Sweden: Strategy Update Ahead of Riksbank

This week is a busy and important one for Swedish fixed income markets. On Thursday, the Riksbank is due to announce the outcome of its policy meeting. According to market pricing, the probability for a cut is 60-65%. However, a couple of weeks ago a 25bp cut was fully priced, suggesting uncertainties have mounted amid slightly better PMI data. The same day as the Riksbank announcement, the notoriously hard to forecast January CPI data will be published. We expect both the rate announcement and the CPI outcome to be bond friendly. Add to this the still unclear situation in Greece with PSI negotiations left to be agreed upon.

• We have closed down curve steepeners, as of now. We reached our set profit target in the curve spread 2Y covered bonds against 10Y government bonds at the end of last week and decided to take a pause (following a 50bp move since we first recommended the trade). We hold on to our spread trade, 2Y covered bonds against matching 2Y government bonds. However, we believe there is more potential, long term, in steepening positions.

• We establish a long position in the 5Y government bond future and thereby achieve a slightly long duration position. We still think the Riksbank will be a bit softer than pricing suggests. Moreover, we do believe there will be more woes, bond bullish, associated with the European debt crisis in general and the Greek drama in particular. The combination, being long covered bonds against government bonds, together with a slight long duration position (overweight 5Y segment) is normally a good “hedge”. The spread trade is often, and has been lately, well correlated with the rate direction (see chart). Amid higher rates, the spread has narrowed and vice versa.

The changes to our strategies, together with the rest of the current trading strategies, can be found in the table overleaf. We still like June 2013 covered bonds in tails with 6M STINA at the front and long dated TED wideners (FRAMAR13 over RIBAJUN13) as a hedge against fixing woes. We also hold on to our BEI 3105 tightener, which will be affected by the CPI outcome this week. However, we see this trade as more of a longterm trade, as we expect inflation to decline significantly over the year. Also, we recommend entering a 5Y/10Y relative steepener in swaps in SEK versus EUR, which should be supported by both the Riksbank and the upcoming issuance in the Swedish long end.

Most important during the week is the Riksbank decision and we expect a cut. The Riksbank’s current macro forecast is obsolete (needs to be more in line with both domestic forecasters and FED, ECB, etc.), the inflation rate is drifting further away from the target, there are signs of a deteriorating labour market and the SEK is still relatively strong. All these factors support our stance.