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

money thanks to widenings of 34bp for MAIN and
“only” 86bp for XO. Over the same period, the Merrill
Lynch High-Yield index is wider by 32 bp while the
iBoxx Non-financials and Financials indices are
respectively wider by 11bp and 37bp.
What’s the call?
As mentioned previously, we continue to see the
compression trade “XO vs. MAIN x5” as a good
way to take a bearish call on sovereigns/banks
despite its very good run. The market is willing to
push where it hurts and pressure on Portugal, Spain
and potentially Italy and Ireland are likely to persist.
In this backdrop, the likely snapback in MAIN and
FIN indices should be limited in time and extent.
The strong earning season and the latest macro
economic data (in both the US and Europe) are
relatively supportive for the High-Yield asset class as
evidenced in the relative behaviour of the High-Yield
and High-Grade cash markets.
Update on LOW-VOL vs. FIN SEN
In the past 2 months, we have been pushing the
strategy of being “Long risk Low-Vol. / Short risk FIN
SEN” to play 1/ a resurgence of systemic/bank risk
and 2/ a re-pricing of HVL vs. MAIN. While the
HVL/MAIN has not materially decompressed, the
sharp underperformance of FIN SEN vs. MAIN
enabled us to close this trade with a net profit of
20bp.
Update on curves
With the focus of the market essentially on the
outright, there has been little trading in curves in the
past two weeks. Regarding indices specifically, 5/10s
have been re-marked slightly flatter, in line with the
move in underlying names.
We have being hammering in past weeks that we
see more downside than upside in MAIN, FIN SEN
and FIN SUB curves as all of them were trading too
steep relative to the outright level of the 5y. They
have nicely retraced from their steepest points. We
still see more downside than upside in MAIN, while
the risk/reward for SEN and SUB 5/10 steepeners
has turned more favourable. We continue to like the
5/10y steepeners in XO s12 and s13.
Update on MAIN 5/10y Curve
Taking MAIN s12 as a starting point to assess the
steepness of the curve relative to the outright in
history, we see the “fair-value” of the 5/10 s12 at
c.7bp. It is 9bp below current level. Regarding the
5/10 s13, we estimate the downside at c.5bp
considering the difference of skews between the two
curves.
200
150
100
-
50
Chart 6: XO – 5x MAIN Trade History
iTraxx s12: XO - 5 x MAIN
Q1 (6m)
Median (6m)
Q3 (6m)
XO Wide
-50
XO Tight
-100
9/09 10/09 11/09 12/09 1/10 2/10 3/10 4/10
-
20
10
-10
-20
-30
-40
-50
-
20
10
-10
-20
Chart 7: 1.25 x LVL – 1 x FIN SEN
iTraxx s12:1.25 x LVL - FIN SEN
Q3 (6m)
Median (6m)
Q1 (6m)
FIN SEN Tight
FIN SEN Wide
1/09 3/09 5/09 7/09 9/09 11/09 1/10 3/10 5/10
Chart 8: MAIN – FIN SEN
FIN SEN Tight
-30
iTraxx s12: MAIN x1 - Fin Sen
Q1 (6m)
-40
Median (6m)
Q3 (6m)
FIN SEN Wide
-50
9/09 10/09 11/09 12/09 1/10 2/10 3/10 4/10 5/10
Source: BNP Paribas
What’s the call?
The focus is unlikely to turn on curves in the short
term. Having said that, should the market continue to
be volatile, 5/10y MAIN is likely to flatten further. In
the stabilization scenario (MAIN back to mid 90s),
there is less chance that this curve flattens but we
see it extremely unlikely to steepen. Note that the
carry of the 5/10y has increased to 1.4bp per month.
Pierre Yves Bretonniere 7 May 2010
Market Mover Non-Objective Research Section
56
www.GlobalMarkets.bnpparibas.com