Strategy - Sweden: Extend Covered Bond Forward ASW Spread‏

Despite the performance in longer (5Y) covered bonds this year, the Swedish covered bond curve is still relatively steep compared with the SEK swap curve. The roll down in longer covered bonds is significant and a good way to take advantage of this is to do a forward ASW spread, which is buying the longer covered bond and selling the shorter one in a tail (nom/nom) against paying in a matching swap.

Compared with doing an ASW spread outright in the 5Y covered bond, this trade is both sensitive to a general performance in covered bonds versus swaps and to a relative flattening of the covered bond curve. We believe both factors will be supportive for this trade.

We have on several occasions recommended this kind of trade, buying the relatively recently issued 5Y covered bonds and selling a 2Y or 3Y covered bond. For instance, we have a trade recommendation on - buying SHYP1579 and selling SHYP1575 against paying in the matching swap - which has performed nicely. However, that trade has probably moved closer to a more reasonable level and we recommend moving further out on the curve now. We keep the old trade for the moment but if we reach our target we will move that risk into the new trade.

We like buying SWH186 against SWH183 and paying in the matching swap at 83bp . It is especially interesting to do this trade in Swedbank Hypotek or LF Hypotek, since the 5Y bonds issued by these institutions are still trading cheap relative to other issuers and thus offer an even better roll down - see the chart below.

This trade will be on a medium-term horizon. We expect the spread to reach 50bp at some point during H1 next year. The carry in the bond tail is +2bp/m and the roll down +2.2bp/m whereas the "roll down" in the forward starting swap is -1.75bp. Hence, total carry and roll down in the trade is 2.45bp/m - compared with an outright 5Y ASW spread with a carry equal to 1bp.

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