MARKET MOVER - BNP PARIBAS - Investment Services India

Inflation: Bring QE to Europe!
• GLOBAL: Mixed reception to dovish CBs
• EUR: Stay Negative. Keep long EUR/FRF.
• USD: Volatile. Low RY. 5/10y BE flattener.
• GBP: Correction in the Gilt rally. 1y rich.
GLOBAL: Central bank rhetoric from the US and UK
remains very dovish. The FOMC is “prepared to
provide additional accommodation if needed to
support the economic recovery and to return inflation,
over time, to levels consistent with its mandate”. This
has fuelled a rally in bonds although equities are
weaker following their initial positive reaction.
Commodities have not benefited hugely from USD
weakness given struggling risk appetite although
enhanced liquidity should help asset and commodity
markets to perform. Real yields offer more protection
from a depreciating currency and the inflationary
impact of quantitative easing. Indeed, US real yields
have rallied by 30bp in a couple of sessions.
Between 9 and 23 March 2009 – the onset of QE –
we also saw a tremendous rally in real yields and
breakevens did not suffer much as TIPS were
included in the programme whilst BEs rose in the
eventual yield sell-off – Chart 1. The UK issued
550mn UKTi-27 via mini-tender whilst Tesoro will reopen
BTPei-21 for up to EUR 1.5bn. Breakevens
suffered elsewhere and we continue to find EUR and
especially FRF breakevens rich and exposed here.
EUR: Core/peripheral spreads generally remain
under widening pressure, causing disparity in
linker/breakeven performance. BTPeis breakevens
have outperformed core linkers at the front end but
have underperformed materially at 7-15y maturities
with real spreads widening much more than nominal
ones. Supply is partly to blame, with 7y+ BTPeis
suffering on the announcement of EUR 1.5bn BTPei-
21 supply next week. Whilst the BTPei-21 has
underperformed vs. OATei, it has outperformed vs.
BTPei-23. The BTPei-21 may look attractive in the
inflation and ASW discount curve, but it is hit by the
richness of its nominal (BTP Mar-21 and the
cheapness of BTP Aug-23, nominal comparator for
BTPei-23). After adjusting for this, we find the BTPei-
21 no longer looks cheap vs. either OATei or BTPei
curves and we expect a further concession – both
outright and in relative terms ahead of its auction on
Tuesday 28 September. BTPei-21 offers amongst
the highest real ASW on the curve, whilst the bond
does have a closer-to-money inflation floor. OATi
breakevens are underperforming their EUR
counterparts sharply at the front end, as we called
for. Our long OBLei-13/short OATi-13 BE spread has
moved above -40bp from -45bp mid last Friday –
Chart 1: 10y USD RY, NY & BE into/out of QEI
2.50
2.30
2.10
1.90
1.70
1.50
23-Mar
1.30
3.00
1.10
0.90
10y USD Generic Real Yield
2.50
10y USD Generic Breakeven
0.70
06-Mar
10y USD Generic Tsy Yield, Rhs
0.50
2.00
Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10
Chart 2: Long OBLei-13/Short OATi-13 BE Spd
0
-10
-20
-30
-40
-50
-60
BOBLEI13 / OATI13 Breakeven
EUR_HICP / FRF_CPI m/m (0m lag) Rhs
-70
-2.0
Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11
All Charts Source: Bloomberg, BNP Paribas
Chart 2. To recap, cumulative inflation (from Aug-
Dec) is expected at 1.30% in EUR compared to
0.75% in FRF and this is not priced with forwards
below the 18m range. We see further potential in this
trade.
USD: Strong rally in real yields post FOMC meeting
although the move is retracing fast on breakevens.
Market felt squeezed (although dealers reported long
on 9-Sep) with 10y real yields at all-time lows and no
supply until end-Oct. Still, Next FOMC is in 6 weeks
and our models find TIPS BEs expensive with poor
seasonals and mixed total return breakevens
dynamics in Q4. Meanwhile, Barcap US Agg Index
story should still add some vol. We expect news from
Friday evening but all depends on the index sponsor,
which is said to be active in the market. Overall we
have no strong opinion near term but are not keen to
short US BEs and expect volatility ahead. We
continue to find the 5y area cheap and 20y area rich.
GBP: Breakevens down sharply (10bp) in the strong
gilt rally. GBP 550mn UKTi-27 mini-tender did not
help although it was digested smoothly (2.2
bid/cover) after concession pre-tender. Real yields
are close to their lower bound and BEs will continue
to experience increased sensitivity to conventionals if
real yields stay this low. We still like selling 1y
inflation swap with a hedge against Dec-10 RPI (via
UKTi-11) and early BoE rate hikes (via the money
market).
5.00
4.50
4.00
3.50
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
Shahid Ladha / Herve Cros 23 September 2010
Market Mover, Non-Objective Research Section
36
www.GlobalMarkets.bnpparibas.com