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

this. Mutual Funds inflows have been growing
steadily for the better part of 2010, but experienced a
big drop-off in growth in December. On a positive
note, retail investors are buying ETFs again in
January, even if not at a brisk pace. While Mutual
Funds data are not available until the end of the
month, we’re seeing a decent amount of buying from
real money accounts even as breakevens are at precrisis
levels and near post-2009 highs.
Anecdotal evidence suggests that the dealers are
short TIPS and will look to cover at the auction.
However, primary dealer positioning is somewhat at
odds with this notion and shows that dealers are net
long USD 2.3bn of TIPS (still a relatively light
positioning). Chart 4 actually suggests that dealers
should have somewhat lower inventory given how far
the BEs have come. However, we acknowledge that
dealer position report is not duration neutral and thus
the overall picture could be distorted somewhat (for
instance, 5s10s RY steepener would show up as a
net long position).
On balance, we could still see a stop short (strong
auction) depending on concession, as traders should
take advantage of this liquidity window to cover their
potential shorts while real money accounts buy to get
ahead of January index extension and coupon
reinvestment.
Real yields look good, but BEs stretched
As a result of the recent selloff in rates, 10y TIPS
yield is 55bp higher than it was at the last auction,
even though 10y breakeven is almost 30bp wider
(Chart 5). We like to receive real yields at these
levels and we think that the 10y point is likely to lead
the way in a rally, so a 5s10s RY flattener is also
attractive (Chart 6).
Chart 4: Dealer Inventory vs 10y BE
$bn Primary Delaer Net TIPS Position ($bn)
6
10y TIPS BE (%, Inverted RHS)
5
4
3
2
1
0
-1
Source: BNP Paribas
Chart 5: Jul20 TIPS RY vs BE
TIIJUL20 Real
TIIJUL20 Breakeven RHS
140
120
100
80
60
40
20
15-Jul 15-Oct 15-Jan
Source: BNP Paribas
130
120
110
100
90
80
70
Chart 6: 5y/10y RY Spread at 1y Highs
TIIJAN15 / TIIJAN20 Real
1.00
%
1.20
1.40
1.60
1.80
2.00
2.20
2.40
2.60
240
230
220
210
200
190
180
170
160
150
140
On the other hand, TIPS breakevens, especially in
10y+ maturities have recovered to a point where
they’re trading around average 2006-07 pre-crisis
levels (Chart 7) and near post-2009 highs. Thus, we
see little value in 10y BE, especially in light of our
CPI forecast in H2. Unlike an outright long TIPS
position, BEs also carry slightly negative at the
moment. Against this backdrop, expectation of some
concession into supply (at least breakeven-wise),
and with commodities / USD back to support/
resistance, we still like 5s10s BE flatteners and short
5s10s20s fly.
In the meantime, as an asset class, TIPS typically do
well in H1 as seasonals improve and net TIPS supply
situation is favorable. The TIPS market should also
benefit from coupon payment mid-Jan which could
favor the 9/10y area since 1y+ TIPS duration is 7.7.
60
50
1-Jan 3-Apr 4-Jul 4-Oct 4-Jan
Source: BNP Paribas
Chart 7: TIPS BEs vs Highs
70
63
BPs Below Post-2009 High
60
BPs Below 2006-07 Avg
50
42
40
30
20
10
11
7
9
6 6
3
3
0
0
6
0
2y BE 3y BE 5y BE 7y BE 10y BE 20y BE 30y BE
Source: BNP Paribas
Sergey Bondarchuk 13 January 2011
Market Mover, Non-Objective Research Section
48
www.GlobalMarkets.bnpparibas.com