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2011: Facing the facts
2010 will be remembered as the year when the sovereign bond market changed for good. In 2011, three years into the financial crisis, it will be time for policy makers to face up to reality. The Fed will have to accept that US Treasury purchases can boost asset prices but cannot buy sustainable growth. The EU will have to accept that someone has to pay the price for past profligacy. And a new ECB president will have to accept a second needle in the ECB’s compass: safeguarding EMU. In this year-ahead edition we provide our colour on these and other themes, and what it all means for the different segments of global bond markets.
The year ahead - key themes:
• The Big Picture: Macro, policy measures and risk appetite should keep Bunds on a bumpy road, lower by mid-year but higher towards the end. The EMU debt crisis is nearing its endgame. This year’s performance ranking could reverse, but not on a risk-adjusted basis. US Treasury yields are set to increase further with the curve outsteepening. (p. 3)
• Economics: The brakes will be released only slowly in the US. Economic divergence in the euro area looks set to widen. China will stay in the fast lane. (p. 7)
• Money markets: For the second year running, € money market rates will be determined by central bank liquidity rather than central bank rates. We are looking for rates to surprise to the upside during the early part of the year and see less upside risks further out. Euribor rates are subject to large directionality, which is feeding into spreads and the 3s/6s swap basis. (p. 10)
• EMU relative value: Another intense year ahead for intra-EMU spreads: we look for further pronounced relief into Q1 but see a high risk that macro and funding tensions will cause another escalation leg in spreads in Q2 before a more sustained relief could set in. (p. 15)
• Supply: Peripheral issuance will drop markedly, core supply will remain at elevated levels. The ‘big duration-extension’ will be the dominant theme across issuers with core-countries keen to benefit from historically low long-end yields while peripherals will have to cut short-end supply to escape the threatening roll-over trap. (p. 18)
• Inflation: €: break-evens look set to stay well anchored especially in H1. Close strategic long 'ei' vs. 'i' with the spread near extremes in 10y. The US should see more break-even widening amid break-even curve steepening thanks to Bernanke and Obama. (p. 21)
• Covered bonds: The massive impact of the sovereign debt crisis, the market entry of newcomers and regulatory developments will remain key themes in 2011. We also expect lively issuance activity to resume, which will continue to be characterised by relatively small lot sizes and diversified spreads though. (p. 25)
• Regulation: We sketch the regulatory roadmap for 2011 and provide colour on the impact on € interest rate and vol trends. (p. 29)
• Derivatives and structured products: A normalisation of the € vol term structure is not imminent. OTM receiver skews are trading flatter and risks of steeper payer skews have increased. Single callables offer attractive pick-ups. (p. 34)
Year-end tactics:
• The excitement of 2010 is not yet over! An EU summit, a Fed meeting, Spanish auctions, funding calendars and large ECB expiries should keep rates, spreads and curves on the move. We provide our views on which direction these moves should take and you will find our regular weekly calendars and analytics from page 45.
2011: Facing the facts
2010 will be remembered as the year when the sovereign bond market changed for good. In 2011, three years into the financial crisis, it will be time for policy makers to face up to reality. The Fed will have to accept that US Treasury purchases can boost asset prices but cannot buy sustainable growth. The EU will have to accept that someone has to pay the price for past profligacy. And a new ECB president will have to accept a second needle in the ECB’s compass: safeguarding EMU. In this year-ahead edition we provide our colour on these and other themes, and what it all means for the different segments of global bond markets.
The year ahead - key themes:
• The Big Picture: Macro, policy measures and risk appetite should keep Bunds on a bumpy road, lower by mid-year but higher towards the end. The EMU debt crisis is nearing its endgame. This year’s performance ranking could reverse, but not on a risk-adjusted basis. US Treasury yields are set to increase further with the curve outsteepening. (p. 3)
• Economics: The brakes will be released only slowly in the US. Economic divergence in the euro area looks set to widen. China will stay in the fast lane. (p. 7)
• Money markets: For the second year running, € money market rates will be determined by central bank liquidity rather than central bank rates. We are looking for rates to surprise to the upside during the early part of the year and see less upside risks further out. Euribor rates are subject to large directionality, which is feeding into spreads and the 3s/6s swap basis. (p. 10)
• EMU relative value: Another intense year ahead for intra-EMU spreads: we look for further pronounced relief into Q1 but see a high risk that macro and funding tensions will cause another escalation leg in spreads in Q2 before a more sustained relief could set in. (p. 15)
• Supply: Peripheral issuance will drop markedly, core supply will remain at elevated levels. The ‘big duration-extension’ will be the dominant theme across issuers with core-countries keen to benefit from historically low long-end yields while peripherals will have to cut short-end supply to escape the threatening roll-over trap. (p. 18)
• Inflation: €: break-evens look set to stay well anchored especially in H1. Close strategic long 'ei' vs. 'i' with the spread near extremes in 10y. The US should see more break-even widening amid break-even curve steepening thanks to Bernanke and Obama. (p. 21)
• Covered bonds: The massive impact of the sovereign debt crisis, the market entry of newcomers and regulatory developments will remain key themes in 2011. We also expect lively issuance activity to resume, which will continue to be characterised by relatively small lot sizes and diversified spreads though. (p. 25)
• Regulation: We sketch the regulatory roadmap for 2011 and provide colour on the impact on € interest rate and vol trends. (p. 29)
• Derivatives and structured products: A normalisation of the € vol term structure is not imminent. OTM receiver skews are trading flatter and risks of steeper payer skews have increased. Single callables offer attractive pick-ups. (p. 34)
Year-end tactics:
• The excitement of 2010 is not yet over! An EU summit, a Fed meeting, Spanish auctions, funding calendars and large ECB expiries should keep rates, spreads and curves on the move. We provide our views on which direction these moves should take and you will find our regular weekly calendars and analytics from page 45.