Eurozone: Risk and supply limit selling pressure on core - BNPP

Patrick Jacq, Research Analyst at BNP Paribas, notes that the rally in core markets has paused as risk-on returns.

Key Quotes

“After being well supported by flight-to-quality trades in late January, core EGBs have suffered a limited sell-off as better supply and demand conditions, and the return of a temporary risk-on mode, support semi-core and peripheral paper.”

“This setback in core bonds could persist until the end of February, but we note that supply and demand conditions will turn less favourable again in March in France, Italy and Spain, and the political environment could support the Bund. In the Netherlands there will be elections in March, and net supply will be positive. We see room for core EGB yields to rise slightly in the very near term, but we expect firmer support for the Bund by the end of February. The 0.45% area on the 10y Bund yield should provide firmer support for the Bund. Keep slight short exposure  in the 10y area.”

“The short end of the curve remains well protected. There have been signs that the short end is still well protected during a sell-off, and outperforms significantly in rallies. Going into the ECB’s final targeted longer-term refinancing  operation (TLTRO) in March, the 4y area could outperform other areas in both swaps and cash. Hedges of the TLTRO will fuel receiving interest in the 4y swap area. 4y semi-core could also outperform other areas of sovereign curves. At -0.14%, the 4y OAT May-21 looks attractive (the TLTRO should be at -0.30/-0.40% for most large banks). The very long end should continue to underperform, as inflation expectations continue to rise.”