FRA pricing can be divided into two parts. First the pricing of the Riksbank and expected rate hikes. Second, the STIBOR fixing relative to the repo, or RIBA contract. We now see both parts of pricing as stretched. Hence, the upside risk to the FRADEC18 yield is, in our view, very limited whereas the downside offer plenty of potential. We see a great risk/reward receiving DEC18 at the current level. Let us explain in more detail below.
We start with the Riksbank pricing implied by the FRA contract (or the matching RIBA contract). We note that pricing of RIBAMAR19 is now in line with a scenario that on previous occasions we have described as the most hawkish possible scenario we can think of given inflation and growth outlook. This scenario is in line with the Riksbank's own repo rate path, see right hand chart below, and we see it as very unlikely that the Riksbank will move more aggressively than was outlined in its April forecast. On the contrary, it is likely that the central bank will tread carefully if it moves much earlier than the ECB. Hence, we see current pricing as stretched, and believe something extraordinary would need to happen if more rate hikes should be priced in for the next nine months. So, current pricing is probably as aggressive as it can be.
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