Fixed Income Strategy: Go For Steeper Curves After Riksbank‏

The Riksbank basically kept its February GDP, inflation and repo rate forecasts unchanged versus December. It argues that the Swedish economy to a large extent is hampered by the crisis in the euro area, but at the same time points to "bright spots" such as fading tail risks, a rebound in foreign and domestic confidence and improving global growth prospects outside the euro area. There is a risk that CPIF will be well below the Riksbank's new January forecast (in fact close to zero) when it is released next week, which could trigger a last cut in April if inflation remains low. But even more importantly, it may slow forthcoming Riksbank hikes as the economy improves, making a case for further curve steepening.

In our view, recent Swedish data suggests that the economic cycle has turned for the better and this – together with the household debt restriction – is the main reason why we do away with our April rate cut call. That said, we are still wary about inflation over the next couple of months. In particular, there is a risk that CPIF will be well below the Riksbank’s new January forecast (in fact close to zero) when it’s released next week, which could trigger a last cut in April if inflation remains low. But even more importantly, it may slow forthcoming Riksbank hikes as the economy improves, making a case for further curve steepening.

Although it was largely priced into the money markets, the Riksbank’s decision resulted in a significant parallel shift of the yield curve, with continued underperformance relative to Germany across the curve. With today’s move we are now trading close to our profit target in the outright short position in SGB1054 and decide to close down the position. SGB1054 currently trades close to the level where the loan peaked last year, so we should expect some technical resistance. Also, given the significant spread widening versus Bunds we have seen in past weeks, we think that tactically it is a good time to take profit on the position. Since we opened the position in mid-January the total profit is 32bp.

As we see a reduced likelihood of further rate cuts from the Riksbank in this cycle, we expect the 5Y point to continue to trade weakly. At the same time, SGB1049 now trades at a level we have a difficult time justifying. We have tried to value the loan according to different scenarios:

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