Swedish Macro Unlikely To Continue Underperforming

Open position @ +95bp. Potential target @ +105bp, stop @ +88bp. Carry (3M) -0.1bp per month.

Swedish data lagging behind euro figures
Some potentially important macro developments have emerged of late. Foremost, after six consecutive quarters of falling GDP, the euro area managed to show moderate but still positive growth in the second quarter. During the first half of the year, manufacturing activity stabilised in France, Italy and Spain and gained momentum in Germany. The US recovery continues at a moderate but steady pace. Against that background, it is odd that Swedish industrial activity has underperformed. Indeed, Swedish industrial output has performed the worst amongst the above-mentioned economies. Accordingly, the recent improvement in European and US surprise indices has not been matched by Sweden. There may be several (unsatisfying) explanations ranging from data error to the possibility of aggressive inventory reductions before summer. In any case, this relative performance is not likely to prevail. Sweden should gain from a more stable economic picture in Europe, not the other way around. Industrial output corrected higher in June but we expect to see further evidence of improvement in the months to come and a catch-up in the Swedish surprise index.

Over the past couple of weeks, Swedish government bond rates have performed significantly relative to German rates (around 10bp in the 5Y segment). However, we argue that expectations of a continued spread in policy rates should continue to put pressure on the spread. Also, over the summer, the Swedish market has probably received some support from no government bond issuance occurring since mid-June. Auctions are due to resume on 21 Augustt Interestingly, the convexity on the Swedish yield curve remains at low levels. If we do indeed receive more firm Swedish data over the next few weeks, the 5Y segment could start trading more neutral. Carry on the Swedish leg is negative regardless of which maturity is chosen but this is offset by positive carry on the German leg.

Risks and alternative trades
Despite the recent performance versus Germany, spreads remain wide in a historical perspective. Should the EUR crisis intensify once again, Swedish government bonds remain attractive as a safe-haven asset. Even though the situation seems stable for the moment, political risk remains high.

One could also consider taking a short position in Sweden in another segment on the curve (such as 2s and 10s), or on an outright basis. However, we prefer positioning for a larger convexity, as the 5Y segment appears depressed on the curve.

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