Market Economics | Interest Rate Strategy - BNP PARIBAS ...

EUR: Bund ASW Risk/Reward Analysis
• We combine swap spreads’ single-factor
sensitivity into a scenario matrix.
• STRATEGY: Buy Bund 10Y ASW at 22bp,
target 35bp, based on risk/reward analysis.
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Chart 1: Impact of Fiscal Variables
Germany federal govt budget (EUR bn)
Bund 10Y swap spread (RHS)
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We aggregate the single drivers of Bund swap
spreads into a scenario matrix. The idea is to provide
scenario projections and thus minimum/maximum
boundaries for spreads. We can then derive a
strategy based on risk/reward arguments.
We look at the following factors:
• Fiscal variables (German budget);
• ECB expectations (Eonia forwards);
• Yield curve (EUR 2/10s);
• Liquidity (OIS/Bor spreads);
• Credit variables (iTraxx and SovX); and
• Global variables (Tsy swap spread and Vix).
Estimating swap spread sensitivity is not a trivial
exercise, especially during the transition from a precrisis
to a crisis environment. Nonetheless, we report
the aggregate impact of two distinct scenarios (“risk
on” versus “risk off”) on the Bund swap spread in the
table below. Note how the risk/reward is tilted
towards a spread widening strategy.
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BNP
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Paribas 0.10
f
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1997 1999 2001 2003 2005 2007 2009 2011 2013 2015
Source: BNP Paribas
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Chart 2: Impact of Liquidity
OIS/BOR
Bund 10Y z-spread (RHS)
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Jan-07 Aug-07 Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11
Source: BNP Paribas
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Trade: Buy Bund 10Y ASW at 22bp, target 35bp.
Bund 10Y Swap Spread Scenario Analysis
Bund 10Y ASW 22
Protracted Risk Scenario Variable Current Level E2011 level Change Weight Impact on ASW
Government Budget (%) -3.5 -5 -2 0.125 7
Rate expectations (bp) 0.793 0.5 -0.3 0.125 16
EUR 2/10s yield curve (bp) 153 200 47 0.125 10
EUR OIS/BOR (bp) 34 50 16 0.125 38
VIX (% pts) 17 30 13 0.125 38
EUR iTraxx Master 10Y (bp) 120 150 30 0.125 44
SovX 5Y 190 250 60 0.125 45
US TSY 10Y ASW 7 30 23 0.125 36
Bund 10Y ASW projection 29
Risk Normalisation Scenario Current Level E2011 level Change Weight Impact on ASW
Government Budget (%) -3.5 -1.5 2 0.125 42
Rate expectations (bp) 0.793 1.1 0.307 0.125 28
EUR 2/10s yield curve (bp) 153 100 -53 0.125 35
EUR OIS/BOR (bp) 34 20 -14 0.125 8
VIX (% pts) 17 10 -7 0.125 13
EUR iTraxx Master 10Y (bp) 120 100 -20 0.125 6
SovX 5Y 190 150 -40 0.125 5
US TSY 10Y ASW 7 0 -7 0.125 18
Bund 10Y ASW projection 19
Alessandro Tentori 20 January 2011
Market Mover, Non-Objective Research Section
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www.GlobalMarkets.bnpparibas.com