Societe Generale, Goldman Sachs, Citigroup and other major banks advise to look at European assets next year.
Kit Juckes, a strategist at Societe Generale SA:
«As the post-financial crisis policy architecture — which boosted asset prices and anchored bond yields, credit spreads and volatility — is unwound, investors need to choose between holding on to carry, which may be all they have left, and finding a safe place to hide. Beware of sleeping volcanoes.»
Brexit seems to instill uncertainty but most analysts agree that the pound is likely to strengthen next year. That view is pegged to the thought that the Britain will be able to agree with the EU on the main issues of Brexit before the country leaves the bloc in March 2019.
Bank of America Merrill Lynch’s recommends buying pound versus a Swiss franc. ING Groep NV says the British currency will reach $1.40 next year.
#background The pound has grown almost 9% this year after weakening 16% in 2016 after the U.K. voted to leave the EU.
ING strategist Chris Turner:
"Sterling has suffered since the Brexit vote, but a lot of bad news is already in the price. An agreed deal will be the antidote to the pound’s uncertainty-driven weakness, triggering a positive re-appraisal of the U.K. economic outlook and a hawkish re-pricing of Bank of England policy expectations.«
- ING: Buying 4-month GBP/USD call spread (buy 4-month call with 1.3800 strike, sell 4-month call with strike 1.4100); cost 0.52% (spot reference 1.3472); maximum potential return 2.2%, cost-return ratio = 1:4.2.
- BofAML: Buying 6-month 1.40/1.45 GBP/CHF call spread; spot reference 1.31; cost of 21.915 GBP pips.
The euro is the best Group-of-10 performer of 2017. Goldman Sachs Group Inc., Morgan Stanley, Societe Generale SA and ING remain bullish as the European Central Bank (ECB) unwinds stimulus and the continent’s growth improves.
#background The euro has rallied 12% this year.
Goldman Sachs strategist Francesco Garzarelli:
«FX reserve managers have not started to cover their substantial euro underweight. Continued inflows into euro-area assets should support the euro, even as interest rates remain low.»
Societe Generale sees the currency benefiting from a potential increase in bond yields next year. Morgan Stanley believe it will strengthen versus the Swiss franc.
- Morgan Stanley entered position versus Swiss Franc at 1.16 with 1.28 target, at which point they’ll reassess the trade.
- ING has similar trade on with a target of 1.25, saying the pair could «easily push above 1.20» into the year-end. Entry level: Buy 50% of notional at EUR/CHF 1.1640, 50% of notional EUR/CHF at 1.1540. Target 1.2500; stop-loss 1.1370; target return 7.8%.
- SocGen forecasts EUR/USD at 1.25 and EUR/GBP at 0.97 by September 2018.
- Goldman Sachs targets EUR/JPY at 140 with stop at 130.
Short Italian government bonds
Banks worry that investors may grow complacent about EU’s political situation in Italy. Elections in the country are due before May, and the anti-establishment Five Star Movement is currently leading in some polls. Therefore, Credit Agricole SA, Citigroup Inc. and JPMorgan Chase & Co. are recommending bearish positions in Italian bonds.
Citigroup strategists Jamie Searle and Aman Bansal:
«We continue to believe it will be the Italian election that has the potential to generate more in terms of spread turbulence. We therefore enter 2018 with a bearish view on BTPs.»
- Credit Agricole recommends selling BTP 3.25% 09/2046 against SPGB 2.9% 10/2046 for a give-up of 20bps; target 40bps, stop-loss 10bps. Also, sell BTP 5.5% 09/2022 against BTP 3.75% 03/2021 and 4.75% 08/2023 wings at 18bps; target 30bps, stop-loss 11bps.
- JPMorgan proposes a short position in the 30y sector vs Spain and adds a short in 20y vs Portugal.
Short German long-term bonds
Banks expect that in 2018 bond yields will move higher. The removal of ECB’s quantitative easing program will stimulate the increase of German bonds’ profitability. JPMorgan recommends shorting Europe’s safest securities. Credit Suisse sees German 10-year bunds yields rising from 0.29% to 1%. Morgan Stanley and Credit Agricole recommend selling them and buying U.S. Treasuries.
Credit Suisse strategist Andrew Garthwaite:
«We particularly see upside risks to bund yields. We can see yields ending 2018 close to 1 percent given the strength of European growth, overly conservative ECB rate expectations, the end of QE in September 2018 and some signs that inflation is being underestimated.»
- JPMorgan suggests opening short EU100mn bund 08/2048 at 1.156%. 3m carry: −1.8bps and 3m slide: 0.3bp. Keep short EU100mn bund 08/2027 at 32.9bps. 3m carry: −3.5bps and 3m slide: −4bps. P&L since Oct. 13 inception: −11bps.
- Credit Agricole recommends tightener in 10y bunds vs Treasuries entering at 200.2bps, with a target of 175bps; originally placed on Nov. 1.
- Morgan Stanley has long 30-year Treasuries versus bunds as one of their top trades; enter at 163bps, target/reasess at 70bps.
Buy a sovereign debt of Portugal
S&P and Fitch Ratings upgraded Portugal sovereign debt rating to investment grade. Rabobank International, JPMorgan, and Credit Agricole remain bullish even after the country’s bonds notched up their eighth consecutive monthly gain in November.
Rabobank strategist Richard McGuire:
"There is an apparent sea change of sentiment in Portugal — Portugal looking to finally be regaining peripheral status as it escapes the gravitational pull of the bailout era. Portuguese bonds should outperform both Italian and Spanish peers."
- Credit Agricole recommends buying OT 3.875% 02/2030 versus BTP 3.5% 03/2030 for a 36bps yield pickup, target a move to 10bps; stop-loss 50bps
- Similarly, JPMorgan suggests opening long 20y versus Italy; EU25m OT 04/2037 vs short EU23.9m BTP 02/2037 at 43bps. 3m carry: 0.5bp and 3m slide: 0bp
Also published on Medium.