Buy BTP 4.40% 05/33 and BKO 2.50% 03/25 and Sell BTP 4.50% 03/26 and DBR 1.70% 08/32: currently trading at c.118.4bp, target 100bp (stop loss 128bp).
After the recent market turmoil, the Italian credit risk curve in the 3Y-10Y area has returned to being relatively steep both vs. peripherals and core. This steepening is common to all the sovereign curves, with the German one leading the bullish steepening in the last two weeks as a result of the risk-off price action. We believe the term premium in the Italian curve now offers an attractive entry point after steepening by more than 32bp.
In our view, the maturity mismatch between the German 2Y (March 2025) and the Italian 3Y (BTP March 2026) could be useful to hedge the box against the risk of any violent risk-off market events, and if this were to be the case, we would expect the GER2Y-IT3Y spread to perform better than the GER10Y-IT10Y spread. Moreover, looking ahead, the BTP May 2033 should benefit from the fact that the bond will remain the CTD of the IK futures (June contract) but without any significant additional supply pressure, as we expect the next auction on Thursday to be the last for this bond. Lastly, we selected the two German bonds as the CTD of the DU and RX futures contracts.
Looking at the correlation between this box and bond volatility and filtering for phases of high-volatility, the levels seen in the last two weeks appear to be outliers with respect to previous phases of extreme market volatility.