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

EUR: Colour On the Cross-Ccy Basis
• In addition to the usual variables (global risk
and local liquidity), a third variable – EUR
sovereign risk premium – has entered the crossccy
equation.
• STRATEGY: Consider locking in wide levels
in EUR/GBP cross-ccy basis.
0.6
0.4
0.2
0.0
-0.2
-0.4
-0.6
-0.8
Chart 1: Global Liquidity Still Ample
Global liquidity
USD 10Y swap spread (RHS)
Tight liquidity conditions
1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
150
100
50
0
-50
Cross-ccy basis in EUR ended the year wider by
about 15bp in the 5y sector, with impressive volatility
in Q4 (range: -17/-37bp). The market has been
characterised by ample global liquidity, which has
helped global risky assets to perform (Chart 1). This
situation is quite different from late 2008 and early
2009, when USD illiquidity was pushing systemic risk
higher and making it hard to fund USD investments
externally.
We have also observed protracted periods of strong
decoupling between EUR cross-ccy basis and its two
theoretical drivers (global liquidity and local liquidity,
see previous research). This decoupling was most
evident in April-May and September-October (Chart
2). In both periods, the precipitous rise in EUR
sovereign risk premia added to the relative quality of
USD-denominated assets (safe haven), thus
widening the cross-ccy basis.
The situation is even more complex within Europe,
where EUR/GBP basis exploded in Q4 (2y +20bp).
Again, EUR sovereign risk is the main driver,
reflecting the difficulty of Irish financial institutions in
funding their GBP-denominated liabilities through the
sterling interbank market, while still being able to
access EUR liquidity via ECB operations. The
specificity of the intra-European liquidity flows is also
evident in Chart 3. We can see here how cable
cross-ccy has normalised in line with global themes
(S&P 500 as proxy), while EUR/GBP bases have
drifted to theoretically unsustainable levels due to
significant liquidity differentials.
Arbitrage arguments and seasonal issuance patterns
need to be considered in the context of ongoing high
sovereign risk premia (e.g. accumulation of risk
factors at the start of Q2 with a peak in Spanish
redemptions). However, current EUR/GBP basis
levels look attractive both for strong names that can
issue in the GBP market, as well as for those carry
players who hold GBP-denominated debt and intend
to swap back their risk into EUR, thus locking in the
impact of cross-ccy on the ASW.
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0
-10
-20
-30
-40
-50
-60
-70
EUR 5Y ccy basis
S&P500
Aug-07 Jan-08 Jun-08 Nov-08 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10
Source: BNP Paribas
Chart 2: Sovereign Risk Affecting EUR Basis
0
-10
-20
-30
-40
-50
-60
Lehman crisis
EUR 5Y cross-ccy
ECB SMP
1st EUR govie crisis
-70
2008 2009 2010 2011
Source: BNP Paribas
1700
1500
1300
1100
900
700
500
Irish crisis
Chart 3: GBP Cross-Ccy Outperforming
20
0
1650
1450
-20
1250
-40
-60
-80
GBP 2Y cross-ccy
S&P500 (RHS)
1050
850
-100
650
Jan-07 Aug-07 Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11
60
40
20
0
-20
GBP/EUR 2Y cross-ccy
GBP/EUR 5Y cross-ccy
GBP/EUR 10Y cross-ccy
-40
2007 2008 2009 2010 2011
Source: BNP Paribas
Alessandro Tentori 13 January 2011
Market Mover, Non-Objective Research Section
32
www.GlobalMarkets.bnpparibas.com