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Long-term hedge against higher rates: As the EUR long rates have moved lower and the yield curve has flattened, there is increasing interest in long-term hedges against a scenario of rates eventually moving higher. EUR short and intermediate rates should remain anchored by durably low ECB key policy rate and 4y maturity TLTRO II.
On the other hand, ongoing euro area recovery, increasing headline inflation in the coming months and progressive loosening of the fiscal policy should provide some incentive to protect against a sell-off at the long end of the curve. EUR long rates are also still being influenced by global factors: any UST sell-off triggered by a hawkish re-pricing of Fed expectations would drive EUR long rates higher, bear steepening the EUR swap curve.
The bull flattening of the EONIA curve has marginally richened reds and greens EONIA: a cumulative 15bp of easing is priced in by mid- 2018.
We find greens EONIA rich and keep reds/greens EONIA curve outright steepener.
As an alternative, for investors concerned about a further bull flattening of the curve we also advise a reds/greens EURIBOR conditional bear steepener implemented via 1Y and 2Y mid-curve put spreads.
EONIA fixings drifted marginally lower averaging almost -34bp. The EONIA market prices only about 15% probability of a 10 bps cut in the deposit rate at the September meeting.
Although the risk/reward may appear attractive for long positions vs. our baseline call we believe the bar for the ECB to cut the deposit rate in September is quite high and keep a bullish bias in Dec16 ECB OIS, as cheap hedge against further easing to take place before year-end, more likely as part of a package of further easing (QE extension).
However, with market pricing about 50% probability of another 10bp cut in December we refrain from entering outright longs.
