Buy SWH180 ASW at 55.5bp. P/L: 40bp/67bp. Carry: +1.4bp/m.
Swedish SEK covered bonds have underperformed significantly since the summer (see Chart 1). We have seen three factors behind the covered bond struggle.
1. Supply worries.
2. General credit woes and outflows from credit bond funds, which prompted selling of the more liquid SEK covered bonds.
3. Elevated yield volatility.
These three factors have sent covered bond spreads to both government bonds and swaps close to multi-year highs. The spreads have not moved tighter again despite the recent market developments. Over the past few weeks we have seen the following.
• More evidence that supply worries are overdone. In our view, the brunt of the issuance is behind us. We have seen some SEK as well as EUR issuance. However, mortgage institutions have been somewhat reluctant to issue in the SEK market due to the expensive levels. This signals that institutions are well funded. Moreover, it is much cheaper to issue in the EUR covered bond market and swap into SEK (see Chart 2).
• Indications that credit woes have eased. Itraxx, for instance, is off recent highs. Covered bonds normally have decent correlation with Itraxx. However, the spreads have not declined in line with the recent move in the Itraxx Index (see Chart 3).
• Volatility in the market has eased over the past few weeks. This boosts the environment for carry trades (see Chart 4).
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