Market Outlook - BNP PARIBAS - Investment Services India

Inflation: BEs Collapsing in Europe
• GLOBAL: Weak but key data looming.
• EUR: Bearish. 2/10y BE Steepener.
• USD: Favour 10y TIPS (BE) into month-end.
• GBP: Further BE curve post UKTi-40.
Chart 1: Jan Surprising to Downside in Europe
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Richen Jul
2009 2008 2007 2006 2005
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2004 2003 2002 2001
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0.00%
-0.20%
-0.40%
Cheapen Apr & Sep
GLOBAL: Equities and commodities are lower as the
-1.00%
Maturities
flight to quality intensifies on weak economic data
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
(US new home sales and UK GDP), unprecedented
Chart 2: 2/10y BE Curve Too Flat at Fwds
widening of Greek bond spreads and further inflation
120
80
supply. Breakevens are down everywhere with
BTPEI12 / OATI17 Breakeven
100
100
OATI17 Breakeven Rhs
Europe underperforming sharply following very weak
120
80
German preliminary CPI data. Oil fell to USD 73/bbl,
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60
shrugging off bullish DoE inventory data. After a less
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dovish FOMC, the State of Union address triggered a
40
180
mild consolidation in risky assets. We maintain our
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20
negative call on rich EUR breakevens, and still
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0
favour GBP and USD breakevens at least up to 10y
240
-20
1-Apr Fwd Not
maturities. Focus on key economic data next week
Priced! 260
including US Q4 GDP, NFP, ISM.
-40
280
Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10
EUR: Collapsing breakevens across maturities.
German preliminary HICP printed -0.7% m/m vs.
Charts source: Bloomberg, BNP Paribas
-0.4% consensus due to very weak core inflation and
despite higher food inflation. The trend of increased
EUR 650mn BTPei-41 re-opening was better
January discounting (Chart 1) intensified – German
received (premium of 38 cents, bid/cover at 1.84).
discounts were nearly twice those of recent years. USD: 7y+ breakevens have been remarkably
We expect the deceleration in core to materialise in resilient given the broader flight to quality. The front
other countries in Jan due to similar discount end may remain volatile – we stay bearish. The TIPS
practices and limited ability to increase administered Jan-11 is not suffering from its drop out of the TIPS
prices (unlike most years) but to be less pronounced Index. Historically, this is usually priced in advance –
than the surprise in Germany. We now expect Jan the Jan-11 has looked the cheapest front TIPS vs.
HICP Ex-tob at 107.88, -0.67% m/m implying very our forecasts for some months. That said, any
negative carry in the month of March. At the 2y point, significant concession would represent a buying
1-April BE forwards are close to the top of their 9m opportunity. 10y TIPS should benefit from index
range when upcoming negative carry, deflationary extension bid (+0.20y) and inflows into the product at
news, widening of peripherals and risk averse asset end-January, particularly ahead of new 30y TIPS
markets suggest they should be closer to their 9m issuance in February which should keep 15y+ TIPS
lows. This is typically priced in February and frontend
suppressed. Whilst TIPS Jan-20/Jan-25 BE spread
(2-5y) BEs have exhibited negative total returns looks quite flat at +5bp, it could invert into the 30y
in both Jan and Feb in four of the past five years. We supply.
stay negative on front-end EUR BEs. Meanwhile, the
10y remains depressed in the cash inflation curve
GBP: Breakevens under pressure as UKTi-40
with the EUR 1.052bn BTPei-17 tap weighing. It
syndication failed to impress triggering volatility at the
came with a premium of only 3 cents, bid/cover of
long end. The size of the book was just above GBP
1.58). The 2/10y BE curve remains way too flat esp. 4bn – less than half that of 2009’s linker syndications
on a forward basis – we keep our BTPei-12/OATi-19
and GBP 3.5bn was issued compared to GBP 5bn
BE steepener. The trade has 10-20bp further
for both UKTi-42 and -50 in Q3 2009. The UKTi-40
potential (1-Apr in negative territory!). The negative
came at UKTi-37 RY – 3bp, in the middle of our fair
Jan surprise is worth 5-10bp in itself and the recent
value range but not rich. Investors seem concerned
widening in peripheral/core nominal spreads has not
by the prospect of increased linker issuance in FY
yet been fully reflected in real spreads, leaving BTPei 10/11 whilst the lack of a RY concession since the
BEs richer across the curve. Long-end breakevens
coupon fixing did not help. We continue to favour
also suffered early in the week although the smaller
shorter maturities (up to 10y) and favour a flatter
inflation curve ahead.
Shahid Ladha / Herve Cros 29 January 2010
Market Mover, Non-Objective Research Section
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www.GlobalMarkets.bnpparibas.com
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