Market Outlook - BNP PARIBAS - Investment Services India

EUR: Timing the 20Y Point
• The long end of the EUR curve and, more
specifically, the 20y point offers a relatively
cheap alternative to outright 2/10s flattener
strategies that bank on a full normalisation of
excess liquidity conditions in the Eurosystem.
• STRATEGY: We suggest receiving the EUR
10/20/30y butterfly at slightly higher levels (entry
target in the 58/60bp region). Alternatively, we
propose looking at 20/30y steepeners on the
cash curve, looking to enter the trade on a
consolidation of the current widening trend in
20y-Fwd 10y ASW.
0.90
0.80
0.70
0.60
0.50
0.40
0.30
0.20
0.10
Chart 1: Monetary Policy and the Long End
EUR 10/20/30Y
EUR 2Y (RHS)
Reversion to 2Y
rate implied levels
0.00
1999 2001 2003 2005 2007 2009 2011
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
5.5
6.0
Source: BNP Paribas
Chart 1 plots the EUR 10/20/30y butterfly against the
level of 2y rates. Aside from a minor RV correction
(5bp max), there does not seem to be any particular
dislocation according to our models.
However, the fly’s directional link with the level of
short-term interest rates (i.e. the link to ECB policy),
the relatively high correlation between the fly and the
2/10s spread (R2: 0.85), as well as the limited cost of
carry (10bp for 10/20/30s versus 45bp for 2/10s),
make receiving the fly an attractive strategy for those
investors looking for: a) a normalisation of Eonia and
b) an increase in rate hike anticipation (currently
12x24 Eonia is at 1.60%).
To substantiate our argument, we present a basic
model of the EUR curve that reflects the correlation
structure between the 2y rate and other points alone.
The results in Table 1 highlight the compression of
the 10/20/30y fly as a function of a higher 2y rate
(this argument is also valid for a flatter 2/10s curve).
Similar arguments can also be made in cash space,
where the cheapness of 20y government bonds is
even more evident. As for the swap curve, the 10/20y
cash curve is relatively steep, while the 20/30y curve
is still relatively flat. Another way to show the
cheapness of the 20y point is to compute the implied
20y-forward 10y cash yield and compare it to the
20y10y swap rate. Chart 2 plots this 20y-fwd 10y
ASW for Bunds, OATs and BTPs.
STRATEGY: The EUR 10/20/30y butterfly has been
quoted in a 55/62bp range for the past nine months.
Currently, the fly is at the bottom of this range. With
excess liquidity likely to persist in Q2, we suggest
waiting for a better level before receiving the 20y
rates versus the wings. We are targeting the 58/60bp
Table 1: Curve Correlation Analysis
Bump
Response
2Y 10Y 20Y 30Y 10/20/30Y
-100 0.69 2.58 3.22 3.22 63
-50 1.19 3.02 3.58 3.54 60
Live 1.69 3.46 3.94 3.86 56
50 2.19 3.89 4.29 4.18 52
100 2.69 4.33 4.65 4.50 49
200 3.69 5.20 5.37 5.14 41
Source: BNP Paribas
3.50
3.00
2.50
2.00
1.50
1.00
0.50
0.00
Chart 2: Implied 20Y-Fwd 10Y ASW
20Y10Y ASW
-0.50
May-08 Aug-08 Nov-08 Feb-09 May-09 Aug-09 Nov-09
region. Similarly, we prefer to wait for a consolidation
of the 20y-fwd 10y ASW widening trend at slightly
wider levels before buying 20y bonds versus 30y.
OAT
Bund
BTP
BTP Curve Fwd Cash Fwd Swap Fwd Zspread
9/19 vs 5/31 0.85 5.56 4.64 0.93
9/19 vs 8/39 0.86 5.29 4.28 1.01
5/31 vs 8/39 0.01 4.91 3.50 1.41
5/31 vs 9/40 0.06 5.07 3.46 1.61
Source: BNP Paribas
Alessandro Tentori 29 January 2010
Market Mover, Non-Objective Research Section
35
www.GlobalMarkets.bnpparibas.com