Buy SGBi3105 outright or vs SGB1049 in a BEI spread @ 130bp. P/L: 160bp/110bp Carry: +11bp to 1 June.
How about a stable AAA-rated 2Y government bond yielding 1.7% up to maturity in December 2015? That is some 60bp above the Swedish 2Y benchmark (SGB1049), and 165bp above the matching German 2Y bond. This is not fiction: it is the implied nominal yield in the CPI-linked bond SGBi3105 based on our inflation forecast. The bond will also protect investors against a higher-than-expected inflation rate over the next couple of years. The BEI rate is trading too tight, making the bond look very attractive.
We have once more looked at our inflation forecast, yet again, to detect any hidden negative surprises but feel comfortable with it. The strength of the krona will have a limited impact on consumer prices despite our assumption about an appreciation equal to 4-5% against both EUR and USD over the next year. Based on historical patterns, we believe the market is over-estimating the effect of a strong krona. The largest impact will come in CPI components such as travelling. Both energy and food prices are, in our projection, relatively close to the headline and do not deviate from the past few years. Our central scenario contains four rate hikes up to late 2015, but adjusting the forecast so it reflects pricing in RIBA and FRA (that is two hikes by the end of 2015) will only shave 0.12 off our inflation forecast up to SGBi3105 maturity – 1.8% instead of 1.92%.
Clearly the short real rate bond offers a yield well above the nominal bonds and is very close to what the shortest covered bonds yield. This is a government bond that offers a nominal yield in par with matching covered bonds. The longer linkers are more in line with nominal peers; our forecast stretches out to 2016. We have assumed an average inflation of 1.75% and five-year covered bonds are the best choice (yield to duration wise) in that segment. The chart clearly shows the attractiveness of the bond. End investors searching for yield should pay attention.
In addition, the debt office will start buying back the bond in a series of switch auction starting in December this year. The total amount in the auctions is set at SEK20bn (the current volume of the bond is SEK45bn). Hence, there will be a big buyer of the bond prior to the maturity even though we think it is a buy and hold product. The inflation is just about to reach its bottom in this cycle – historically, a good time to start buying the bond. Moreover, the screen BEI rate has increased over recent months. However, adjusting for seasonality reveals that inflation expectations have not risen nearly as much as the screen BEI rate suggests (see chart).
In sum, the nominal yield in the bond is very attractive. This is of course based on our inflation forecast, but the cushion is huge despite our view on the Riksbank and how we expect the strong currency to affect inflation. Current market pricing presents a golden opportunity to buy the bond outright or against the 2y nominal bond or swaps in a BEI rate, as the inflation rate should have bottomed.
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