Central banks’ week: less hawkish, but how much less?
In the case of the Fed we expect some stretching out of the view that combines the improvement in the data with the still-concerning resilience of some risk factors: more precisely, it may still be advisable to leave open the possibility of extending the “rates at their highs” (or eventually higher) strategy in the months ahead. The key question is whether this is “credible enough” in the eyes of market participants.
We expect the ECB to modify its discourse on the back of the recent positive evidence on inflation (some tweaks to the wording that would mostly consist of talking down the risk/necessity of further interest rate hikes in the future). However, we do not see enough evidence to expect a sharper U-turn in the message, such as hints about imminent rate cuts (in the way the market is currently anticipating). There is still room for the ECB to tackle further measures beyond purely interest rates, which may have the effect of tightening financial conditions (Minimum Reserve Requirement, PEPP roll-off, etc…). We are inclined to believe that the underlying message sent by the ECB in this meeting may end up being less dovish than the market currently appears to anticipate.
Our strategic/tactical approach to the peripherals
Last week core rates continued to fall in the medium-to-long part of the curves, while the short part of the curves suffered a yield correction of c.8-10bp, leading to a generalised flattening of the curves. In RV terms vs. Germany, the Italian bonds suffered the most while Spain faced limited pressure and more concentrated in the long part of the curve. Looking ahead, two key market movers in the next couple of weeks: i) the round of central bank meetings this week; ii) with a more strategic perspective in terms of market impact, the decision about the European fiscal framework for next year onwards.
Our approach to peripherals: i) after the cheapening observed in the Italian short-end last week, we still maintain our preference for a spread tightening in BTP vs. DBR in the short area of the curve with a target level in the 2Y area at 40bp; ii) regarding the Italian and Spanish curves in RV terms, we like to play the flattening of the Italian 3Y-10Y vs. the steepening of the Spanish 3Y-10Y and, in the long part of the curve we like the flattening of the Spanish curve in the 10Y-30Y area vs. steepening positions in the Italian long end.
Weekly supply
On the bills market total issuance will be c.EUR22.2bn in gross terms and c.EUR12.8bn in net terms (redemptions from Germany and Italy). In bonds Austria, Italy and Belgium will be active. Total issuance is expected to be c.EUR7.1bn in gross terms and negative c.EUR21bn in net terms (redemptions from Italy and Germany).