Sweden Switch Auction: Debt Office To Buy 2015 Bonds Against Longer Ones

The last auction in real rate bonds this year is a switch auction. In fact, it is split in two occasions, on Thursday and Friday this week. On Thursday SEK3bn of SGBi3105 (December 2015) will be bought back in a risk neutral switch against the one and a half year longer SGBi3107 (June 2017). The next day SEK2bn will be bought back against the same bond, but now in a cash neutral switch. Although the exact volumes in SGBi3107 are not yet set (will be announced on 4 December), some risk will be issued to the market. These switches are the first in a series where the Debt Office (DO) will buy back the 2015 bond against longer ones. In March and May an additional amount of total SEK15bn of the 2015 bond is scheduled to be bought back. Prior to that, the new 10y "benchmark" linker, SGBi3109, with maturity 1 July 2025 will be introduced. Hence, the switches next year will most likely be against the new bond SGBi3109 and possibly some in the SGBi3108 (1 June 2022). The bond SGBi3107 will be above SEK31bn after this week’s switches and thus should soon be considered as ‘completed’. The DO has indicated that parts of the switches next year will also be done cash neutral. Hence, it will mean a lot of risk to the market.

We expect the auction to be successful. The market is currently pricing a very low average inflation rate, not just the next two years, but over the next four years. If the market prices in more inflation, we expect it to start a bit out on the curve. We have on several occasions mentioned the inconsistent pricing of inflation relative to Riksbank hikes over the next few years. We do not agree with the pricing since we think rate hikes, as they are discounted in the market, are conditional on a significant rise in inflation. The Riksbank has been under heavy criticism for not being able to reach the inflation rate target for a few years. Given this "legacy" we find it unlikely that the central bank can push the repo rate considerably higher unless the inflation is moving much closer to the target. Hence, it looks attractive to do extensions along the real rate curve. Moreover, the implied inflation compensation in linkers over the next few months is all but great and a way to avoid the strong negative carry in the shortest linker is to participate in the switch. The negative carry up to April next year makes it very tempting to do the switch in the auction.

The next ordinary auction is scheduled for 23 January, so the one and a half months after the switch auctions and up to the next issuance will possibly be fairly quiet. There is potentially a lot of action coming up next year, though. Issuance is planned to increase to SEK15bn in 2014 (up from SEK12bn this year and SEK6.5bn in 2013) and we expect that the majority of this will be done in the new bond SGBi3109. Hence, a lot of risk to the market. On top of this we have the switch auctions in the spring, which will add to the issuance of risk. In 2014 we expect issuance in linkers, both in nominal terms and in terms of risk, to be the highest since, at least, 2004. This suggests a steepening of the real rate curve, which will be augmented if tapering is conducted.

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