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

Inflation: FTQ Forces Trounce Breakevens
• GLOBAL: EUR fears hurt BEs everywhere.
1: Core Outperform Periphs in BE & ASW Disc.
• EUR: More disparity between core and
peripherals’ BEs.
• USD: Increased supply esp. 10y. TIPS rich.
10
5
0
-5
-10
0
-5
-10
BTPEI19 / BUNDEI20 / BTPEI23 Breakeven
-15
-20
-25
-30
• GBP: 20y+ inflation swap still the best sell.
-15
-20
-15
-35
-40
GLOBAL: Flight-to-quality forces are dominating
asset markets as the Greek aid package fails to
provide support whilst contagion fears (to Portugal,
Ireland and Spain) are intensifying. Little action from
the ECB to help and the German Constitutional Court
challenge are likely to keep uncertainly high in
Europe. Equities are down 3-5% and oil has fallen
over 7% and is currently close to, but below,
USD80/bbl. Global inflation markets have taken a
battering this week unlike last week when most of the
decline in breakevens was concentrated in the
eurozone and a recovery was seen late on. After
their recent resilience, TIPS breakevens tightened
the most in line with our view of TIPS richness in real
yield and breakeven space. Directionality of the
inflation curve may be returning in EUR and GBP
where inflation curves steepened significantly in the
fall in breakevens. In the ongoing volatility and
illiquidity, we continue to recommend light positioning
in inflation markets and have a bearish bias on
breakevens.
EUR: Breakevens are down sharply led by shorter
maturities. Peripheral linkers have been under the
most pressure in breakeven space (and obviously
real yield space) with the disparity between core and
non-core ASW discounts growing (up to 20y
maturities). Core breakevens/ASW discounts held up
well especially DBReis. We are not convinced risk
aversion is over and prefer to stay relatively neutral
despite selective value in EUR breakevens amidst
strong positive seasonals/carry. Violent market
moves have left significant RV opportunities although
we would wait for a stabilisation in risk appetite
before entering. BUNDei-16 looks extremely rich as
does the OBLei-13 particularly versus ‘cheap’
BTPeis. At the very front end, 1y EUR swaps are
pricing in around 0.5% more inflation than our
economists (due to risk of higher indirect taxes?)
whilst the 2y point (in swap and cash) remains the
most strikingly rich versus BNPP’s forecasts. We
continue to favour selling 1y1y inflation forwards
(almost) everywhere with EUR (and USD) 1y1y
forward real yield at 0bp! On EUR/FRF speads, we
still find 5y5y EUR inflation swap fwd relatively
attractive at 30bp below its FRF counterpart (its low).
-25
-30
-35
-40
-45
-20
-25
BTPEI14 / BUNDEI16 / BTPEI19 Breakeven
BTPEI12 / BOBLEI13 / BTPEI14 Breakeven Rhs
-30
Jun-09 Sep-09 Dec-09 Mar-10 Jun-10
2: 5y5y EUR Inf Swap at Low Levels Esp. vs FRF
240
230
220
210
200
190
180
170
160
150
140
5
0
-5
-10
-15
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-30
OATEI20 Breakeven
OATI23 / OATEI20 / OATI17 Breakeven Rhs
-35
Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10
All Charts Source: BNP Paribas
E5.5 / F5.5 Breakeven
USD: TIPS are not immune as a significant
correction in breakevens takes place, finally. The
quarterly refunding announcement stated that the US
Treasury will increase TIPS supply from USD 70-
80bn to 80-85bn in 2010 with ‘more’ in FY 2011. The
10y area will bear the brunt of this supply with an
additional re-opening for new 10y TIPS. Jan maturity
10y TIPS will be re-opened in March and May, whilst
Jul maturity 10y TIPS will be re-opened in September
and November (six 10y TIPS auctions in total) whilst
the size of 10y auctions will probably be increased
(to region of USD 10-14bn). The market did not take
the news well, especially the 10y area. As we have
stated before, TIPS remain rich in both real yield and
breakeven space and we stay bearish on BEs here.
GBP: Strong tightening in front-end breakevens
sending the inflation curve much steeper. We were
correct in recommending taking profit on long front
BEs and 3/30y BE flatteners last week. UKTi-11 is
still a tad rich vs. BNPP forecasts but UKTi-13 is
starting to look interesting again at 20bp+ cheap. As
expected, 20y+ real/nominal ASW discounts have
been tightening (5-10bp on the week) despite a
climate of decreasing liquidity/increasing risk
aversion. We continue to prefer shorting 20y+
breakevens via swap and maintain a bearish bias on
breakevens.
-45
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-55
-60
15
10
5
0
-5
-10
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Shahid Ladha / Herve Cros 7 May 2010
Market Mover, Non-Objective Research Section
52
www.GlobalMarkets.bnpparibas.com