Keep calm and carry on

- Overview: "We are oozing with bond bullishness. Nothing has changed. The cycle is playing out exactly as we expected. If (a big if) it continues to do so, we have high confidence that 10-yr bunds will be the first non-Japan major to have a 1.xx% handle in a very few weeks. Leg one of the rally is done with shorts exited. If data continues to be weaker than the strangely buoyant consensus predicts, watch out for leg two: longs established & equity->FI reallocation, making for violent yield lurches lower. If this plays out, we can easy see 10-yr bunds as the first non-Japan major market to have a 1.xx% handle in a very few weeks."
- Euro Area: "Deteriorating US lead indicators can take us through our longheld 2¼% 10y Bund target. Ignore German strength and trade a test of 2.0%. The curve mechanics to get to this level on a recession are not that challenging given that the liquidity trap becomes more embedded."
- UK: "There’s a new target for the rolling flattening of the curve; 5s10s. On a variety of measures 5s10s looks too steep, and should flatten in around 40bp from here as the lower for longer themes meet the duration grab."
- Scandinavia: "the Swedish recovery is steaming on at this point in time and this will probably be reflected in another set of strong confidence figures from Swedish households and corporates."
- Inflation-Linked: "The question of whether we are heading toward a Japanese liquidity trap or just back to a 2004-5 style European slump is a crucial decision for the economy bears. We suggest a strategy of longs in inflation hedged with longs in real yields (overweighting linkers in a breakeven trade). Italy now looks rich against France on breakeven and we think that a cheapening into supply makes a sensible play."
- Volatility: "The bullish flattening 2y forward 10s30s is our proposed trade to benefit from expected flattening of GBP curve. We expect this trade pays off well if the BOE initiate the second round of QE and follow the tradition of buying Gilts all through the curve."

RBS European Rates Weekly 20100820

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