Overview

2021 will start with lingering drags on growth from selective COVID-19 restrictions but we expect to see a solid rebound from 2Q21 onwards, with strong support from monetary and targeted fiscal policy. The growth profile should have upside risk from less confrontational trade policy, and with a Brexit skinny deal on the horizon, but the recovery will remain incomplete with damaged balance sheets and large slack in the labour markets, largely removing inflation pressure. Clarity on vaccine rollout should support a gradual move higher in long end yields with steeper curves, but with muted volatility as central banks will likely keep large monetary policy accommodation. Thematic trades will remain intra-EMU tighteners and short vol. Risks to our rate outlook appear balanced. 2021 Outlook survey on DM CBs: additional, but only selective, easing will be delivered

Euro

10Y Bund yields to range trade in early 2021 and drift gradually higher to around -30bp by the end of 2021. We have a 2s/10s and 10s/30s steepening bias and prefer 2s/5s or 2s/10s steepeners as convex short duration proxies. Bullish bias on 1Yx1Y HICP. In intra-EMU, we expect search-for-yield dynamics to continue into 2021 under game changer ECB PEPP and EU Recovery Fund safety nets. We hold long 10Y Spain vs. France and will be looking to add OW Italy exposure in coming weeks. Intra-EMU credit curves to continue flattening and hold 10s/30s Italy-Germany flattener. Country preference: Italy and Spain favorites for strategic OW in the periphery, OW Ireland in core, especially vs. France and Cyprus still attractive on excessive liquidity premia. We recommend 3Yx1Y/15Yx5Y swap curve steepener as a positive carry bearish duration proxy. Recommend selling unhedged Bund straddles. Hold tactical Bund swap spread widening bias into 2020 year-end but keep a modest medium-term narrowing bias on negative directionality to higher yields and tighter intra-EMU spreads. Flattening bias in 2s/10s and 10s/30s swap spread curve. Favour receiving greens FRA/OIS as carry trade vs. paying post 15Y forwards. In volatility, stay short 6Mx(2Yx1Y) and 3Mx(10Yx10Y) midcurve gamma with infrequent delta-hedging

UK

The recent positive vaccine news puts upside risks around both the timing and magnitude of the expected 2021 growth rebound. However, the BoE will remain cautious. We target 10Y gilt yields at 45bp in 2Q21 and 65bp in 4Q21. Trading themes: 1) tactically trading ranges in 10Y yields (30-40bp) over 1Q21 with a modest bearish bias over 2H21, 2) 10s/30s gilt curve flattening bias, 3) range-trade 10Y swap spreads, 4) hold 10Yx5Y/15Yx15Y RPI curve steepeners, and 5) stay short 6Mx30Ygamma