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Covered Bonds

Covered bond spreads to stabilize and yield curve to steepen

Maureen Schuller

Maureen Schuller

ING

The higher than expected US nonfarm payroll numbers pushed underlying yield levels up further in mid-January 2025, with 10yr swap rates approaching the 2.6% seen last at the end of July 2024. Also, at the front end of the curve swap rates have been trending 40bp higher since November, albeit not as much as in the longer end (+50bp in the 10yr area).

Our rates strategists look for more EUR yield curve steepening, with yields at the front end of the curve held back by the anticipated ECB rate cuts, while the evolution of inflation and term risk premia will impact the longer end in opposite direction.
In our view, this development is set to keep a steady interest for covered bonds in the shorter maturity buckets, where the relative value metrics of covered bonds versus Govies and SSAs, and versus preferred senior, also remain more appealing. The recent rise in shorter maturity yield levels may even support some renewed investor appetite for the front end of the curve ahead of the further ECB rate cuts.

At the same time, we note that the combination of yield curve normalization and asset swap curve steepening does make shorter maturity instruments look progressively less interesting from both an asset swap spread and yield level perspectives. Besides, at higher yield levels in the longer end investors may also increasingly feel satisfied settling with a bit less asset swap spread compensation in the longer end of the curve. We expect the longer end to become particularly more enticing again to investors once the ECB is done cutting interest rates, as this will halt the rate cut pull effect on shorter maturity yield levels. Our economists expect the ECB deposit rate to land at 1.75% in June 2025 and stay stable afterwards. Hence, we do look for some asset swap spread curve reflattening in covered bonds this year, but mainly so in 2H25.

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