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

GBP: Tap of Gilt 4.25% 2036
• This year, the tapping of the nominal long
end of the Gilt curve begins next week with the
auction of Gilt 4.25% 2036.
• STRATEGY: We expect healthy appetite
from investors on the back of RV and demand
factors.
4.8
4.6
4.4
4.2
Chart 1: Evolution of 30y Yield
4.0
The tapping of the nominal long end this year begins
next week. On Thursday, the DMO will re-open Gilt
4.25% 2036 for GBP 2.25bn, thereby taking the total
amount issued to GBP 22.48bn. The free float
(amount outstanding net of BoE and DMO holdings)
will increase to around GBP 15.1bn.
The bond was launched in early 2003 and has been
re-opened five times since. The average b/c is 1.62.
The bond trades on the cheap side in our view, with
the yield currently hovering around 4.44%. This is
some 14bp above the average for 2009-now (Chart
1). In asset swap space, it is around 6M Libor
+ 27bp. Value has also been detected by our
parametric model of the Gilt curve (Chart 2).
In terms of strategy, we like overweighting the 30y
sector relative to the 10y sector as a medium-term
position. Chart 3 (upper panel) explains the rationale.
The long end of the Gilt flattens in an environment of
rising rates and vice versa. The relationship only
broke down in 2009 due to the distortions produced
by the BoE’s asset purchase programme. As shown
by the lower panel, the relationship has gradually
resumed since early 2010.
While our economists call for one rate hike by the
end of August at the latest, CPI and RPI data for
December to be released next Tuesday could trigger
another wave of sell-off at the front end. In the
meantime, September Short£ contracts at 98.67
imply two rate hikes assuming stable OIS/Bor while
Sep MPC hovers around 88bp. In fact, if spreads
compress going forward – as the early SLS
repayment profile would suggest – further (expected)
tightening is required to put fair value around current
valuation.
In terms of demand, note that the PPF 7800
aggregated index surplus was GBP 20bn at the end
of December while seasonality also supports LDI
activity from pension funds at the start of the year.
Supply is often the trigger.
Overall, we expect next week’s auction to meet good
demand.
3.8
Fitted 30y yield
Gilt 4.25% 2036
3.6
Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11
Source: BNP Paribas
Chart 2: Residuals from Fair Value Gilt Curve
Model
8.0
6.0
4.0
2.0
0.0
-2.0
-4.0
-6.0
-8.0
-10.0
Series1
Series3
1y 1y 3y 4y 5y 7y 9y 10y 14y 18y 21y 25y 29y 32y 39y 49y
Source: BNP Paribas
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
Chart 3: Gilt 10s30s vs Front End
Gilt 10s30s
1y1y (RHS, INV)
-2.0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
1.2
1.1
1.0
0.9
0.8
0.7
0.6
0.5
0.4
2.6
Jan-10 Apr-10 Jul-10 Oct-10 Jan-11
Source: BNP Paribas
Gilt 10s30s
1y1y (RHS, INV)
1
2
3
4
5
6
7
8
1.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
Matteo Regesta 13 January 2011
Market Mover, Non-Objective Research Section
40
www.GlobalMarkets.bnpparibas.com