Market Outlook - BNP PARIBAS - Investment Services India

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US: After FOMC, Favour Calls on Front End • In light of the FOMC statement, outright front-end carry positions no longer look as attractive since the market could be spooked by strong data and aggressively push frontend rates higher. • We still feel the Fed won’t hike any time soon and have long recommended playing the base-case scenario of a Fed on hold using options. This takes advantage of the outsized rolldown in the short end. • STRATEGY: Buy 6m1y and sell 6m10y receivers in a costless structure to take advantage of a highly attractive entry point due to the flatter forward curve and historically cheap vol ratio. Chart 1: 6m1y/6m10y 50bp OTM Vol Ratio 160% 140% 120% 100% 80% 60% 40% Jan-04 May-05 Sep-06 Feb-08 Jun-09 Chart 2: Entry Level Compared to Spot 1y10y 350 The trade is a conditional bull-steepener although the outsized carry at the front end is the main impetus for the trade. We sell the 6m10y receiver around 75bp out of the money so as to strike it at 3.30%, some 50bp below spot and the lowest level on the 10y rate in recent months. While we expect this to fall out of the money, the 6m1y receiver can be expected to end up in the money. To make it costless, the 6m1y receiver can be struck at around 0.64%, which compares favourably with the spot 1y range of 0.43- 0.67% in recent months. From a curve perspective, the credentials are very strong, since the effective curve strike is 266bp. The spot 1y10y is currently trading at 330bp and has been above the entry level since May last year (see Chart 2 for 3m and 6m breakeven floors). The risk to the position is deflation concerns or a number of economic setbacks which could bull-flatten the curve. Chart 3 shows the expect P/L under curve movements in 1y10y which are led by the 10y (as per current market dynamics, the 1y is relatively pegged while the 10y leads). In a sell-off, the position can actually be expected to be in the black. The current market environment suggests that the 10y will lead the sell-off, so the receiver we are short will depreciate faster than the receiver we are long. In a 300 250 200 150 3m Floor 6m Floor 100 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Chart 3: Expected P/L Under Curve Movements 400,000 300,000 200,000 100,000 - (100,000) (200,000) (300,000) 6m Holding (400,000) 3m Holding (500,000) -75 -50 -25 0 25 50 75 All Charts Source: BNP Paribas 1y10y Curve Changes bear-flattening scenario, the receivers simply fall out of the money. Table 1: Trade Details for 6m1y vs 6m10y Conditional Bull-Steepener Structure Strike Notional ($) PV ($) PV01 ($) Vega ($) Gamma ($) Theta ($) Buy 6m1y Rec F - 43bp 200,000,000 125,000 5,133 31,829 1,149 (1,197) Sell 6m10y Rec F - 75bp (24,000,000) (125,000) (3,494) (39,456) (651) 1,566 Net 0 1,639 (7,627) 498 369 Source: BNP Paribas Suvrat Prakash 29 January 2010 Market Mover, Non-Objective Research Section 28 www.GlobalMarkets.bnpparibas.com
US: Rolling Down the Agency Spread Curve • Short maturity agencies are attractive on forward basis vs Tsys and OIS swap due to the steep agy spread curve and carry advantage. • Establishing long agency position vs short Treasury or OIS swap protects the investor in a sell-off and offers a decent cushion against agency underperformance. • STRATEGY: Buy agency bullet around 2y sector vs short Treasury position or against paying fixed in a matched maturity OIS swap. We find agency bullets in the front end of the curve attractive on the forward basis vs Tsys or vs paying fixed in OIS swap for two reasons: due to the steepness of agency spread curve and the carry advantage. The agency/OIS spread curve is particularly steep in the 1y to 2y sector (Chart 1), which makes for an attractive rolldown profile for agency bullets around the 2y maturity point. Furthermore, agency/OIS spreads for short maturities have stabilised in a tight range since mid-2009 (Chart 2), improving the basis risk profile. Lastly, agencies' carry advantage means that they look even cheaper vs OIS or Treasuries on a forward basis (Table 1). In Table 1, we present a sample of three agency bullets ranging in maturities from 23 to 29 months. For instance, FHLMC 1.125 12/11 which currently trades at 10bp spread to 2y OTR Tsy, 12bp spread to OIS and around 16bp spread to similar maturity Treasury note (adjusted for the curve). By going long this bullet vs paying fixed in matched maturity OIS swap, in 1y time the position should end up at around 19bp spread to OIS using rolling o/n financing (assuming o/n financing doesn’t blow out) or at around 16bp spread to OIS using term financing. Relative to Tsy, the position should end up at a 33- 36bp spread on 1y forward basis. This compares favourably to Agy/OIS spread of around 3bp and Agy/Tsy spread of around 2bp in 11m maturities (23m bullet will roll down to the 11m horizon maturity in 1y time). In other words, long Agy/short Tsy position will build 33-36bp of spread in 1y time, whereas the horizon (11m) Tsy spread is currently around 4bp, implying a profit of 29-32bp. Similarly, long Agy/pay OIS position will build 16-19bp of 20 bp 15 10 5 0 15 bp 10 5 -5 -10 Chart 1: Agency/OIS Spreads Agy / OIS Spreads (First 2 Years of the Curve) 0 2/10 5/10 8/10 11/10 2/11 5/11 8/11 11/11 Chart 2: 1y CM Agy/OIS Spread History Breakeven 1y Const Maturity Agency / OIS Spread -5 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 40 bp 35 30 25 20 15 10 5 0 Chart 3: 1y CM Agy/CMT Spread History -5 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Source: BNP Paribas (All Charts and Table) Breakeven 1y Const Maturity Agency / Tsy Spread spread over 1y, implying 12-15bp profit considering that horizon maturity (11m) trades at just 4bp spread to OIS. Charts 2 and 3 also show that over the last seven months, forward Agy/OIS and Agy/Tsy spreads have been comfortably under our forward level, implying a decent cushion against agency underperformance. Maturity Sergey Bondarchuk 29 January 2010 Market Mover, Non-Objective Research Section 29 www.GlobalMarkets.bnpparibas.com
Page 1 and 2: Market Economics | Interest Rate St
Page 3 and 4: GGBs and other peripherals will rem
Page 5 and 6: The subtle changes in the wording o
Page 7 and 8: US: Get It While You Can • As the
Page 9 and 10: 500,000, the months-supply level of
Page 11 and 12: France: Roaring Consumption • Ret
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Page 15 and 16: UK Inflation: Bridging the Gap •
Page 17 and 18: eceive roughly 60/40 weight within
Page 19 and 20: 1.2% m/m in November, partly offset
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Page 23 and 24: Japan: Polarisation in Machine Tool
Page 25 and 26: Australia: The Next Step • Data r
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Page 33 and 34: Fannie Mae has not discussed the in
Page 35 and 36: EUR: Timing the 20Y Point • The l
Page 37 and 38: EUR 3-5bn (new 10y) in February? Co
Page 39 and 40: JGBs: Supply Continues to Weigh •
Page 41 and 42: Table 1: BNP Paribas' Inflation For
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Page 45 and 46: Pricing Date Repo Rate EUR DRI FRF
Page 47 and 48: CNY: Revaluation and FX Reserves
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Page 53 and 54: Currency Spot Trade Recommendations
Page 55 and 56: Economic Calendar: 29 Jan - 5 Feb (
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Market Outlook - BNP PARIBAS - Investment Services India

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