From Goldman's Fracnesco Garzarelli:
Trade Update: Closing our 2013 Top Trade recommendation to go Long 5-year Spanish Government Bonds, for a potential 5.5% total period return
We recommend closing long positions in 5-year Spanish bonds, one of our Top Trade recommendations for 2013. Since inception on 6 December, the position would have returned 5.5%.
On 6 December 2012, we recommended going long Spanish 5-year government bonds (SPGB 5 ½ 30-July-17 – the 5-year generic at the time), with an initial target of 3.50%. On January 11, the yield fell below 3.50% and we extended the target to 3.00%. Since inception, the 5-year Spain has rallied 111bp, from an initial yield of 4.29% to 3.18% currently (mid-market).
Our decision to close our trade recommendation now is motivated by the following two main reasons:
- First and foremost, we are very close to our (extended) 3% yield target. Our model calculations based on Spain’s current economic and fiscal consensus projections in relation to Germany’s indicate that 5-year bonds are fairly valued. From here, further scope for a decline in yields is down to a more material improvement specifically in the domestic growth outlook. This remains very possible given the negative skew in the distribution of GDP forecasts, in our view. But it has not yet been reflected in analysts’ forecast revision dynamics.
- Second, Spain has outperformed Italy since the start of the year, and bonds have held up remarkably well in the face of political uncertainty in the latter. This is a testament to the divergence in relative positioning between the two markets – one of the factors underpinning our preference for Spain. In the coming two weeks, negotiations towards the formation of a new government in Italy will intensify. Although our baseline case remains positive, the market is locally vulnerable to headline risks.
Along with a view that Treasury yields would increase towards 2.25%-2.50%, reflecting an improving economic outlook and a relaxation of the Euro area risk premium, a convergence in intra-EMU government bond yield spreads represents one of our top conviction calls in the macro rates space for 2013. We continue to believe in both market dynamics, and will continue to explore and recommend ways of capitalising on them.