Not conductive environment for outright shorts in the European bond markets – RBC CM

Research Team at RBC Capital Markets, suggests that the environment does not appear conducive to outright shorts in the European bond markets.

Key Quotes                               

“It remains unclear how large a hit the European economies will be taking following the Brexit vote – and that uncertainty is likely to linger. Furthermore, both the BoE and the ECB are likely to deliver some changes, even though, for the time being, they remain elusive. We have been pointing out that at current levels we had recovered a good part of the post Brexit yield drop already and at around 0% in 10y Bund yields, the air appears to be getting thinner.

Also peripheral yields have been reaching all-time lows again and have bounced. That being said, we would rather look for opportunities to enter the market on the long side than try to trade from the short side at these levels.

Our preferred position, however, remains shorts in implied vols through straddle and strangle positions on, say, the Bund future which should capture the current trading range quite nicely over the summer period. At present, selling Sep16 Bund future straddles (expiry before the  Sep ECB meeting) still yields a premium income of around 220 ticks which translates roughly into 15bp, ie a 30bp trading range around current levels. Before those positions lose money, the 10y Bund benchmark yield would have to either break back into the trading range in place before Brexit or print new lows.

And while it certainly is possible for the ECB to make a move on Thursday that would yield another leg in the rally, we think the risks for Bund yields from ECB action are slightly to the upside, but also reckon that even a small sell-off would quickly be bought again.

We think there is a very good chance for those positions to end up in the money and think that this is a good way of approaching a summer of low but stable yields.”