Greece again at the forefront

Both core and non-core sovereign markets further sold off in late May / beginning June, while sovereign curves steepened. Since the low reached in April, the 10-year German yield increased by 91 bps up to 0.98%. The 10-year Italian yield increased 123 bps up to 2.36%. The reasons were multiple: squaring back of “Quantitative Easing” consensus trades, improving inflation data and the uncertainty surrounding Greek negotiations.

Indeed, the EMU debt markets have suffered from contagion from the Greek crisis, as another round of negotiations between Greek government and its creditors collapsed. A sizable repayment to the IMF in late June and another one to the ECB in July must be made to avoid default. As a result, we keep a close eye on the evolution of the talks. Unfortunately, we believe that a temporary agreement should be reached to buy more time but should not adress the structural issues of the country. In this environment, the volatility should stay high in the coming weeks.

Neutral on non-core debts / Negative on core

Thus, we further reduced our non core EMU debt exposure, as Greek event risk and risk aversion have spread. The lower underlying liquidity on futures markets combined with the very long investors’ positioning on non-core EMU sovereign debts could amplify the spread widening. We further moved positive on Spain relative to Italy. Spanish debt underperformed the Italian one during the sell-off while the macroeconomic developments are improving quicker for Spain. The recovery is still gaining momentum with Spanish PMI Manufacturing standing at 55.8 (Chart 2). The macro figures continued to improve in Spain while the growth is hovering in Italy. Italy remains also penalised by its significant debt burden.

In the euro zone overall, the macro situation continues to improve with PMI Composite on an upward trend (53.6 versus 53.4 a month earlier) and unemployment rate on a downward trend (11% versus 11.3% a month earlier). On the inflation side, the data continues to surprise to the upside with CPI figures at 0.3% (YoY) versus 0% earlier and 0.2% expected by the consensus. In this context, there is room for further rise in real and nominal rates to leave the expensive territory from a fair value perspective.

Short on US Treasuries

After a difficult Q1 penalised by bad weather conditions, some market participants thought the FED could further delay its first rate hike. However, the US economy has recently firmed with better labour data (Non-Farm Payrolls figures came at 295K well above consensus at – Chart 3) and inflation data. They indicate that the FED should be more comfortable to enter a hiking cycle in Q3 albeit at a prudent pace to avoid any sustainable disinflation. As a result, we prefer to adopt a negative positioning on US Treasuries on the 10-year part of the curve.