Merrill Lynch Investment Managers will make an off-index bet on the European corporate market once the yield curve flattens later this year. Currently, the steep European corporate yield curve favors trades in the swaps market, says London-based portfolio manager, Nick Gartside. The specific credits the firm will add to its E500 million European government bond portfolio have yet to be determined, but it will likely select lower-rated defensive names in the retail and utilities sector. In addition, depending on the relative value of zloty- and forint-denominated bonds, Gartside may tap into the Polish and Hungarian bond markets for some excess returns. Gartside would make these trades on purely an opportunistic basis.
For the time being, the portfolio is neutral its bogey the J.P. Morgan Euro-traded index, which is roughly 82% euro-denominated debt and 13% sterling-denominated debt. Gartside notes the portfolio is slightly long duration in euros--he prefers long-dated paper--and short gilts. He says that low inflation, along with pension funds' and insurance companies' willingness to buy all the supply on the long-end of the duration curve, should support 30-year paper in the core markets of Germany, the Netherlands and France. Merrill is short duration on gilts because they now trade about 65 basis points inside bunds, a situation which is unlikely to change unless the U.K. decides to join the single currency.
Gartside is also maintaining a position in Spanish debt, which has tightened to almost the same levels as bunds since the sovereign was upgraded last month. Gartside predicts that spreads on these bonds and in the swaps market should stay 2tight through out the first quarter, after which time he will look for an opportunity to take profits.
