Strategically positive on Euro linkers; Tactical profit-taking on UK breakevens

Global Rates Strategy

Strategically positive on Euro linkers; Tactical profit-taking on UK breakevens

In Europe, breakeven protection is strongly positive, and the breakeven inflation model is more supportive than in other areas, as is the inflation cycle. Hence, on the back of these elements and an improved carry, we maintain a positive exposure to European breakevens. After a strong run since the beginning of the year, drivers are less supportive for linkers in the UK. In spite of a generally supportive inflation cycle, breakeven levels and carry are not as attractive as before and our breakeven inflation model is now markedly lower. In this context, we sold off our UK breakeven positions.

Spread trade long US vs. short Eurozone

While the overall activity cycle is positive, it is no longer accelerating as in previous months. Furthermore, it is important to note that the credit impulse is markedly lower. In spite of hawkish signals from the Fed, rate hikes should remain gradual. Finally, the woes of the current administration continue to weigh on markets, as President Trump now faces accusations regarding possible leaks of sensitive information from the Oval office and the unexpected firing of Mr. Comey, the former FBI director. Finally, we have noticed that the level of short positions on the mid- to long-end segment of the US Curve continues to decrease, as investors seem to be unwinding the trade. In light of these events, we aim to hold a long exposure to US rates.

In Europe, on the other hand, we note the strong acceleration in inflation and the activity cycle, We also acknowledge that the credit impulse is very much present. Monetary policy rhetoric is pointing towards a more hawkish stance and calls for an ECB QE tapering are increasing. There has already been a significant reduction in PSPP purchases (April), and the announcement of an adjustment in QE is expected in the coming months as we approach the limits of the programme. With the election of Emmanuel Macron (the pro-Europe candidate) and the defeat of the far right, political risk has diminished considerably in the Eurozone. Furthermore, core markets remain expensive, with rates at extremely low levels. In this context, investors might no longer focus on safe havens, and EU core rates (especially German ones) are likely to rise. Our stance on non-core sovereigns in the Eurozone remains positive. Investor positioning, which had been reduced earlier in 2017, has increased again on the segment. We hold a tactically favourable view on Portugal while locking in profits on our tactical long stance in Italy.