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Europe ITraxx Credit Indices • Outright: Being long or short MAIN has moved further towards being a macro call on European sovereigns. The trade which offers the best risk/reward to play further volatility in Sovereign is the “Long risk XO / Short risk MAIN x5” trade. • SUB/SEN: the attractive entry point and the non-directionality of the trade over the mediumterm prompt us to recommend the SUB/SEN decompression trade with a ratio of 1.5 x 1. That’s a normalization trade with limited downside. • XO/MAIN: although the ratio has reached new lows this week, we think there is more to come and keep our recommendation “Long risk XO / Short risk MAIN x5” trade which has already performed by 85bp. • LVL/FIN SEN: thanks to further underperformance of FIN SEN vs. MAIN and some decompression HVL/MAIN, LVL has kept on outperforming all other indices. We advise investors to took profit on the “Long risk LVL / Short risk FIN SEN” recommended the 18-Feb. • FIN SEN and SUB 5/10y: we have been right to call for the flattening of these two curves. After their retracement of 6bp (in SEN and SUB), the downside at +4 in SEN and +3 in SUB looks extremely limited. We like the two steepeners as mid-term normalization/carry-trades. • XO 5/10y: we keep our steepeners in s12 and s13. Outright Being long or short MAIN has moved further towards being a macro call on European sovereigns; it is mainly due to the spill-over of the Greek crisis into Spain and Portugal and the increase of single-names related to threatened sovereigns; there is only one Greek name (OTE) but the number of PIIGS names is 18 (Portugal: 3; Ireland: 0; Italy: 8; Greece: 1; Spain: 6). Actually, the picture is a bit more complex with direct exposure of non-PIIGS based financials (and to a lower extent non-financials) to PIIGS risk. In any case, the correlation between MAIN and SOVX has reached new highs. The direct consequence of the loss of confidence in the weakest members of the Eurozone has been further pressure on the EUR currency, which has Table 1: Curves’ Levels and Changes 5y 5/10y 1W Chg 1M Chg MAIN s13 109 10 -2 -4 MAIN s12 105 16 -0 -2 SEN s13 153 4 -3 -6 SEN s12 149 12 - -1 SUB s13 225 3 -2 -6 SUB s12 221 10 - -3 HVL s13 151 15 -5 -5 HVL s12 141 25 - - XO s13 502 15 -5 - XO s12 466 30 - +5 MAIN XO 120 110 100 Chart 1: MAIN 5y vs. EUROSTOXX 600 90 80 70 R 2 = 0.5135 60 230 240 250 260 270 280 575 555 535 515 495 475 455 435 415 395 EUROSTOXX 600 Chart 2: XO 5y vs. EUROSTOXX 600 last 3M reached new 12-month lows (versus USD) this week. The correlation between iTraxx MAIN and EUR/USD which was almost inexistent in previous months has now clearly increased (Chart 2) and MAIN is now more correlated to EUR/USD than to the EUROSTOXX 600. last R 2 = 0.9137 375 230 240 250 260 270 280 Source: BNP Paribas EUROSTOXX 600 last 3M last Pierre Yves Bretonniere 7 May 2010 Market Mover, Non-Objective Research Section 54 www.GlobalMarkets.bnpparibas.com
What’s the call? It is relatively hazardous to take a view in this market; the underlying trend remains negative for the weakest members of the Eurozone and for the EUR currency which does not bode well for SOVX and MAIN as well as for FIN SEN and SUB indices. That being said, a lot of efforts are made by officials to stop the bleeding and a momentarily snapback is very likely to come in the next days. For us, the index which should continue to outperform is XO as it should remain relatively more immune to developments in PIIGS. We nevertheless note that some High-Yield names like Irish Eircom and Spanish Codere, ONO and Sol Melia have recently underperformed the market. All in all, we continue to expect the XO/MAIN ratio to decrease and see the risk/reward of the “Long risk XO / Short risk MAIN x5” trade, which is a disguised bearish call on MAIN, more attractive than an outright short on MAIN. Update on FIN SEN vs. FIN SUB It is probably the pair trade on which we have the highest level of conviction given (1) its very attractive entry level and (2) its relative lack of directionality. Regarding the entry level, we view a very favourable risk/reward in the decompression trade at x1.50. The downside is probably limited to x0.10 while its upside can be as high as x0.30 if the ratio catches up with SUB/SEN levels prevailing when the SEN index was trading in the 130-150 range. Moreover, the widest member of the basket (BESPL) is already trading at a SUB/SEN ratio of x1.17, a 2- year historical low and an already very compressed level where hedgers could start thinking about buying SUB protection rather than SEN keeping in mind that all the debt deliverable into the SEN CDS can also be delivered into the SUB. That being said, UK single-names RBS and HBOS, with SUB/SEN ratio between x1.6 and x1.7 have some room to compress further. Regarding directionality of the trade, the long-term history of the ratio has shown that the SUB/SEN ratio is a non-directional play. It is evidenced on Chart 3 which displays the value of the SUB/SEN ratio against the absolute level of the SEN index. It is less valid if we consider the past month (orange dots on Chart 3) which shows a relatively resilient regime in which the SUB/SEN ratio decreases as the SEN index widens and inversely. The very basic explanations for this new regime are 1/ hedging needs are putting more pressure on SEN CDS than on SUB CDS and 2/ the slight outperformance of LT2 vs. Senior in cash (2-week spread changes of iBoxx LT2 and SEN indices of 20% and 23% respectively). What’s the call? Chart 3: SUB/SEN Ratio vs. FIN SEN in Past 12 Months - SUB/SEN ratio 2.20 2.10 2.00 1.90 1.80 1.70 1.60 1.50 2.0 1.9 1.8 1.7 1.6 1.5 y = -0.0026x + 1.8623 1.4 35 55 75 95 115 135 155 FIN SEN 12M-3M 3M-2M Chart 4: SUB/SEN in Past 4 Years iTraxx Sub / Sen (s13) Q1 (6m) Median (6m) Q3 (6m) 1.40 12/05 4/06 8/06 12/06 4/07 8/07 12/07 4/08 8/08 12/08 4/09 8/09 12/09 4/10 Chart 5: 1.5 x FIN SEN – 1 x FIN SUB History 20 -20 -40 -60 -80 -100 -120 -140 09/08 11/08 01/09 03/09 05/09 07/09 09/09 11/09 01/10 03/10 05/10 Source: BNP Paribas The attractiveness of the entry level prompts us to jump in the SUB/SEN decompression trade (Long risk EUR15m SEN vs. Short risk EUR10m SUB). At the time of writing, entry levels are 160 for SEN and 235 for SUB. Starting from these levels, we see about 20bp potential in the trade. Update on XO vs. MAIN We have been pushing the outperformance of the XO index relative to the MAIN since the beginning of April (8-Apr) via a compression trade “Long risk XO / Short risk MAIN x5”. The trade is now 85bp in the Last 1M Pierre Yves Bretonniere 7 May 2010 Market Mover Non-Objective Research Section 55 www.GlobalMarkets.bnpparibas.com
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Market Economics | Interest Rate St
Page 3 and 4: UK: all eyes on the election US: re
Page 5 and 6: Event response The ECB is being ove
Page 7 and 8: Eurozone Periphery: Compare and Con
Page 9 and 10: over 20% in Q1) and, last but not l
Page 11 and 12: Market Stress Charts • Signs of s
Page 13 and 14: Chart 7: Greek Bank CDS* 900 Greece
Page 15 and 16: • The plan also contains a number
Page 17 and 18: Germany: Downs and Ups • The impa
Page 19 and 20: Retail sales data from month to mon
Page 21 and 22: On inflation, the statement was als
Page 23 and 24: quarterly average of 2.7% in the fi
Page 25 and 26: US Credit: Still the Recovery’s B
Page 27 and 28: Japan: Rising Chance of Sales Tax H
Page 29 and 30: BNP Paribas Surprise Indicator •
Page 31 and 32: UK headline After surprising to the
Page 33 and 34: US: Supply Could Affect Swap Spread
Page 35 and 36: steep curve is typically associated
Page 37 and 38: decline. We continue to maintain ou
Page 39 and 40: Chart 12: 90-119 Day Dlq for FRE 90
Page 41 and 42: the gamma sector for some time now.
Page 43 and 44: EUR: Limited Nervousness at ECB Ten
Page 45 and 46: with the big redemption (EUR 17.7bn
Page 47 and 48: measures are not promptly taken to
Page 49 and 50: Table 1: BNP Paribas' Inflation For
Page 51 and 52: Table 3: BNP Paribas' Inflation For
Page 53: Table 1: BNP Paribas Carry Analysis
Page 57 and 58: Update on FIN SEN and FIN SUB 5/10y
Page 59 and 60: Germany 10y: Within MT falling wedg
Page 61 and 62: Judging Currencies by Liquidity •
Page 63 and 64: type of regulation would reduce mon
Page 65 and 66: Euro Dives • The euro is collapsi
Page 67 and 68: Currency Spot Trade Recommendations
Page 69 and 70: Economic Calendar: 7 - 14 May (cont
Page 71 and 72: Key Data Preview Chart 1: US Payrol
Page 73 and 74: Key Data Preview Chart 5: UK Manufa
Page 75 and 76: Key Data Preview Chart 9: French GD
Page 77 and 78: Key Data Preview Chart 13: US Indus
Page 79 and 80: Treasury and SAS Issuance Calendar
Page 81 and 82: Central Bank Watch Interest Rate EU
Page 83 and 84: FX Forecasts* USD Bloc Q2 '10 Q3 '1
Page 85: RESEARCH DISCLAIMERS: IMPORTANT DIS
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