon find ourselves at levels where shorts could make sense… Lagarde’s comments during the Q&A plus today’s downshift have narrowed down the distribution of outcomes, in our view, which is negative for volatility…Today’s meeting reinforces our view that the peak in EUR yields is behind us and that rates can remain in a range as we head into the summer
“Quantitative tightening will result in steeper EGB curves, particularly in the 20y-30y sector as we see less natural demand here to replace the ECB, in contrast to the sub-10y area, which should be relatively better supported by banks and retail investors. Within the eurozone, we think peripheral curves will suffer the most at the long end, especially as the hunt for yield declines due to higher rates
“QT, combined with elevated net supply this year, should help to cheapen swap spreads this year as collateral starts to shift back into the market (as a result of the remuneration shift on government deposits at the ECB).”
Deutsche Bank: “We interpret the latest ECB decision as a ‘hawkish 25’…We are holding our baseline view of a 3.75% terminal rate, with 25bp hikes in June and July. However, our earlier description of balanced risks around a 3.50-4.00% landing zone is no longer appropriate. It feels much less likely that the hiking cycle will end at 3.50% after one more hike in June. We see upside risks to our 3.75% call again — a 4%+ terminal rate is possible. Given sticky underlying inflation and robust labour market dynamics, the data going forward need to confirm that transmission is strengthening if the ECB hiking cycle is to stop at 3.75%.”
New issues: Heinz meanz bondz
- US crackers and beans giant Kraft Heinz Food is preparing a €600m 2y NC1 FRN at 3mE +50bps through DB.
- US truckmaker PACCAR Financial Europe plans a €500m 3y at around swaps +35bps via BNPP (B&D), ING, Rabo and SocGen.
- EU last week sent an RfP to dealers for a potential deal.