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Trade Recommendation: 2y2y EUR Swaps

ByDanske Markets
Published 10/26/2012, 03:09 AM
Updated 05/14/2017, 06:45 AM
SMT
1.85%
BMAm
-4.20%
NWSA
0.11%
Weak data and early signs of policy fatigue

The data releases out of Europe have been rather disappointing. While consensus was expecting improvements in PMI and Ifo data, they only signal stabilisation at best. Further, today’s data for monetary developments in the eurozone confirm a continued credit contraction in loans to the private sector. Overall the short-term growth outlook remains dim for the eurozone.

The EU summit last week did not deliver much news. Germany continues to back-track on the banking union issue and the Spanish government now seems to be directly liable for the EUR100bn banking aid package. Moreover, there are no signs that Rajoy has moved closer to asking for ESM aid and activate the OMT.

The EUR market has sold off and this has pushed the EUR 2y2y forward rate up from just below 1% to currently 1.15%. We retain a fundamentally more optimistic view on the global outlook and expect that Spain will eventually apply for aid, which will be risk positive. That said, we think that the EUR 2y2y offers a good risk-reward as an insurance trade against a risk-off move, if the markets become impatient about Spain or should the fiscal cliff concerns for the US intensify.

The trade also fits our core views:
1) We still recommend paying US 10y10y. Adding the 2Y2Y EUR to this position effectively turns it into a steepener trade, which fits the current macro environment.

2) We believe the upside for rates is bigger in USD than in EUR.

3) Short-end rates will be kept in check as global central banks remain on easing bias. The risk remains tilted towards further ECB easing, which could put downward pressure on short-end EUR rates and steepening pressure on the forward curves.

To Read the Entire Report Please Click on the pdf File Below.

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