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

US: Treasury Curve and Fly Opportunities
• Last week’s non-farm payroll data halted the
sell-off of rates which started from the
beginning of this year. Since then, Treasuries
have rallied led by the 5y.
• PCA on the Treasury curve shows that the
2y and 3y points look rich while the 10y looks
cheap.
• STRATEGY: Scale into 5s10s Tsy flatteners.
Also consider buying the belly in 3s10s30s and
selling the belly in 2s3s5s.
Table 1: QE2 Fed Purchases vs Tsy Issuance
Maturity
Expected Fed
Purchases
During QE2
Gross Supply
During QE2
Issuance Net of
Fed Buying
1.5 - 2.5y 45 280 235
2.5 - 4y 180 256 76
4 - 5.5y 180 280 100
5.5 - 7y 207 232 25
7 - 10y 207 176 -31
10 - 17y 18 0 -18
17 - 30y 36 112 76
Source: BNP Paribas
Chart 1: 5s10s Tsy Curve
Non-farm payrolls applies brakes on optimism
Last week’s article “The Macro Picture and
Delta/Curve Bets” had cautioned against the
ubiquitous optimism in the market as economic data,
such as both the ISMs and ADP, led the sell-off in
rates.
The disappointing payrolls report brought a bid back
to the market and, since then, the 2y Treasury has
richened by 6bp, 5y by 11bp and 10y by 5bp while
the 30y is flat. This caused 5s10s to re-steepen and
we took the opportunity on Wednesday to start
scaling into a flattener at 138.5bp. We briefly explain
why we like this as a core strategic position and also
why the timing could be favourable now. Also, there
is value in butterfly positions that fit with the results
from PCA and also look to be at historically extreme
levels.
5s10s Tsy flattener
5s10s reached its all-time highs of 150bp around the
time of the QE2 announcement in November last
year. One of the main reasons for this was that the
market was assuming Fed purchases would be
centred on the 5y area, allowing this sector to lead
the rally into November. However, the actual QE2
details revealed that the 7-10y sector will probably
get the largest Fed support, relative to how much
supply will be coming in that sector (Table 1).
However, since November, 5s and 10s have moved
almost in tandem with one or the other leading the
sell-off, keeping the curve at steep levels. We initially
put on a flattener right after the QE2 announcement,
successfully, and now like re-entering the position
given 5s10s looks to have moved back to the top of
its short-term falling channel (Chart 1).
160
150
140
130
120
110
100
Nov-09 Feb-10 May-10 Aug-10 Dec-10
Source: BNP Paribas
3
2
1
0
-1
-2
-3
5s10s Tsy Curve
Chart 2: 1- and 2-Factor PCA Z-Scores
Adjusting for Level of Rates
Adjusting for Level of Rates and Curve
2Y 3Y 5Y 10Y 30Y
Source: BNP Paribas, PCA on last 1 year of data
One reason to like the timing of the trade here is that
Principal Component Analysis (PCA) on the constant
Rohit K Garg / Suvrat Prakash 13 January 2011
Market Mover, Non-Objective Research Section
28
www.GlobalMarkets.bnpparibas.com