- Close the position to receive 3Y1Y versus paying 2Y1Y in EUR swaps. The
- position is closed with a profit of 10.5bp.
- 1Y forward curve flatter following the front end sell-off
Following the ECB meeting, the front end of the EUR curve has been selling off. This has been driven by a combination of the ECB closing the door for further rate cuts and a shift in the market towards focusing on the impact of the voluntary LTRO repayments, which will begin by January 30.
The sell-off has been driven from the very short tenors, which has led to a flattening of the forward curve. This has benefited our trade recommendation to receive 3Y1Y versus paying 2Y1Y.
The trade was originally initiated as a roll down trade, with protection against higher rates. The level of rates was very low back in December, when the trade was opened and at that time we found it relevant to hedge some of the outright exposure.
However, following the recent flattening we believe that risk reward is not that attractive anymore, as the spread now trades close to the lows seen over the past year. Furthermore, when the trade was opened it had an expected roll down of 19bp during the first year.
Now this roll has deteriorated to 6bp, due to the front-end driven flattening of the forward curve. Hence we see little value in keep the trade open.
Including the one month of roll down since the inception of the 3Y1Y, the 2Y1Y spread is now trading at 32bp (mid price). The trade was opened in 44bp. We can close the trade with a profit of 10.5bp (including trade costs).
We remain exposed in the short end toward lower rates, as we retain ½ position open for receiving 3Y1Y on an outright basis. This position that was entered at 1.195% has been hit by the sell-off and is now some 10bp out of the money. For now, we hold the position. Based on the current curve, the 3Y1Y currently has a estimated one-year roll down of 34bp.
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