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The political risk in 2Q and the ECB have been lingering as the main drivers of Euro area rates, while Brexit negotiations are expected to take the back stage as Article 50 is triggered next week.
We anticipate receding political risk in France in a baseline scenario of Macron Presidency, while the ECB is likely to turn to a neutral stance but still keeping the QE tapering/rate hike sequencing unchanged.
German yield curve is biased steeper while French and peripheral credit curves are expected to flatten.
The growth is great and warrants higher yields, but we believe in the old ECB sequencing (QE tapering first), hence we keep steepening exposure.
Le Pen’s chances are slim but not zero: enter intra-EMU tighteners vs. Germany, but keep cheap hedges: short end OLO and DSL UW, add France and Spain 3s/10s credit curve flatteners, OW low-coupon bonds vs. high-coupon.
ECB’s neutral stance will steepen the money market curve. Receive Jun18 ECB OIS. Keep 2s/5s/10s bear belly cheapener and sell Jun19 in the Jun18/Jun19/Jun20 50:50 Euribor fly.
Hold reds/blues and 2s/10s weighted bear steepeners. French hedges: keep 1Y swap/Bobl conditional bull flattener, Sep17 FRA/OIS and 2Yx2Y cross currency basis wideners.
Swap spread medium term narrowing bias. Take profit on Bund/Buxl swap spread curve flattener buy pay Bund swap spread in the Schatz/Bund/Buxl swap spread curve fly. Take profit on Jun17 Bund bear widener.
Stay short gamma at front end via Jun17 OTM Schatz put and Mar18 Euribor straddles.
