Renuka Fernandez, Senior Rates Strategist at TDS, suggests that the ECB meeting comes amid significant speculation and the front end is pricing in 12bps of cuts for March, whereas we believe that the long end may not be fully priced for a step up in monthly asset purchases.
Key Quotes
“Gap risk is high on the 10Y, for this reason we choose not to hold onto an outright short 10Y duration position going into the ECB meeting; although we do expect 10Y bund yields to fall into negative territory in H1. Instead we expect the TSYBund spread to widen after the announcement, at which point we will look to own 10y Treasuries over Bunds targeting a 175-185 entry level.
We favour EUR 2s10s curve flatteners near term as Bund scarcity should keep back end yields low, whereas the front end should remain anchored on increasing levels of excess liquidity. Medium term we favour a steeper 2s10s curve, as the ECB will likely have to move away from the capital key weighting for bond purchases in order to continue with QE.
We also favour periphery spread compression as further ECB QE should support credit. In addition, in our opinion further QE will ultimately involve a switch away from a capital key weighting for bond purchases, which should further accelerate spread compression.
If the ECB introduce a 2-tier deposit rate system, we could see an initial drift higher in Eonia as some excess liquidity is temporarily taken off the ECB balance sheet. Over time however Eonia should continue to track the rate which determines the marginal cost to banks.”
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