Receive SEK FRASEP19 and pay FRASEP21 for steeper curve while doing the opposite in corresponding EURIBOR FRA contracts (flatter curve) in a box at +11.5bp (indicative). P/L:+25bp/ 0bp.
The SEK FRA contracts MAR, JUN and SEP19 are all cheap options if the next few Swedish inflation prints disappoint and/or growth slows more abruptly (there is, by the way, a risk that Sweden's Q3 GDP q/q will be negative - see Reading the Markets Sweden , 5 October). In our view, the market is discounting Riksbank hikes too aggressively up to H2 19. The FRASEP19 contract prices 46bp of hikes (up to the October meeting in 2019). This is basically in line with the Riksbank's own rate path and we find it unlikely the central bank will lift the path near term, probably the opposite if anything. However, further out, in 2020-22, we argue that too little is priced when taking risks into account. In our view, such market pricing does not reflect (what we today think) is the most likely scenario for the next few years.
Our clear view is that Swedish inflation (also headline CPIF) will move towards the long-term average, i.e. 1.5%, in 2019 (see chart overleaf). The reason is that we see little evidence that wage growth is picking up. However, the next wage round, in early 2020, could end up in a higher deal. At least, we would not rule it out on the back of signs of higher wages in Europe (Germany) and the low real wage growth recently (close to zero since 2017). Hence, unions could look for a better deal this time. If they are successful, it could potentially affect inflation in late 2020 to 2022. It remains to be seen whether it will be enough to push inflation persistently towards the 2% target but with higher wage growth the chance increases. In addition, if the Riksbank moves in late 2018 or 2019, as expected, it would be well ahead of the ECB, while hikes in 2020 and beyond would be conducted in tandem with the ECB (according to pricing). Deviations in policy rates could have less impact on SEK when both banks are tightening in contrast to the Riksbank alone tightening.
The FRA box SEP19-SEP21 trades close to the three-year low (see chart below). We see this as a good opportunity to go against recent relative flattening. A further flattening seems to us unlikely, as it already trades close to flat. Admittedly, back in 2011 the box was trading negative ('inverted') but 3M (NYSE:MMM) STIBOR was 80-160bp above 3M EURIBOR at that time.
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