Macro context and the ECB’s strategy
- Growth prospects: a recession has apparently been dodged, but what about the speed of recovery? After the positive surprises in 4Q22 and 1Q23 GDP figures, growth forecast revisions seem more likely to be to the upside than rather the contrary. All in all, a growth rate for the area of 1%- 1.5% (but definitely not more) in FY23/FY24 is the best (hawkish?) credible/feasible scenario.
- Credit conditions: the air is definitely getting thinner. The gradual soaking up of its liquidity components (TLTRO III repayment, geared-up APP roll-off) when combined with the still-ongoing cycle of rate increases will very likely “leverage” the pass through of monetary conditions to the real economy.
- Inflation: the focus is clearly now on core (more resilient) components. Even assuming that headline inflation may have peaked and that we could see some moderation in the months ahead (with 4 - 5% YoY as a feasible reading for 2H23 prints), core inflation (lagging headline) is now the main focal point (unlikely to correct significantly below 5% until late 2023 or 1H24, in our view).
- The ECB’s strategy: At this stage we are inclined to believe that the ECB may take a pause (albeit not necessarilly finish) in the hiking cycle at 3.50% (Depo Facility rate) just to look at macro developments while progressing on with the rest of the toolkit (liquidity retrieval). Also important, we struggle to buy the scenario of a reversion of rates in 10-12 months’ time and rather see rates being maintained at close to their peak for longer (barring accidents).
Rates Outlook
- We still see real rates as the main driver of nominal yields. we believe that there may be more room left to the upside. We still expect Bund yields to stand at around or somewhere above 2.50% in 2H23 (3.20% for the 10Y swap). However, in the short term, banks’ risk profile is the main (dovish) driver: the risk factor related to potential episodes of bank stress seems unlikely to recede any time soon.
- Slopes: the end of flattening/inversion is close, but the time for the end-of-cycle related bull-steepening may not have arrived either.
- Asset swap spreads still stand above fair value: further compression is foreseeable, but the timing may be impacted by eventual risk-off episodes. The recent market turmoil has pushed asset swap spreads higher (natural risk-off reaction) with the short tenors now looking the most deviated. However, we believe that we should see some gradual compression in the medium term..
Peripherals sovereign issuance activity: their watchword is frontloading
- In gross terms: peripherals took advantage of RV positive market conditions in 1Q23 frontloading their funding programmes for this year (Italy and Spain at c.46%, Portugal at 56%). In net terms: Italy and Portugal have covered more than their FY23 net target and Spain is at 75% of its net funding needs. Considering the ECB’s APP roll-off, Portugal has already fully covered its net recourse to the market, Italy 90%, and Spain 62%.
- Looking ahead, we expect: i) a slight moderation in Spanish net issuance in 2Q23, but with a higher level of net supply in 3Q23 due to the lack of any redemptions; ii) a significant decrease of net issuance level for Italy in the remainder of the year (even negative by c.EUR25bn in 2H23); iii) with the aim of limiting the supply to institutional investors in June (due to the lack of relevant redemptions and for the TLTRO repayment), Spain and Portugal might decide to launch a new 10Y benchmark in May. Italy has already announced it will offer a new retail BTP (BTP Valore) in June and we do not expect any institutional syndications in 2Q23
Peripherals relative value
- We maintain our view of a slight market bias toward higher spreads by the end of 1H23 with a flattening of the credit curves as the overall blurred context on banks potential stress (globally) combines with a gearing up of the liquidity withdrawal (TLTRO III.4 repayment in June and APP roll-off in 2H23): we still see room for some core-peripherals spreads widening in 2H23 (but the peaks observed in 2022 will not be visited, in case we expect 110/115bp for SPGBs and around 200bp for BTPs). For the latest part of this year, thanks to the lower net supply and based on the hypothesis that the ECB pauses its hiking cycle, the outlook for peripherals may become more benign, in particular for tenors up to 5Y.
- SPGBs: the Spanish credit curve in the 10Y-30Y area continues to be steeper vs. Italy. In particular, the SPGB 15Y area looks cheap in historical terms, notably in RV terms vs. peers. 10Y target for end 2H23 at +90-105bp vs. the Bund.
- BTPs: the highest value for the Italian curve continues to be in the 5Y-10Y area. After a tepid approach from foreign investors in 2H22 and 1Q23, we expect them to limit their underweight on Italy. 10Y target for end 2H23 at +170-185 vs. the Bund.
- PGBs: should benefit from a rather reduced net recourse to the market for the rest of the 10Y target for end 2H23 at +75-90 vs. the Bund and a steepening of the 2Y-10Y credit curve to 80-85bp.