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

with the big redemption (EUR 17.7bn) not taking
place until 30 July.
The escalation of the contagion effects and the more
systemic nature of the risk under current
circumstances can also be seen with a PCA analysis
on 10y spreads. The second principal component
(PC) can be seen as a proxy for the credit slope
among different sovereigns in analogy with a PCA on
the term structure where the second PC accounts for
the slope of the curve. Chart 3 shows the factor
loadings with respect to the second PC for each 10y
spread. If we look at the RHS of the chart where
Irish, Spanish, Portuguese & Greek spreads lie and
compare the loadings today with their values on 18
March, it can be seen that this curve has flattened,
implying that Greece has become less of an outlier
as Portugal, Spain and Ireland to a lesser extent
have become more sensitive to the second PC too.
This escalation of contagion effects to other countries
could work only as an accelerator with respect to EU
decisions and prompt actions on Greece. The Greek
MinFin has admitted that there are no funds available
for the 19 May redemption, while several EU
countries’ parliaments have yet to vote for the Greek
aid package. While part of the recent peripherals selloff
is based on doubts about the unanimity of the
participation in the aid mechanism and the German
constitutional court, these will eventually finish after
19 May. On these grounds, we still think that a
massive re-steepening of the Greek ASW curve is
imminent under the umbrella of the EUR 110bn
package. Of course once the aid mechanism
implementation doubts are out of the way, the only
concern will be the actual implementation of the
Greek fiscal plan and whether or not this will be
socially acceptable, with the quarterly reports of
progress being key events in the second half of the
year.
Top Trade Ideas
The latest escalation in contagion has resulted in a
pronounced flattening of peripheral ASW curves.
Chart 4 shows the 2/5s slope in Ireland, Italy,
Portugal and Spain, where all curves now look
inverted. Portuguese curve has out-flattened the rest,
but remains far from the Greek 2/5s inversion,
currently at -300bp. Speaking of the Greek 2/5s in
ASW, we’ve seen some resistance in the last two
days with respect to the underperformance of the
front end. This resistance is expected to become
stronger once the first disbursement of the aid
package is delivered and Greece manages to go
beyond the 19 May redemption with success. Since
Greece won’t have to visit the primary markets for at
least two years, the default probability within this
period will diminish and this should lead to a resteepening
of both CDS & ASW curves.
Chart 4: Inversion of ASW 2/5s in Peripherals
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-110
ITA
SPA
POR
-130
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Source: BNP Paribas
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IRE
Chart 5: ITA/POR/SPA ASW Curves
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2011 2013 2015 2017 2019
Source: BNP Paribas
POR ITA SPA
We believe that the Spanish and Italian inversion of
2/5s in ASW terms is overdone and should correct
once the unanimity around the aid mechanism is
secured and the first disbursement is on its way. Two
weeks ago, we’ve chosen to play a flattener in
Portugal versus a steepener in Spain (2/5s ASW
BOX) in order to benefit from the widespread
uncertainty around the EU/IMF mechanism. We
closed this trade ahead of last weekend’s EU/IMF
announcements at a profit of 68bp.
We believe now is the time to start monitoring the
2/5s in order to play the opposite trade, but since
PGBs have become extremely volatile, we would go
for an outright steepener of the Spanish curve as our
first choice this time. The SPGB Apr-12 Vs Apr-15
spread of ASWs is at -15bp at the moment, and our
first target would be a disinversion of this curve
sector. The BTPs Mar-12 Vs Apr-15 spread is +1bp
as the Italian curve has been more resilient. In the
event of correction of this flattening move, we’d
expect the Spanish curve to out-steepen the Italian
one; therefore a 2/5s ASW BOX between these two
would be a way to lower volatility, but would curb the
trade’s upside as well. This BOX trade is directional
on the Spanish 2/5s ASW, and while the main risk is
a further acceleration of contagion to Spain, we think
that, if this happens, not only Italy but all eurozone
countries will feel the pressure. In that sense, the
BOX trade offers protection vs outright steepeners.
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Ioannis Sokos 7 May 2010
Market Mover, Non-Objective Research Section
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