Index-Linked Report: Tap Auction SGBi3107‏

Tomorrow the Swedish National Debt Office (SNDO) is set to tap SEK1 billion of the June 2017 CPI-linked bond SGBi3107. Just one and a half hours earlier, August CPI data will be released. Hence, the carry in October will be decided just before the auction. Despite the recent outperformance of short-dated linkers in the Swedish fixed income market (see chart overleaf), we see room for further performance. In our view, the market is still underestimating inflation over the next three years a lot. Our inflation forecast up to SGBi3105 maturity (2015-12-01) implies an average inflation rate of 2.10%, while the market pricing is 1.53% for the moment (zero-coupon rates).

In order to emphasise that the market pricing is too low, in our opinion, we have calculated an implied BEI rate based on CPIF (CPI excluding changes in mortgage costs). We exclude what is priced in terms of rate hikes in the government bond curve from the BEIs (and assume no risk premium). Hence, we can decide whether the deviation in our forecast relative to the market is related to different views on the Riksbank or whether it stems from different views on "underlying inflation". Interestingly, the complete deviation of around 60bp is a reflection of deviations in the view on CPIF. The market is pricing an average CPIF inflation rate up to September 2015 equal to 1.3% (running at 1.2% currently), followed by two years of an average CPIF inflation rate (between 2015 and 2017) equal to 1.06%. The two-year average rate in CPIF inflation has barely been below 1%. Moreover, remember also that we have just passed the trough in this inflation rate cycle. Our CPIF forecast up to maturity of SGBi3105 implies an average rate of 1.90%. This 60bp difference is significant and we are very comfortable with going against the current market pricing, and would like to buy both SGBi3105 and SGBi3107 in BEI spreads or in BEI boxes for a flatter BEI rate curve.

We sense the market has started to look at short-term BEI rates, and we think it is very likely we will see good demand at the auction. We continue to recommend Swedish short-end linkers as we believe repricing of Swedish inflation over the next four years has just begun despite the very good performance in short linkers recently.

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