Macro context and the ECB’s strategy
- A coming slowdown looks certain but, how “unexpected”/bearable might this be for CBs? Overall, leading indicators continue to point to an imminent phase of very weak or even slightly negative growth ahead, but they do not (yet?) suggest a long-lasting and severe stagnation will necessarily follow.
- The fight against inflation: from tailwinds to headwinds. Progressing through the first stage of the reversal of inflation may be fast enough (from 6% to 4%). However, the next steps (core inflation moderating to 3% or lower) may take longer to materialize.
- The ECB’s strategy: We believe that the ceiling in the ECB rates policy gas been reached and that the ECB has now entered a phase when it will prefer to keep the high levels for longer than what the market expects (the key element to mull is not only the level of the terminal rate but the duration of the current restrictiveness.
- Gear-up of the retrieval of excess liquidity by the ECB: the inclusion of the PEPP in the roll-off programme and the increase in the reserve requirement are the main candidates for these new measures.
Rates Outlook
- Reassessing the CB’s “put” on duration risk: real rates in full upward adjustment to levels more consistent with fundamentals: we now see Bund yields visiting levels around or somewhere above 2.90% in 4Q23 and eventually stretching out to a range of 2.90% - 3.20% during 1H24. This would be consistent with the US10Y Try yield closing 2023 around 4.70% and consolidating at these levels during most of 1H24
- Our strategic/tactical approach to EUR curves: i) we like payers in the 2y to 5y; ii) we like steepeners: 5y vs 10y and 5y vs. 15y look interesting; iii) asset swaps further compression, although the timing is still uncertain; iv) we like receiving inflation over the next 12/15 months.
What does the “higher-for-longer” scenario mean for the periphery in 2024
- In terms of government’s fiscal stance, Italy is now holding a less ambitious fiscal consolidation plan in the years ahead (2.8pp higher in 2023 and still around 4.3% in 2024). Despite the context of “higher-for-longer” yields any concern about debt sustainability would result premature in our view.
- Rating, Italy is the most exposed issuer to any negative credit actin. As of now, we don’t expect Moody’s to take any negative action in the next 1 or 2 windows (but the outlook thereafer is more blurred). The medium-term outlook for Spain remains constructive whereas Portugal seems is bound to be upgraded in the next windows.
- Peripheral sovereigns’ issuance: looking into 4Q23... and FY24: Italy: we expect a gross bond issuance of c.EUR350-360bn (net issuance of c. EUR90bn). As for Spain our first approach contemplates a gross bond issuance of c.EUR180bn (c.EUR173bn in FY23) whereas net issuance could be of c.EUR50 -60bn. The net recourse to the market (considering the ECB’s roll-off) would stand around EUR70-90bn
Value in the peripheral curves
- Spreads vs. Bund: Italy: there seems to be room for an additional structural widening of c.15-20bp from current levels in the 10Y tenor (230bp as the upper bound of the range). Spain could c visit references closer to (but arguably not significantly above) 120bp.
- Curves slope: we foresee steeper curves in the 2y-10y area, especially for Italy. In the long-end the Italian credit curve might flatten more than the others due to the cheapening of the 10Y tenor.
- Tail-risk monitoring: we still don’t find enough evidence suggesting that a sharp negative market stance on Italy is brewing. A sharp negative credit event (Italian rating sent to sub-investment grade -somewhat remote in the short term) would lead to a completely different market approach, in particular to a strong bearish flattening of the 2Y-10Y area. We recall that a scenario of a deterioration of the issuer’s credit profile due to domestic factors (not really market fragmentation) is not the one that would necessarily trigger the ECB TPI tool.
- RV value in the curves: i) we like the fly 3y-7y-10y in the Spanish curve. In the 10y-30y, we might expect a gradual flattening, especially if the Spanish Government asks for NGEU loans disbursements (further reduction in the long-end supply).; ii) the Portuguese 15y area is the most valuable area in which to invest in PGBs, with c.20bp of pick-up the fly 10y-30y; iii) The 2024-2025 CCTs-eu continues to offer a not-negligible pick-up vs. BTP curves and they offer a good hedge for the “higher-for-longer” scenario.