- Open ½ position @ -23bp with an option to open next ½ position @ -32bp
- Potential target @ 0bp, stop @ -42bp, indicative roll-down: -4bp in 3M
At yesterday’s meeting, the ECB revealed little change in its policy bias. Growth and inflation forecasts for 2013 and 2014 were only revised marginally lower. Draghi noted that these revisions mostly reflected the slightly weaker incoming hard data, rather than a change to the expected path of recovery. He also noted that most survey data had shown meaningful signs of improvement, while hard data has been disappointing.
Although he did not close the door for further rate cuts, our overall impression was that it will take a turn for the worse in both hard and soft data to trigger a further cut in policy rates. When asked about negative deposit rates, Draghi said: “The unintended consequences of a measure like that can be serious...”. In our view, the likelihood of a negative deposit rate is very limited.
We have a positive view on the global economy, and believe that we are about to see the first synchronised global expansion since 2009. Various leads also suggest that both hard and soft data for the euro area will improve further in the coming quarters. In that case, the door for further ECB rate cuts will gradually close during the spring. Further, the EONIA market is only factoring in very limited normalisation of the liquidity situation during 2014. From this perspective, the European money market curve seems excessively flat and in our view the risk reward has turned for higher rates in the front.
During the sell-off in January, the 2-5 slope steepened while the 5-10 flattened, which led to a relatively significant upward move in the 2-5-10 fly. This later reversed as liquidity concerns faded and central banks resumed dovish speak. 5-10 is now close to record high, and we see limited downside steepening potential in the 2-5, as the deposit rate should stay at zero.
Given the current correlation, the fly will be positively exposed to a repricing of the European money market curve. The fly is also positively exposed towards a continued long-end-led sell-off in the USD swap curve. This is a scenario that is consistent with our strategic macro view on the US.
One alternative to the EUR 2-5-10 fly would be to just pay the five-year swap. However, we believe that the risk reward is better in the fly.
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