This Is One Rally You Probably Shouldn’t Fade (And I’m Not Talking About Stocks)

Last week was all about the Schatz rally.

Indeed record low 2-year German yields present something of a paradox for markets as traders and investors struggle to reconcile a voracious bid for one of the world’s safe-haven assets par excellence with buoyant risk (i.e. record stocks), suppressed vol, and tight credit spreads both in the US and Europe.

With stocks disconnected…

… and credit asleep as iTraxx Main trades inside of swap spreads for the first time since 2008…

… here’s a rundown of the Street’s take on what is surely to be a hot topic going forward even if French election risk recedes.

Via Bloomberg

Schatz rally being driven by increased ECB QE purchases, demand from other central banks as a result of currency intervention, haven buying and re-denomination risk, strategists say.

• JPMorgan doesn’t want to fade bund rally but adds 10s30s steepener, Deutsche Bank closes long OAT vs BTP/Bund, now recommends short 3y OAT as cheap election hedge

• Deutsche Bank (strategists including Francis Yared)
  • French spreads to Germany are impacted not only by French specific risk, but also by German richness, especially in the front-end; more recent spread widening is likely to reflect re-denomination risk, with market pricing around 3-6% chance
    • Outperformance of Germany also due to conservative investors reducing exposure to France, moving into Germany, particularly as Germany is perceived to be a hedge against re-denomination risk
  • Increased pace of intervention by the SNB and with the Czech national bank stating that it will be removing its floor around mid-17, attracts inflows; likely that intervention will favor the front-end of Germany
  • In terms of trades, exit Bund ASW tightener as it reached stop level, close long France vs Italy and Germany; close EUR 1y1y/3y1y steepener, as repricing required unlikely to happen with French election risk
    • Rotate short Italy 10Y into the 5Y sector and add a short France 3Y, to benefit in a convex way from an acceleration of the stresses in France and the pricing of further re-denomination risk