Euro Area Rates Strategy: Tail Risk Is Fading: What Next?

Research evidence excerpt

Euro Area Rates Strategy: Tail Risk Is Fading: What Next?

IdeaM

Interest Rate Strategy

Euro area | Tail risk is fading: What next?

Luca Salford

MORGAN STANLEY & CO. INTERNATIONAL PLC

Luca.Salford@morganstanley.com +44 20 7677-1337

Maria Chiara Russo

+44 20 7677-3499

Maria.Chiara.Russo@morganstanley.com

Exhibit 1: Summary of our views and trades

Preferred trades

Duration Curve RV Derivatives EGB spreads SSA

Short FRTR 2/31 vs 2/29 and

Long TKYH8 ERZ6Z7 flattener 2y2y €STR/6s widener Long Ireland vs Belgium

5/33

Buy EU6C 98.1875-98.75 call

Enter long BTP G 10/31 vs

spread vs EU6P 97.9375-97.6875 Short Austria vs Netherlands

OBL 4/31

put spread

Source: Morgan Stanley Research

Our view is unchanged following the ECB meeting: we still recommend longs in TKYH8

and ERZ6Z7 flatteners as there is a wide gap between our baseline and scenario-weighted

projections for short-term rates and current market valuations ( Exhibit 2 ).

Exhibit 2: There is a wide gap between our baseline and There are three drivers of the short end that we have been paying

scenario-weighted projections for short-term rates and current attention to: 1) obviously, developments in the Middle East, given the

market valuations strong relationship between energy and rates since the onset of the

conflict, 2) US macro developments, with the swing from expected

%

easing to expected tightening impacting, at least locally, euro rates

3.0

markets, and 3) central bank commentary.

2.6 On the latter, we believe once more that ECB President Lagarde

navigated the complexity of the Middle East conflict relatively well. In

2.2 our view, the presentation of the scenarios by default framed the

discussion in a hawkish direction as the ECB picked 25%, 50%, 75%,

1.8 and 95% percentile distribution for energy prices, and used a