Ahead Of March ECB Meeting, Market Again Speculating In Refi Rate Cuts

Close 5Y/15Y/30Y EUR fly, 10Y tails (½ position) with a profit of 12bp

On 11 January a ½ position was opened @ - 15.5bp

Including roll down the position has been closed @ -3.5bp

Long-end steepening to take a pause
Over the past year, a relatively stable inverse correlation has been in play between the steepness of the long-end EUR swap and money market curvse Hence, a flatter money market has generally been consistent with a steeper 10-30.

Following the ECB meeting in February, and a smaller-than-anticipated initial repayment of the second 3Y LTRO, the European money market curve flattened back towards the lows. This happened amid some disappointing macro data and increasing uncertainty from the outcome of the Italian elections. Ahead of the March ECB meeting, the market was once again speculating in refi rate cuts.

This flattener move in the money market during much of February and into March has benefited our position to pay the 5Y15Y30Y, 10Y fwd. The fly was initiated on 11 January as a roll-down trade with a 10-30 steepening bias.

After the recent ECB meeting, we believe that positions with a long-end steepening bias are somewhat at risk. This is due to our view that the EUR money market curve is excessively flat. Improving macro data will imply that the window for ECB easing will close in the spring. In combination with even a partial repricing of the LTRO repayment expectations for 2014, this is expected to re-steepen the EUR money market curve.

Given the inverse correlation with the long end, we believe the 10-30 EUR swap spread could flatten somewhat on a tactical horizon. We believe that the risk reward to pay the 5Y15Y30Y 10Y fwd fly has deteriorated. So we'll book the profit and close the position.

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