FxWirePro: Euro fixed income perspectives - Low-cost hedges against Italy and Brexit amid bearish duration bias

EURUSD is little changed on the day and we look for more range trading with a modestly positive bias in the near term.

Advanced markets growth modification has been reasonably constructive in the past 2-3 months with gyration moving further towards the US and away from the Euro area, whereas 2018 EM cumulative growth revisions have turned negative lately. Global growth should hold up: the growth gap between the US and the Euro area is projected to narrow down in 3Q and 4Q of 2018 and the cross country standard deviation to decline, providing more resilience to the global outlook. We revisit the market stress during the month of August and note that rates markets largely retraced 50% of the initial risk-off move as trade tensions partially eased, while some concerns increase on Italian political risk, EM and to a lower extent risk of a no-deal Brexit. We add risk off hedges to our portfolio. 


Risk markets are now on tenterhooks as European equities slide back to year-long range lows (German industrial production fell again this morning, following a poor factory orders reading yesterday), industrial commodities and currencies also remain under pressure as we wait to hear if President Trump will initiate tariffs on another $200bn of Chinese imports.

In the Euro area, the news flow is mixed but we keep 30Y Bund shorts on valuations and expected future developments. Keep paying Mar20 ECB OIS. Hold bearish trades: reds/5Y swap curve steepener and paying greens in reds/greens/blues swap fly. Keep Oct18 Schatz/Bund weighted bear steepener and favour 2s/5s weighted bear steepener. As a bullish hedge, we recommend Dec18 Schatz/Bobl/Bund conditional bull belly richener. 

Book returns in the 3Y BTP calendar spread. We have a modest widening bias to Schatz swap spreads. 

Initiate Dec18 Schatz OIS swap spread widener beta-hedged with reds/blues EONIA curve steepener. Roll Bund swap spread narrower from Sep18. Hedge Italian political risk with OTM Dec18 Bobl swap spread conditional bull widener. Stay long 3Mx10Y gamma. 

Initiate 2s/10s OTC vol curve steepener. Buy deep OTM Oct18 BTP call. 

Intra-Euro area, we are positive on Italy in the medium term but stay neutral in the short term and add to hedges: add long body in level-adjusted 2s/5s/10s BTP fly. 

In core, we keep 5Y France-Germany widener and focus on RV. Special Focus: Q&A on Italy. 


In the UK, enter bullish option hedges on M9 Short Sterling. Keep paying 2Yx1Y SONIA vs. 2Yx1Y USD OIS. Neutral 10Y duration, sell the belly of the level-adjusted 5s/10s/30s gilt fly. 

Keep 30s/50s gilt curve flatteners. Enter tactical 2s/5s OIS swap spread curve steepeners and keep 10Y OIS swap spread narrowers. Keep receiving 10Y GBP/USD cross currency basis. 

Keep 3Mx2Y/3Mx10Y volatility curve steepeners and stay long 1Yx2Yx20Y forward volatility. 

Hold 2s/15s weighted bull flatteners via 3M options and stay long 3Mx30Y GBP vs. EUR receivers. Courtesy: JPM

Currency Strength Index: FxWirePro's hourly EUR spot index is inching towards -67 levels (which is bearish), while USD is flashing at -1 (which is absolutely neutral), while articulating at (12:20 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex