Pay 15Y15Y swap (vs. EUR6M). Scale in with ½ entry @ 2.745% and the possibility of adding another ½ below 2.60%
Target 3.50%, Stop 2.30%, 6M roll +2.5bp, 1Y roll +5bp
Room for higher long-end forward rates in EUR swaps
Since early this year, long-end EUR swap rates have declined sharply. Ahead of the ECB meeting, the EUR 15Y15Y rate reached the lowest level for more than a year. The decline has been driven partly by lower inflation expectations for the euro area amid a passive ECB and partly by the spill-over from the US market where long-end forward rates have nose-dived as well.
Looking 12 months ahead, we expect long-end EUR rates to be higher. Firstly, the ECB has just announced aggressive easing measures, which we deem credible in the sense that they will boost future growth and inflation expectations. This is also what the Fed achieved when the Bernanke/Evans rule was established in September 2012, which indeed led to a significant repricing of the very long end in the US. In light of the aggressive measures announced by the ECB, we believe there is room for higher EUR 15Y15Y rates. We expect 15Y15Y year EUR rates to take out the recent highs.
Further, after a long rally in US fixed income markets, we now believe that risk reward is beginning to tilt towards higher US rates. US data is improving, inflation is troughing and our models are turning a bit more positive on the US economy. Moreover, our positioning index for US fixed income is no longer extremely short as was the case in early 2014, implying less resistance to higher yields. Currently, the correlation between USD and EUR rates is rather high. Hence, a turn in US rates would be an important factor for particular long-tenor forward rates in the EUR swap curve.
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