Sweden: Tap Auction In SGBi3107‏

On Thursday the Debt Office will tap SEK1bn of the 2017 bond SGBi3107. We still like the shortest linkers best. So far this year, the shortest linker SGBi3105 has, together with SGBi3102, yielded the highest return for an end investor among all government bonds. Only the very shortest covered bonds have yielded a higher return. See Chart 1 for YTD returns in Swedish bonds. The market is still pricing, in our view, a too subdued inflation over the next few years (see Chart 3 for a comparison). The inflation rate is at a trough and we believe it will gradually inch higher from the current level. This has normally been a good opportunity to buy short end linkers in BEI spreads or in real rate steepeners.

Best Risk-Adjusted Nominal Yield
We believe the outperformance of short linkers will continue for some time. Chart 2 shows the risk-adjusted nominal yield for various bonds (the nominal yield for linkers is based on our inflation forecast and the yield is divided by bond duration in order to get an assessment of the risk adjusted yield). Clearly, short-end linkers offer best risk-adjusted nominal yield among government bonds. Indeed, they offer risk-adjusted yields close to what covered bonds do. Hence, short-end linkers should be very interesting for end investors.

The flatter nominal bond curve, together with a more subdued move in the real rate curve, has made the BEI curve much flatter over the last months. However, the seasonally adjusted BEI rates reveal that the BEI flattening is not as dramatic as the screen BEIs indicate. Where the BEI curve will go from here is very dependent on where the longer nominal bond yields move. Here we are more or less in the hands of where Bunds move. So, we are happier to take chances on short-end BEI wideners and/or real rate steepeners.

In cross-country spreads we like buying short-end BEIs in Sweden against EUR BEIs. In Sweden we are, as we have said previously, close to lows in this cycle, whereas in Europe the inflation rate will probably decline for some time yet. The BEI box SGBi3107 versus DBRi 2016 is currently trading at +10bp. Given our inflation outlook, this is, in our view, too tight. Both BEI spreads trade close to 1.40-1.50%. Our forecast up to maturity is above 2% and the ECB’s projections for inflation in 2013 and 2014 are 1.60% and 1.3% respectively. The benefit of doing the BEI box rather than doing the Swedish leg isolated is that it would protect the position from a swift and unexpected decline in energy prices and/or commodities.

So, we like short-end linkers in various combinations. For end investors it looks like a very good asset, especially if concerned with higher rates going forward. We also like the short-end linkers in BEI spreads and in real rate curve steepeners. Hence, we suggest buying SGBi3107 in the auction, or SGBi3105 in the market.

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