摩根士丹利-全球投资策略-全球宏观策略师：在破碎的玻璃上行走

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June24,202210:17PMGMT

GlobalMacroStrategist|Global

WalkingonBrokenGlass

Centralbankshavebrokenglassfortheinflationemergency,andnowmustproceedtowalkonit,despitetheattendantpain:aslowdownineconomicactivity.Upsiderisksremainforinflation,governmentbondyields,andtheUSdollar.

GlobalMacroStrategy

WeflagadeclineinUSCEOconfidenceasaharbingeroflayoffs.WebelievethemarketisunderpricingtheimpactonCNYfromthetariffcutandrecommendlongEUR/CNHputspread.WediscussliquidityandmarketfunctioningintheJGBmarketaftertheBoJ'spurchasingspree.

InterestRateStrategy

IntheUS,wemaintainourshorttheMarchFOMCmeetingviatheFFJ3contractandUST1s10sflatteners.InEurope,weclosetheJulyECBmeetingreceivingtrade.Wekeepourshortdurationtrades(EUR10y10yandlongEUR5y5yinflationswap)hedgedwithAugustBund150/152/153brokencallfly.Weenter30s40sOATRVflattenersandkeepourASWandnon-coreEGBtrades.IntheUK,wemaintainourtacticallybullishstancebestexpressedthroughlongpositionsin10yrealrates.Atthesametime,wehaveintroducedalong5yRPIideagiventhecheapnessoffront-endinflation.InJapan,weremaininJGB10s20ssteepenersandlongJBU2.Weshiftfrom1y1yvs.10y10yonTONAOISto1y1yvs.10s20ssteepener.

Currency&ForeignExchange

USDupsiderisksarerisingalongsideglobalrecessionconcerns.EurozoneCPIisthenextbigtestforEUR/USD.WethinkrisksareskewedtothedownsideforSEKheadingintoRiksbankmeetingonJune30.WethinkdipsinCHFwillcontinuetobeboughtgiventhehawkishSNBmeeting.WediscussthepotentialforSNBFXreservesellingandhowtheirreservesarecurrentlyinvested.

Inflation-LinkedBonds

IntheUS,weupdateourrealyieldcarrymodelforthenextseveralmonths.WecontinuewithourworkonCPWIfixingsbyansweringthreecommonquestionswereceivedonfixings'behaviorandvol.Weintroduceahigh-convictionideaintheUK:buy5yRPIswapstargeting5%aswejudgethefront-endinflationforwardtobeexcessivelycheap.Inothergeographies,andgiventhecurrentvolatileenvironment,takeawait-and-seestance.Thatsaid,wekeepourJBI27BEIlongtradeon.

Short-DurationStrategy

WediscusstherecentwideningofSOFR/TONAbasis.WemaintainreceivingTONA/SOFRbasis2s10s20sfly.

MORGANSTANLEY&CO.LLC

MatthewHornbach

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MorganStanleydoesandseekstodobusinesswithcompaniescoveredinMorganStanleyResearch.Asaresult,investorsshouldbeawarethatthefirmmayhaveaconflictofinterestthatcouldaffecttheobjectivityofMorganStanleyResearch.InvestorsshouldconsiderMorganStanleyResearchasonlyasinglefactorinmakingtheirinvestmentdecision.

Foranalystcertificationandotherimportantdisclosures,refertotheDisclosureSection,locatedattheendofthisreport.

+=Analystsemployedbynon-U.S.affiliatesarenotregisteredwithFINRA,maynotbeassociatedpersonsofthememberandmaynotbesubjecttoFINRArestrictionsoncommunicationswithasubjectcompany,publicappearancesandtradingsecuritiesheldbyaresearchanalystaccount.

2

GlobalMacroStrategy

MORGANSTANLEY&CO.LLC

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MatthewHornbach

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LosingConfidence:FirstUSConsumers,NowUSCEOs

Aftervaccinesbecameavailableinearlytomid2021,consumersbeganregainingconfidencelostduringthedepthsofthepandemic.Butthatconfidenceboostdidn'tlastlong.StartinginJuly,asthesummerof2021kickedintohighgear,consumerconfidencebegantoslip.Andithasn'tlookedbacksince.

Thiswasdespiteour2-factormodelfortheConferenceBoardmeasureofconfidencecontinuingtoclimb(seeExhibit1).Ourmodelsawthedeclineintheunemploymentrateandcontinuedrallyinequitiesasaboonforconsumerconfidence.

Thereasonwhyconsumersweren'tfeelingasgreatasthemodelsuggestedhadalottodowiththelingeringeffectsofthepandemic.Butconsumerswerealsoseeingpricesrisemorestubbornly.AndthiscamethroughintheUniversityofMichiganconsumersentimentsurvey,whichisaffectedmorebyinflationdynamics(seeExhibit2).

However,thisyearourmodelestimateforConferenceBoardconsumerconfidencehasturnedlower,thoughnotyetdecisively.Therecentdeclineintheestimate,whichbeganinJanuary,remainssmallcomparedtohistoricaldeclines.Andithasbeendrivenentirelybyequitypricedeclines.

Exhibit1:ConferenceBoardconsumerconfidencevs.two-factormodelprojection

Index

150

125

100

75

50

25

120.2

106.4

May-97May-02May-07May-12May-17May-22ConferenceBoardconsumerconfidence2-FactorModel

Source:MorganStanleyResearch,BLS,ConferenceBoard,Bloomberg

Exhibit2:ConferenceBoardconsumerconfidencevs.UofMichiganconsumersentiment

ConfBoard

UofMich

160

140

120

100

80

60

40

20

120

110

100

90

80

70

60

50

Jun-97Jun-02Jun-07Jun-12Jun-17Jun-22ConferenceBoardconsumerconfidenceUofMichconsumersentiment(rhs)

Source:MorganStanleyResearch,ConferenceBoard,UofMich,Bloomberg

3

Index

Index

Thousands

Index

CEOconfidencefallsbelow5

110

8

7

6

5

4

3

2

1

8.07.57.06.56.05.55.0

4.5

950

850

750

650

550

450

350

250

150

105

100

6

95

90

85

WhatisholdingupourmodelofUSconsumerconfidence?Theunemploymentrate,

whichhasremainedatapost-pandemiclowat3.6%for3monthsinarow.Thatmightstarttochange,andsoon.StartinginApril,CEOconfidencebegantofallrapidly,alongsidesmallbusinessoptimism(seeExhibit3).

ThisrecentdeclineinCEO

CEOconfidenceremainedbackofastrongequitymarketUSgovernment.

ThedeclineinCEOconfidence,measurefellbelow5.0waslate

thereafter(seeExhibit4).In

–somethingwealsosawtheof2019.

theon

anotablechangefromtheperiodincludingbuoyantduringCOVID-19,perhaps

aggressivestimulusfromtheFederal

at5.6inJune,bearswatching.ThelastUnemploymentclaimsbegantotrend

jobopeningsviatheJOLTSdatabeganCEOconfidenceapproached6.0in

pandemic.the

confidenceis

relatively

Reserve

and

and

timehigher

theshortlyfallsummer

whichprinted

2007.

tothe

addition,

lasttime

Exhibit3:CEOconfidenceandsmallbusinessoptimism4:CEOconfidenceandunemploymentclaims

Exhibit

5.

Jun-12

Jun-14Jun-16Jun-18Jun-20Jun-22

Jun-06Jun-10Jun-14Jun-18Jun-22

CEOconfidenceindexSmallbusinessoptimism(rhs)CEOconfidenceindexUnemploymentclaims(4WMA,

rhs)

Source:MorganStanleyResearch,CEOMagazine,NFIBSource:MorganStanleyResearch,CEOMagazine,BLS

IstheMarketUnderpricingTariffCutsforCNY?

RecappingourbullishCNYview:WerecommendedturningbullishonCNYtacticallyonMonday(seeEMStrategy:AsiaMacroStrategy:AddBullishCNYTradeTactically,June20,2022).Torecaptheview,weanalyzedthepotentialimpactonCNYshouldatariffcuthappen:In2018-19,USD/CNYwashigherby1.8%foreveryUS$10billiontariffincrease.

Theoppositewouldbetrueshouldatariffcuthappen,inourview,butthesensitivityshouldbesmallerthistime,given:1)2018/19alsosawastrongUSD;and2)Themarketisawareoftheupcomingtariffreduction.

Whattodo:ButwestillbelievethatUSD/CNYshouldbelowerpostthenewsandrecommendinvestorstogolong3mEUR/CNH7.00/6.80putspreadwithapotentialmaximum~3xpayout.WealsoliketoaddalimitorderforlongSGD/CNHat4.75,withatargetof4.95andstopof4.65,toreflectourmedium-termview.

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Exhibit5:Tarifftimeline

TrancheEffectivedateGoodscoveredNo.oftarifflinesValueofimports(USDbn)Tariffrate

List16-Jul-18Industrialgoods(Machinery&vehiclesetc)818$34bn25%

List2

23-Aug-18

Industrialgoods(Machinery,motors,chemicalsetc)

279

$16bn

25%

List324-Sep-18

Chemicals,rawmaterials,seafood,vacuums,bicyclesandfurnitureetc

5733

$200bn

25%(from15-Jun-19)

10%(24-Sep-18to14-Jun-19)

List4A

1-Sep-19

Consumergoods(Stationery,sportsequipment,watches,metals,clothing&footwear,foodetc)

3233

$112bn

7.5%(from14-Feb-20)15%(01-Sep-19to13-Feb-20)

Source:USTR,PIIE,MorganStanleyResearch

Whatisthefeedback?Sincewepublishedthetradeidea,thefeedbackhasbeenmixed.SomeinvestorsagreedwithourviewandputonsomeUSD/CNHdownsidetrades.Otherinvestorspushedbackandarguedthat:1)Themarketisalreadypricingtariffreductiontosomeextent;and2)TheUScouldannounceotherhawkishmeasuresonChinatooffsettheimageofbeingsoftonChina.

Isthemarketunderpricingthis?Togaugethefirstquestion,wereviewthestatisticsof'tariffcut'searchesonGoogleversusUSD/CNYandCNYCFETSmoves.Inthepast12months,therehavebeenthreeepisodeswhenthepublicfocusedontariffcuts:

1.ThefirstepisodewasinNovemberlastyearwhentheUSandEuroperemovedsteelandaluminumtariffsandtheUSbusinesscommunitycalledfortheUStoremoveChinatariffs.

2.ThesecondepisodewasinFebruary/MarchthisyearwhentherewasmoretalkabouttariffcutsandtheUSreinstated352productexclusionsfromChinatariffs.

3.ThethirdepisodehappenedrecentlywithmorecommentsfromPresidentBidenandSecretaryoftheTreasuryYellenabouttariffcuts.

Exhibit6showsthatUSD/CNYwouldbeslightlylower:0.1%inepisode1and0.6%inepisode2.Inepisode3,USD/CNYis1.5%lowersofar.ToremovetheUSDimpact,wealsolookattheCNYCFETStoreflectitsrelativeperformanceversusChina'stradingpartners.WenotethattheCFETSappreciationwasmoreinepisode1and2–2.2%and4.9%,respectively–whiletheappreciationsofarisonly1.2%.Basedonthedataabove,wemakeafewobservations:

1.Recentappreciationisduetoacombinationoftariffnewsandapullbackfollowingthesharpsell-off:TherecentrallyofCNHversusUSDcouldbeseenasthemarketpricinginsometariffreductionexpectationbutalsotherallyhappenedafterUSD/CNHmovedfrom6.30to6.80inApril/May.So,theappreciationcouldbeduetothereverseofasharpappreciation.

2.CFETSappreciationthistimeismuchlessthanwhatwehaveseeninthepasttwoepisodes.ThissuggeststhatCFETShasmoreroomtorallyshouldthetariffcuthappen.

5

1.5

1.0

0.50.0

-0.5

-1.0

-1.5

-2.0

Exhibit6:HowUSD/CNYreactedtotariffcutheadlinesExhibit7:HowCFETSreactedtotariffcutheadlines

90.0

80.0

70.0

60.0

50.0

40.0

30.0

20.0

10.0

0.0

Jul-21Sep-21Nov-21Jan-22Mar-22May-22TariffcutsearchedonGoogleUSD/CNY(RHS)

Source:Bloomberg,MorganStanleyResearch

6.9

6.8

6.7

6.6

6.5

6.4

6.3

6.2

90.0

80.0

70.0

60.0

50.0

40.0

30.0

20.0

10.0

0.0

Jul-21Sep-21Nov-21Jan-22Mar-22May-22TariffcutsearchedonGoogleCFETS(RHS)

Source:Bloomberg,MorganStanleyResearch

108

107

106

105

104

103

102

101

100

99

98

AnyshortcoveringbythoseinvestorscouldcauseCNYtorally:Meanwhile,investors

remainlargelycautiousonCNY.GBI-EMinvestors,agoodrepresentationofforeignrealmoneyinvestors,are1.6%UWCNYintheirportfolioandonly20%ofinvestorsarebullishonCNYasofMay.TheUWpositionisthehighestsinceChinajoinedtheindexin2020.

Inotherwords,themarketmighthavealreadypricedintariffcutstosomeextent,butthepositioningisnotthereyet.AnyshortcoveringbythoseinvestorsonthebackofactualtariffcutscouldcauseCNYtorally.

Exhibit8:RealmoneyremainsUWCNY

Positionvsbenchmark

Sep-19Feb-20Jul-20Dec-20May-21Oct-21Mar-22

CNYFXPosition

Source:Companywebsites,MorganStanleyResearch

Exhibit9:Only30%ofinvestorsarebullishonCNY

%offundOWvsNooffundinthesamle

p

100%1000

90%

80%800

70%

60%600

50%

40%400

30%

20%200

10%

0%0

Sep-19Feb-20Jul-20Dec-20May-21Oct-21Mar-22

CNYFXOW%

Source:Companywebsites,MorganStanleyResearch

TheotherconcernisaboutthepotentialhawkishactionbytheBidenadministrationalongwiththetariffcuts,assuggestedbyourpublicpolicyexpertMichaelZezas.Weagreethatitisarisktowatchforbut,aslongasthehawkishactiondoesn'tleadtoanotherroundoftariffs,theimpactonCNYshouldbelimited,inourview.

Overall,webelievethatthemarketisstillunderpricingthetariffcutsforCNYandwouldliketopositionforatacticalrallyinthecurrency.

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千

Tradeidea:LongSGD/CNH(limitorderat4.75),withatargetat4.95andstopat

4.65

Tradeidea:Long3mEUR/CNH7.00/6.80putspread

JGBMarketFunctioning:SomeProblemsWorseThanOthers

TheBoJ’sJunestatementappearstohavedampenedoverseasspeculationaboutthepossibilityofnear-termpolicyadjustments.Still,thecentralbankhasalsofounditselfneedingtobuyuplargeamountsofJGBsinordertodefendits+0.25%“yieldcurvecontrol”(YCC)ceilingforthe10yJGByield.

TheBoJ’sJGBpurchasessofarthismonthhavebeensomeJPY8.5trilliongreaterthanoriginallyplanned,withthe5y–10ysectoraccountingforthelion’sshareandthelatestdatasuggestingthattheBoJhasalreadyabsorbedaround88%ofthenewest10yJGB(JB366)fromthemarket(seeExhibit10andExhibit11).

Exhibit10:MonthlyBoJ'sgrossJGBpurchases

JPYtn

14

12

10

8

6

4

2

0

Jun-16Jun-17Jun-18Jun-19Jun-20Jun-21Jun-22

3-5y

under1y

Source:BoJ,JapanMof,MorganStanleyResearch

Exhibit11:CurrentBoJholdingsharefor7-10yrsJPYtn

5

4.5

4

3.5

3

2.5

2

1.5

1

0.5

0

366

365

364

363

362

361

360

359

358

357

356

MarketOutstandingBoJshare(RHS)

Source:BoJ,JapanMof,MorganStanleyResearch

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

Moreover,asdiscussedinImmigrationRemainsClosed,priceactioninJGBfutureshasrecently“decoupled”fromthatinthecheapest-to-deliver(CTD)issueasaconsequenceofthelatterbeingincludedintheBoJ’spurchases.

MarketparticipantshaveunderstandablystartedtoexpressconcernsaboutdeterioratingJGBmarketfunctioningasthecentralbankcontinuestoenforceitsYCCcommitments.SomeinvestorsevenaskwhetherYCCitselfmightsoonneedtobeterminatedasaresult.

Ofcourse,higherBoJownershipshouldmatterfortheliquidityofthespecificissue.But,theBoJ’sSecuritiesLendingFacility(SLF)shouldenabledealerstoborrowscarceissuesfromthecentralbankandtherebyhelpshort-coveringinvestorstobuysometimeuntilthenextliquidityenhancementauction.

7

15th-Jun

21th-Jun

22th-Jun

24th-Jun

16th-Jun

13th-Jun

14th-Jun

17th-Jun

20th-Jun23th-Jun

ThebiggestproblemfromaliquidityperspectivehasbeentherecentpriceactioninJGB

futures.FutureshavecheapenedsharplyasaconsequenceofspeculativepositioningforBoJpolicyadjustmentsbyCTAsandoverseasinvestorsaswellasasomewhatacceleratedunwindingoflongpositionsbyrelativevalueplayers.

Atthesametime,theCTDissuehashaditsyieldcappedat25bpbyinclusionindailyfixed-rateoperations.Theresulthas,ofcourse,beenatemporarybreakdownoftheusualCTD-versus-futurescorrelation(seeExhibit13).

Exhibit12:MarketfunctioningDIvsInvestors'JGBtradingvolume

Source:JSDA,BoJ,MorganStanleyResearch

Exhibit13:CTDyieldd/dchangesvsFuturesimpliedyieldd/dchanges

Futuresy

ieldd/dchg(bp)JBM2JBU2

30.0

25.0

20.0

15.0

10.0

5.0

0.0

-5.0

-10.0

-15.0

-20.0

-10.0-5.00.05.010.0

CTDyieldd/dchg(bp)

Source:MorganStanleyResearch,Bloomberg

FuturesarethemostliquidproductintheJapanesebondmarketandplayavitalroleinpricediscovery.Dealersreferencefutureswhenpricingeventhemostilliquidofproducts.Inparticular,changesinfuturespriceswillaffectpricingofalllessliquidproductsduring(say)theeveningsessionorotherperiodsoflowliquidityinthecashbondand/orswapsmarket.

AbreakdownofCTD-versus-futurescorrelationthatleavesthefuturesprice“untethered”mayultimatelyleavedealerswithlittleoptionotherthantofollowquotedpricinginthebrokermarket.Theresultisliabletobeanegativespiralinwhichwidebid-offerspreadsmakeitimpossibletopositioninsizeandtherebyreducemarketparticipationyetfurther.

TherehaveinfactbeensomesignsoffuturesandtheCTD“recoupling”oflate(seeExhibit14),butmarketfunctioningobviouslystillleavesmuchtobedesiredwithfuturestradingvolumeremainingsolowdespitehighvolatility(seeExhibit15).

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Exhibit14:FuturesimpliedyieldvsCTDyield

Source:MorganStanleyResearch,Bloomberg

Exhibit15:JGBfutures'tradingvolume

Units

70,000

60,000

50,000

40,000

30,000

20,000

10,000

0

Dec-21Feb-22Apr-22Jun-22

Tradingvolume(5dayaverage)Dailyrange(5dayaverage)

Source:MorganStanleyResearch,Bloomberg

250

200

150

100

50

0

WeexpectCTD-versus-futurescorrelationtoreturntomore“normal”levelsonbackoftherecentdeclineinyieldsandsubsequentshort-coveringinfutures.TheeasingofSLFtermsandconditionsalsohasmadeiteasierforrelativevalueinvestorstoholdshortpositionsonagrossbasisaheadofnextfuturesrollover.

However,weexpectJGBfuturestobedisconnectedtosomeextentvsCTDsforawhile,i.e.,futuresimpliedreposhouldremaintightvsitsCTD,giventheriskofanotherdecoupling.EvenarecoveryofCTD-versus-futurescorrelationmightstillleavefuturescomparativelyineffectiveasahedgeagainstrisesininterestratesifBoJYCCcontinuestocaptheYCCyieldataround25bp.

Naturally,itispossibletoconceiveofascenarioinwhichfuturescontinuetobesoldevenastheCTDyieldremainsstuckat25bp,buttheresultant“decoupling”wouldonceagainbelikelytoreduceconfidenceinJGBfutures.

SuchproblemsareperhapsunavoidablesolongastheBoJremainsdeterminedtopersistwithYCC,sofuturesneedtopriceindecouplingrisktosomeextent.Moreover,marketparticipantswillobviouslyneedtoremainmindfuloftheriskthatliquiditycouldagainevaporatejustasbondsstarttoselloff.

OurCurrentStanceOnMarkets

Inglobalratesmarkets,wekeepour1s10sflattenersandourshortFFJ3position.Wecontinuetosuggestselling3m10yATMSOFRstraddlesandbuying+/-50bpOTMSOFRstranglesasawaytoplaytherange.

Wealsosuggestbuying2y1yCPIswaps,whileremainingmoreneutralondurationandcurvestactically.Inaddition,wecontinuetorecommendshort0.125Jul24TIPsvs.long0.375Jul25TIPs,2y2s30scurvefloorspreadsstruckATMF/ATMF-75bp,and6m5s30sconditionalbull-steepenersasacheaphedgetoourdeltaview.

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Intheeuroarea,wecloseourreceiveJulyECBmeetingposition.WeopenOAT48/Apr

60flatteners.Wecontinuetorecommend5s10sBTPflatteners.WemaintainconditionalBundASWwidenerandBundbrokencallfly.WecontinuetorecommendatacticallongOATinvoicespread,longJune23FRA/€STRpositions,short30yBTPvs.OAT,andkeepourshortdurationthroughtheEUR10y10ypayingtradeandthelongEUR5y5yinflationswap.Wealsocontinuetorecommendlong5yBoblASWvs.BUXLASW,shortSPGBOct2026vs.OBLOct2026.

IntheUK,weenterarecommendationtobuy5yinflationswaps.WekeepbuyingIL31,andcontinuetorecommendlongUKT0H61ASW,2s10sSONIAsteepeners,andrecSep'22SONIAMPCmeeting.WealsokeepUKT1Q51vs.UKT1F71.

InJapan,wechangeourreceiveTONA1y1yvs.pay10y10ytoreceiveTONA1y1yvs.10s20ssteepener(DV01neutral).WerecommendmaintaininglongJBU2outright,andJGB10s20ssteepeners(DV012:1),TONAOISreceive1y1yvs.pay10y10y,longJBI27BEI,TONA/SOFRbasis2s10s20sfly,long20yJGBASWvs.ESTRcompound,andZTIBOR-OIS5s20sflattener.

Indollarbloc,wemaintainshortBAZ2.WecontinuetofavorNZ1y5yOISflatteners.

Inforeignexchangemarkets,wemaintainshortAUD/CAD(target0.860,stop0.925).InFXoptions,wemaintainlong3mUSD/JPYseagulls(initiallypriced25-Apr-220.69%)andshortUSD/CADriskreversals(initiallypriced25-May-22).

10

InterestRateStrategy

UnitedStates

InthewakeoftheJuneFOMCmeeting,wesuggestedinvestorsconvert2s10sTreasurycurveflattenersinto1s10sflatteners.Why?AstheFedcontinuestomoveaheadwithaggressive,"expeditious"ratehikes,basedonavarietyofbackward-looking,laggingeconomicdata,wethinktheriskofapolicyerrorgrows.Themostegregiousbackward-lookingindicator–theUniversityofMichigan5to10yinflationexpectationsgauge–movesinlinewithwhatheadlineCPIinflationhascompoundedannuallyoverthepast5years.Despitethedownwardrevisionpost-FOMCmeeting,wesuspectitwillbeonlyabriefreprieve–keepingusshorttheFFJ3contract.

Asthethemeoffront-loadingratehikesinevitablycontinues,investorswillquestionincreasinglywhetherhikeswillleadtoaPowellpolicypivot.Already,themarketispricingincutsin2023–justoverayearafterratehikesbegan.Asthepricingofratecutsbuilds,itweighsonn-yearforward1yearrates(ny1y).Asa1-year(spot)rateisjusttheaverageofmarket-impliedovernightratesthroughouttheyear,sosimilarlyare2-year(spot)ratestheaverageofthe1-yearspotrateandthe1-yearforward1-year(1y1y)rate,andsoon.

Thishistoryofhikingcyclessuggestsameaningfulnegativecorrelationbuildsbetweenmonthlychangesin1yand1y1yrates,whichraisestheriskoflower2yyieldsrelativeto1yyieldsasthehikingcycleprogresses-especiallyiftheprogressionremainsexpeditious.Hence,weprefer1s10sflattenersover2s10s.

Euroarea

Thebearmarketrallyhasbeenstrongerthanexpectedthisweek.However,wecontinuetoforecast10yBundyieldstotradeinabroadtradingrangeoverthecomingweeks–perhaps1.40/1.75%beforetheresumptionofthebearmarket.WekeepourEUR10y10yswapandEUR5y5yinflationswapbearishtrades.WecloseourJulyECBmeetingtrade,whichisbackbelow30bp.

Ontheswapcurve,wewaitforafurthersteepeningoftheEUR10s30sswapcurveandsomedislocationversusourmodelbeforereenteringtacticalflattenerstoplaythe-10/-35bprange.WelookedatthebalancesheetofEurozoneMFIsandthechangeinEGBholdingsduringtheperiodofnegativereporates.Non-coreMFIssignificantlyreducedtheirshareofdomesticdebt.Historicalvolatilityremainstoohightoleadthemtoreturnintocarrytrades,inourview.

Onthecashside,weupdatedourmodelon30s50ssemi-coreslopes.TheOFR50yOATisverycheapandoffersvalueversus30yOAT;therefore,weinitiatea30s40sOATRVflatteners.Onperipherals,wethinktheshortcoveringisbehindusandthe10yBTP/Bundspreadfoundafloorinthe190/195bparea.WekeepourshortOFR5yBonovs.OBL,5s10sBTPflatteners,andshort30yBTPvs.OAT.

11

UnitedKingdom

Wehaveexperiencedasignificantrepricingofyieldslowerovertheweek,sothetypicalsummerrallyhasplayedoutintheUK.Thishastakenbothnominalandrealyieldslower,withthemostnotablemovebeinginmoneymarkets(a50bpreversalinreds).TheIL31auctionon28Julywillactasaliquidityeventforinvestorswhoshareourviewtobelongrealyields.

Front-endinflationforwardshaveexperiencedsignificantcheapeninginthisdurationrally;forexample,1y1yRPIhasfallenbyabout120bpoverthelastmonth.Weseethisasabuyingopportunity,andwerecommendbuying5yRPIswapsaswefindlonger-datedforwards(2y3y)toalsobecheap.

Japan

WeanswerfrequentlyaskedquestionsregardingmarketfunctionalityofJGBmarketintheeventofsignificantJGBpurchasesbyBoJinordertocontinuetodefendthecurrentYCCcap.WethinkthebiggestproblemfromaliquidityperspectiveistherecentdysfunctionalityofJGBfutures.AbreakdownofCTD-versus-futurescorrelationthatleavesthefuturesprice“untethered”mayultimatelyleavedealerswithlittlechoiceotherthantofollowquotedpricinginthebrokermarket.Thenetupshotisliabletobeanegativespiralinwhichwidebid-offerspreadsmakeitimpossibletopositioninsizeandtherebyreducemarketparticipa