Two central banks down, two to go. The cautious tone from the ECB wasdrowned out by the hawkish tone from the BoE. The Fed and the BoJ headlinethe coming week, with the tone from both likely to reflect the status quo, withone exception: we expect the Fed to announce balance sheet normalization.
CEEMEA credit week ahead: As August approaches, we expect CEEMEA sovereign credit to slowly grind tighter. As we wrote in CEEMEA credit: Prepare for the August grind tighter,buy TURKEY $ '45s our economists have pushed back their next Fed hike call to March 2018 after recent inflation prints and Fed Chair Yellen’s recent comments. With low US rate volatility, we expect investors to search for yield and have added a new recommendation to buy Turkish credit, given its cheapness to the rating and diminished FX risks. We further note that the near-term technical picture is supportive, with new issuance likely to see a seasonal decline in August; on average there was just USD 0.4bn of CEEMEA sovereign issuance in August between 2013 and 2016.
Asian markets are rallying this morning following the release of the FOMC meeting minutes withAsia FX stronger across the board by up to 0.9%. The minutes were consistent with our andconsensus views for a rate hike in June. While some comments were made on balance sheetreduction, we expect a more detailed plan on this process to arise at the Fed’s Septembermeeting.
G4 views: In the US, we suggest investors enter tactical UST 2s30s flatteners,given the risks of a lower dot-plot. We continue to find 2y swap spreadtighteners attractive in relative value terms, given their elevated level comparedto implied Libor-GC forward rates, and we suggest investors maintain a 2s5sswap spread curve steepener at -16bp. In the euro area, we outlined the ongoingEonia reform and we concluded that the Eonia review would not result in asignificantly lower fixing than the current rate in the near term. In Japan, weupdate on recent developments in the USDJPY basis and recommend to receive7y USDJPY basis outright at -59.5bp.
Rating reviews on Friday 28 July: Azerbaijan (S&P, BB+ Neg), Bahrain (Moody’s, Ba2 Neg), Oman (Moody’s, Baa1), Serbia (Moody’s, Ba3), Slovakia (S&P, A+).
In CEEMEA, the focus will be on the South African Reserve Bank’s (SARB) policy meeting wherewe expect the repo rate to be kept unchanged at 7.00%. Yesterday, headline inflation fell sharplyin line with our view to 5.3% y/y in April vs. 6.1% y/y in March. Today, the release of PPI datashould also show a decline on the back of weaker commodity prices. We think lower headline CPIwill prompt the SARB to revise its inflation forecast and turn more dovish in its rhetoric. Given thelack of receiving interest in South Africa, the curve is likely to steepen and drive fixed incomeflows to SAGBs. Yesterday, we saw a rally in the front-end of the curve and now, with 1y1y belowthe fixing, downward pressure on yields will move towards the belly of the curve where rates stillremain above the fixing e.g. 5y. Breakevens remain low in the back-end (10y BE are at 6.15) and,given fiscal uncertainty, we think 10y will lag the rally. We do not recommend chasing ZARstrength below 13. Instead, we would look to buy out-of-the-money calls below 13, should impliedvolatility inch down. We expect the central bank to cut rates by 25bp in Q4 2017, consistentmarket pricing for a 30bp cut in the next 6 months.
AUS and NZ: In Australia, strong data released last week caused the curve tosteepen to a level which we believe is unjustified, given economic fundamentals.
Last week’s performance recap: CEEMEA $ sovereign bonds were 8bp tighter on the week on the back of the positive market backdrop. The strongest performance was seen in
APxJ FID Research Brief。 In Asia, in China, a large gap that has recently developed between the daily CFETS fixing forUSDCNY and the official 4:30pm closing spot price. This suggests that the impact of daily spotclose on the fixing has diminished, which may indicate that Chinese authorities may want the RMBto appreciate more in line with their currency basket. If the PBoC is indeed willing to tolerate alarger gap between spot and fixing, or if the PBoC is sending an outright bullish signal on thecurrency, then we would expect short USDCNY NDF positions to outperform. As such, the team isrolling its short USDCNY position. We thus recommend selling 3m USDCNY NDF targeting 6.80,with stop loss at 7.00. For full details, please see CNY fixings: Sending a stronger message.