Buy Norway 10y ASW Wideners @ 28 bp Stop: 20 bp Target: 60 bp
In the possible event of a rise in the pricing of a Le Pen 'win', as well as possibility of broader peripheral European risks materializing, it could be worth looking at the potential for safe-haven demand in Scandie bonds -specifically, looking at Norway. Norway's firm public debt position at historical lows of 31% of GDP, (better than Sweden's 43.4%) and budget deficit of 6.4% of GDP, and its partially uncoordinated business cycle to the EU, could be reason as to why there should be some natural allocation of a European FI portfolio to Scandies in general.
A stylized look at foreign holdings of SGB's vs peripheral-core spread (BTP-bund below) in 2011, there was a sustained surge higher in demand - which could suggest a safe haven bid characteristic.
One could expect Norway to have less liquid money markets than Sweden and Germany, and in potential scenarios of broader European peripheral risk-off, we could see higher short-end rates, passing through to the swap rates. Ideally, would be to target something like the 5y segment to have exposure to this, but using 2011 crisis as a guide, we can see that widening Norway ASW still occured in longer-end maturities such as the 10y.
NOK 10y ASW vs SEK 10y ASW
We can see that current tights of 28 bps in the Norway 10y ASW has attractive potential to widen. Although Riksbank QE can be assumed to be the main driver of a 24 bps wider equivalent 10y ASW in Sweden, it is worth noting perhaps from an RV perspective that historically, Norway 10y ASW has almost always traded wider than the Sweden 10y ASW - this perhaps can be understood from the fact that Swedish money markets are more liquid than Norway. Aside from the RV proposition, the (obviously) superior yield premium of 10y NGB over 10y SGB of over 100 bps could prove Norwegian bonds more attractive than Swedish bonds in the event of a potential safe-haven bid.
The trade of course is dependent on repo-rates data which I have no access to. With 6m OIBOR currently at 121 bps and the swap spread at 28 bps, as long as repo is < 93 bps, trade should carry +ve.
Rates RV players I speak with have been looking at ways to play a steepening of the NOK curve, particularly for long end to sell off vs belly. A curious peek as to see if you can have the curve steepening bias whilst having the 'ASW' component, we look at the NOK 7y vs NGB 5y. Directional dislocation is not present, with the only recent one in memory being in Q3 '15.
NOK 7y vs NGB 5y
as a curve it does still look attractive to 'steepen' further, just whether its late to enter after its 50 bps tights is the question.. In addition belly in NGBs have been relatively more bid than 10y (lagging) which was the reason why I suggested the 10y ASW purely on better 'value' - and not to mention more carry buffer for repo etc.
With the year playing out to be relatively benign so far, (VIX at 11 and all..), I've only been short EURMXN FX into the year open, to play a tactical reversal in extreme sentiment, and 'bad news is priced in' and that's literally been it so far. It is ironic af that position was covered a few days before Banxico hiked 50 bps and spot tanked another 1.00%... (idiot). That aside..
Sweden has taken many a fancy,with attractive roll for rates players in flatteners, but a more elusive one as a Nordic 'RV' trade, with it being punitive to short SEK rates outright and pay NOK (of course boxing steepener / flattener in forward space has a few possibilities, but being that granular with trade structuring is still unfortunately beyond my grasp). However, when we look at the FX, it's not as bad, and it's a good rates proxy.
Below is a chart of the NOK 5y - SEK 5y which is currently near a 10y extreme in wides. I find it quite difficult to see NOK to be paid that much further..
Norwegian inflation is peaking, with underlying inflation now at 2.10%, below Norges Bank’s target of 2.50%. Swedish underlying inflation in clear upward trajectory to hit 2.00% Riksbank target.
Economic divergence story accentuated below with PMI’s in Sweden rocketing to highs above 60 and Norway’s subdued around only in very slightly expansionary territory. Gap in 2010 in PMI spreads led a 9.00% move lower in spot. Speaking with some seniors, global policy leadership is perhaps still the prevailing reality, so it could be the case that Riksbank waits for ECB, which may mean that if the Riksbank wants to tighten, it wouldn’t mind some SEK appreciation as tightening before actually hiking rates. Although as discussed below, a trade structure I am interested in doesn't go out as long as year-end, I can envision a reasonably higher than a coin-flip probability of policy rate convergence between Riks and Norges, with only 100 bps between them at the moment (although I may be pushing it in this currently still 'zero-rate world').
Oil futures positioning is heading to an extreme on the long-side, with CL futures curve looking to head into backwardation territory. Could see oil-related NOK gains capped, if you look to be a contrarian in the oil story. Fwiw, NOKSEK and Oil correl over 10y is an inconsequential R^2 of 0.12, which gives me comfort that me trading the pair isn't just an oil punt sugarcoated with all these charts. If it gives any bearing, previous major bottom in Oil Post'08 did not translate to a surge higher in NOKSEK, so if Oil does properly rip, doesn't necessarily mean we see NOKSEK rip higher as well.
So how to structure the trade? It's too late to short spot after the 1.1000 test, so look over in options side show that vol term structure relatively flat across 3m-5m. Selling a 3m Parity One-Touch to Buy a 5m same-strike, costs 14% (6:1 risk reward).
One could be a lot simpler and be very aggressive with just a parity one touch, but achieving same risk reward comes at cost of having to play it in the 3m. That seems a bit too tight a time horizon for a proper chance at 1.000 ,but perhaps that's one for some players with some back-book cash to allocate to the yearly quota of random punts, with implieds cheapening quite a bit over a year...
Mostly a place where I write down my macro/RV ideas. Feedback more than welcome.