Market Outlook - BNP PARIBAS - Investment Services India

US: Post-FOMC Treasury Market Overview
• The FOMC struck a more hawkish tone at
its latest meeting, which should arrest the rally
in Treasuries.
• We expect the 1y sector to remain more or
less anchored but the 2 to 5y to come under
pressure.
• STRATEGY: Put on 1s2s steepeners. Sell
the 1s2s3s butterfly (short the belly).
The FOMC statement arguably turned more hawkish
on inflation, with resource slack no longer being
viewed as a downward force on inflation as much as
a constraint to it going higher. The overall
assessment on growth was that the recovery will be
"moderate", replacing the previous prognosis that
economic activity will remain weak. Even the
“extended period” language was called into question
by Hoenig, who dissented.
With these developments, it was no surprise to see
selling pressure on the Treasury curve. The very
front end (0-2yrs) steepened while the curve was
flatter 2yrs and out, and we would expect these
trends to persist for now. The expected bumper GDP
print on Friday and next week’s possibly positive
NFP print (consensus is +27k) could spook markets
and further the sentiment that hikes are closer than
we think. Still, even in that scenario, we expect the
1y sector to remain more or less pegged as it’s
unlikely for more tightening to be priced in for 2010
than 2011. As a result, we favour front-end
steepeners in the form of 1s2s (see Chart 1 for the
close relationship between the direction of rates and
1s2s spread).
We also recommend selling the 2y sector in view of
its sub-par rolldown prospects within the front end.
Chart 2 shows the 6m total return of 1-3y Treasuries
due to rolldown alone (i.e. in an unchanged yield
Chart 1: 3-Month Change of 2y Tsys and 1s2s
200
150
100
50
0
-50
-100
-150
-200
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Source: BNP Paribas, Yield Book
3m Chg in 2y
3m Chg in 1s2s (RHS)
curve scenario). Clearly a barbell of 1s and 3s should
outperform the 2y sector in this scenario. This
suggests an RV opportunity, but we should also
incorporate other scenarios to make a full
assessment, most importantly a bear-steepening in
the front end, consistent with our expectations. When
we run a multi-scenario optimisation along these
lines, we find that – with proper weightings – a
barbell of 1y and 3y is indeed likely to outperform the
2y. Trade details are shown in Table 1.
150
100
50
0
-50
-100
Chart 2: 6-Month Total RoR of 1-3y Treasuries
1.8
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
Buy April 2011s
& Jan 2013s
Barbell
Return
0
1 1.5 2 2.5 3 3.5
Source: Yield Book, BNP Paribas
Sell Dec 2011s
Effective Duration
Table: Trade Details – Sell 2y, Buy 1y and 3y Sectors
Security Price Yield Duration Par Amount ($) Market Amount ($)
Buy T 4.875 04/30/2011 105.541 0.430 1.22 66,561 71,055
T 1.375 01/15/2013 99.870 1.420 2.91 28,967 28,945
Sell Cash 0.169 10,843 10,834
T 14.625 12/31/2011 107.196 0.838 1.85 82,894 89,166
Net -2.536 -0.049 0.00 1,791 0
Source: BNP Paribas
Bulent Baygun 29 January 2010
Market Mover, Non-Objective Research Section
27
www.GlobalMarkets.bnpparibas.com