MARKET MOVER - BNP PARIBAS - Investment Services India

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EUR: Outlook for the Curve • The Fed has clearly opened the door for QEII. QEI was favourable for govvies and mortgages but also for equities as the liquidity bonanza supported risk appetite. Chart 1: QEI Supported Stocks and Bonds • Things are different this time, with significant implication for the curve – especially after the recent sell-off. • STRATEGY: Short the curve on the 5-10y segment. The prospect of more liquidity The latest FOMC statement made it clear: the Fed is on the verge of resuming quantitative easing. It is worth noting that when the Fed conducted QEI in 2009, this allowed both bond and stock markets to perform well. Indeed, in addition to direct purchases of debt by the Fed, easier and larger liquidity supported risk appetite, boosting risky assets such as commodities and equities. One can therefore regard the prospect of QEII as providing firm support for all classes of assets. Of course, the size of purchases matters when it comes to the impact of QE. The Fed will have to buy a lot in order to bring about lower yields and tighter spreads. In the eurozone, the ECB is only extending non-standard conditions for tenders and continues to buy small quantities of sovereign bonds. But the outlook for coming months is that liquidity will remain ample. Big difference with 2009 The backdrop for QEI was very different from the current one. When the Fed started purchases in 2009, the economic outlook was for recovery and reflation. This is far from the current situation. Signs of pronounced weakness in the US economy are mounting, and the euro area is not protected against a slowdown. In addition, in both areas, the outlook for inflation is to the downside. Upcoming data should confirm that core inflation continues to ease. As a result, upcoming quantitative easing may be less favourable for riskier classes of assets, in particular stock markets. This will have major implications for the curve, particularly after the recent sell-off. The curve in coming weeks The strong rally that occurred during the first two months of summer was almost completely led by the back end of the curve. Strong receiving interest dominated, leading to lower long-term yields and a flatter curve. The sell-off that took place during the first half of September was more broadly based across the curve. Indeed, the short end suffered Source: BNP Paribas Chart 2: Market Direction and the Curve Source: BNP Paribas significantly, preventing the curve from resteepening strongly. The question is now whether or not the resumption of a bullish tone will trigger flattening pressures. The sell-off at the short end of the benchmark curve was linked to risk appetite, which favoured stocks and weighed on short-dated sovereign debt. Against this backdrop, if the bullish tone in EGBs goes along with solid equities, the curve will flatten from the 2y area as risk appetite will prevent the short end from rallying. But if upcoming data point to worsening economic conditions, stock markets will suffer and the short end will enjoy a decent rally as well. Near term, we consider the latter situation as more likely. As a result, we see the bullish tone developing along with flattening pressures starting only from the belly of the curve (5y area). Strategy: Short the curve on the 5-10y. Patrick Jacq 23 September 2010 Market Mover, Non-Objective Research Section 24 www.GlobalMarkets.bnpparibas.com
EUR: Re-Enter Flatteners on 5y/10y Segment • Eur 5y/10y segment is lagging red/green Euribor flattening. • RV inputs point to a spread on swaps in the mid-50s. • STRATEGY: We re-entered flatteners after the dovish FOMC meeting Eur 5y/10y segment is lagging Euribor red/green spreads Chart 1 shows Eur 5y/10y segment and 4 th / 8 th generic Euribor spread over the past decade. Not surprisingly – with the exception of some short periods of time – the series have moved very closely. However, with the richening of the belly of the Euro curve (see our desknote on Eur 2y/5y/10y swap fly), the Eur 5y/10y segment on swaps has dramatically lagged the flattening of red/green Euribor spreads materialised by the 4 th /8 th generic spread (the most correlated one). Chart 1: Eur 5y/10y Segment & Euribor 4 th /8 th Calendar Spread 120 100 80 60 40 20 0 -20 Sep-99 Mar-01 Sep-02 Mar-04 Sep-05 Mar-07 Sep-08 Mar-10 Eur 5y/10y spread Source: BNP Paribas 60 40 4th/8th generic Euribor spd (R.H.S) Chart 2: Eur 5y/10y Spread Hedged with 4 th /8 th Euribor Spread Eur 5y/10y too steep 200 150 100 50 0 -50 That lag is confirmed through the regression of Eur 5y/10y segment versus red/green spreads gauged by the 4 th /8 th generic spread. Using that variable since 1999, the regressed 5y/10y segment is trading almost 2.5 standard deviations above its long-run fair level, a gap not seen since June 2003! 20 0 -20 -40 Eur 5y/10y too flat Conditional distribution strengthens traditional approach results The excessive steepness of the Euro 5y/10y segment is also highlighted by a non-parametric approach such as conditional distribution. Chart 3 represents the distribution of the Euro swap segment conditional to red/green Euribor spread. The spread is trading on the far right of its distribution, quite far from the peak in the mid-50s. The main risk for Euro flatteners was a disappointing FOMC meeting on Tuesday. The outcome was ultimately quiet dovish but the flattening mainly focused on the 2y/5y segment the following day while 5y/10y marginally moved. Strategy: We entered flatteners on Wednesday afternoon on 5y/10y futures at 77.5bp (ctds) targeting a 65bp level, which is equivalent to the 55/57 area on swaps. Pure RV players could play the box versus long Sep 11/Sep 12 Euribor (40k 5y/10y vs 25K Euribor). -60 Sep-99 Mar-01 Sep-02 Mar-04 Sep-05 Mar-07 Sep-08 Mar-10 Source: BNP Paribas Chart 3: Distribution of Eur 5y/10y Spread versus Euribor 4 th /8 th Generic Spread 0.05 0.045 0.04 0.035 0.03 0.025 0.02 0.015 0.01 0.005 EUR swap 5/10 with Euribor 4/8 between 33 & 43 h= 2.947 Peak at 54.9 0 -10 0 10 20 30 40 50 60 70 80 90 100 Source: BNP Paribas Current level: 67.9 Eric Oynoyan 23 September 2010 Market Mover, Non-Objective Research Section 25 www.GlobalMarkets.bnpparibas.com
Page 1 and 2: Euromoney Interest Rates Survey 201
Page 3 and 4: ECB on a different page… …but i
Page 5 and 6: developments and is prepared to pro
Page 7 and 8: and property tax payments, dropped
Page 9 and 10: directly to effect outright purchas
Page 11 and 12: Services also on the slide The ‘f
Page 13 and 14: inflation rate is calculated exclud
Page 15 and 16: closer to a more normal level” to
Page 17 and 18: point advance in the June Tankan. P
Page 19 and 20: US: Belly of the Curve is Rich, but
Page 21 and 22: US: A Carry Trade with Extra Potent
Page 23: MBS: Remain Underweight, GNM CBRs U
Page 27 and 28: EGBs: Market Update & Top Trade Ide
Page 29 and 30: EUR Covered Bonds: Market Update
Page 31 and 32: GBP Curve Opportunities Update •
Page 33 and 34: Table 1: BNP Paribas' Inflation For
Page 35 and 36: Table 3: BNP Paribas' Inflation For
Page 37 and 38: Table 1: BNP Paribas Carry Analysis
Page 39 and 40: have been happy to buy the roll to
Page 41 and 42: Technical Analysis - Interest Rates
Page 43 and 44: Trade Reviews Options, Money Market
Page 45 and 46: ond market attracted huge swathes o
Page 47 and 48: warning to Greek banks that it migh
Page 49 and 50: Chart 2: EUR/SEK - major support be
Page 51 and 52: Economic Calendar: 24 Sep - 1 Oct G
Page 53 and 54: Economic Calendar: 24 Sep - 1 Oct (
Page 55 and 56: Key Data Preview Chart 3: US ISM Po
Page 57 and 58: Key Data Preview Chart 7: US Consum
Page 59 and 60: Key Data Preview Chart 11: Japanese
Page 61 and 62: Key Data Preview Chart 7: UK CIPS M
Page 63 and 64: Economic Calendar: 4 - 29 October 4
Page 65 and 66: Next week's T-Bills Supply Date Cou
Page 67 and 68: Economic Forecasts GDP Year 2010 (%
Page 69 and 70: Market Coverage Market Economics Pa

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