Market Economics | Interest Rate Strategy - BNP PARIBAS ...

Market Economics | Interest Rate Strategy | Forex Strategy 16 July 2010 

Market Mover 

Market Outlook 2-3 

Fundamentals 4-20 

• Where Have You Gone, Joe 

4-6 

DiMaggio? 

• US Housing: A Cold Summer 7-9 

• UK: Mind the Gap 10-11 

• Denmark: The Tide is Turning 12-13 

• China: House Price Controls to 14-15 

Continue 

• Japan: Post-Election Outlook for Tax 16-17 

Reform 

• Japan: PM Kan’s Dubious Economics 18-20 

Interest Rate Strategy 21-50 

• US: 10y Range Trade with a Receiver 21 

Fly 

• US: TSY Switches for Yield/Duration 22-23 

Pickup 

• US: Corporate Issuance and Swap 24-25 

Spreads 

• MBS: Higher Coupons Could Speed 26-27 

Up Later 

• EUR: Eonias to Push Up Further 28 

• EUR: Deflation Macro Hedge Via 29 

Options 

• EUR: Yet Another Volatility Deflation 30 

Trade 

• EUR: SAS Diversification to Enhance 31 

Yields 

• JGBs: Fiscal Austerity – Not an Easy 32 

Task 

• Global Inflation Watch 33-36 

• Inflation: Sell 30y in the UK & US 37-38 

• GBP: Evolving LDI Demand with Shift 39-42 

to CPI? 

• Europe iTraxx Credit Indices 43-46 

• Technical Analysis 47-48 

• Trade Reviews 49 

FX Strategy 50-55 

• Strategy: Returning to EURAUD 50-52 

Bearish Strategies 

• Technical Strategy: 53-54 

• Trading Positions 55 

Forecasts & Calendars 56-70 

• 1 Week Economic Calendar 56-57 

• Key Data Preview 58-63 

• 4 Week Calendar 64 

• Treasury & SAS Issuance 65-66 

• Central Bank Watch 67 

• Economic & Interest Rate Forecasts 68 

• FX Forecasts 69 

Contacts 70 

www.GlobalMarkets.bnpparibas.com 

• A strong start to the corporate earnings season has 

brought support to risk appetite. 

• However, the setback in safe-haven flows has remained 

limited, with ongoing concerns about sovereign debt and 

the recent softening of economic data supporting govvies. 

• We remain constructive on the main government bond 

markets over the coming weeks, expecting flatter curves. 

• The minutes of June's FOMC meeting suggest that the 

door to a further round of unconventional stimulus has 

opened further. 

• The results of the EU-wide stress tests will be 

announced on 23 July. The CEBS statement last week 

failed to clarify a number of issues, including in particular 

the assumptions on sovereign debt developments. 

• The lack of concrete information available at this stage, 

on a number of fronts, suggests that national governments 

have struggled to reach agreement over the specific 

details. This is not a good sign. 

• Supply/demand conditions remain favourable for the 

JGB market. 

• We expect the pro-cyclical and commodity currencies 

to remain supported in the medium term. 

• Some further near-term gains are expected for the EUR 

and GBP in the current environment as position unwinding 

persists. 

Market Views 

UST 10y T-note Yield (%) 

2y/10y Spread (bp) 

EGB 10y Bund Yield (%) 


JGB 10y JGB Yield (%) 


Forex 

EUR/USD 

USD/JPY 

Current 1 Week 1 Month 

2.97 ↓ ↓ 

239 ↓ ↓ 

2.65 ↓ ↓ 

186 ↓ ↓ 

1.09 ↓ ↓ 

94 ↓ ↓ 

1.2893 ↑ ↓ 

87.41 ↓ ↔ 

IMPORTANT NOTICE. Please refer to important disclosures found at the end of 

this report. Some sections of this report have been written by our strategy teams 

(shown in blue). Such reports do not purport to be an exhaustive analysis and may 

be subject to conflicts of interest resulting from their interaction with sales and 

trading which could affect the objectivity of this report.

Market Outlook 

Fragile rebound in risk 

appetite after a positive 

start to the earnings 

season 

Government bond markets gave up some of their recent gains over the past 

week following a positive start to the earnings season. In Europe, the 

assumptions behind the stress test appear increasingly credible and the 

remaining question concerns the recapitalisation funds that may need to be 

made available. In addition, the European Financial Stability Facility should 

be operational by the end of August, according to the CEO of the SPV. 

Finally, Greece passed the test of the primary market with relative ease: the 

auction of 26-week bills was well received. 

However, the recent setback in safety trades has remained limited, notably 

as the fundamental context remains bond-supportive. Most of the recent 

economic data have indeed continued to paint a picture of a recovery that is 

losing momentum. The latest FOMC minutes indicate an adjustment to lower 

long-term forecasts for growth and core inflation, and higher for 

unemployment. These concerns about the growth outlook are generating an 

immediate policy response. The Fed is suggesting that excess liquidity will 

remain in place for longer than the market had been expecting while several 

FOMC members are putting forward the view that additional measures 

should be considered if the outlook deteriorates further. This has led to the 

market pushing its rate hike expectations out further along the curve, also 

providing support for the Treasury market. 

The strong start to the earnings season supports risk appetite but 

govvies remain resilient 

4.0 

10 yr N ote Y ield 

3.9 

3.8 

3.7 

3.6 

3.5 

3.4 

3.3 

3.2 

S&P (RHS) 

3.1 

3.0 

2.9 

Jan Feb Mar Apr May Jun Jul 

10 

Source: Reuters EcoWin Pro 

1225 

1200 

1175 

1150 

1125 

1100 

1075 

1050 

1025 

1000 

Supportive environment 

for Tsy though the upside 

potential looks limited on 

short-dated maturities 

We remain constructive on Treasuries over the coming weeks, with the 

prospect of another downward surprise to core CPI looming. The FOMC 

minutes should now set the stage for a dovish monetary policy report from 

Bernanke to Congress next week. With long-term forecasts being revised to 

show a bleaker picture than forecast a few months ago, the talk has shifted 

away from when the Fed could tighten. Instead, Fed speakers are now 

discussing the implications of disinflation, and possible further asset 

purchases or other forms of stimulus. 

One risk to our positive call on Treasuries is that the stock market continues 

its recovery as expectations for corporate earnings are generally upbeat. We 

are certainly wary of this and favour having short exposure in the front end 

as cheap protection against our main view. At 0.60%, the 2y note is again at 

the low end of its yield range so risk/reward favours a short, although with 

the cost of negative carry. 

Cyril Beuzit 16 July 2010 


2 

www.GlobalMarkets.bnpparibas.com

2-10s receivers attractive 

in the 150bp area 

JGBs remain solid 

In Europe, we also remain more comfortable in the short run being 

positioned for a flatter curve – rather than going for outright longs on longdated 

maturities. The front end of the curve still looks at risk, with further 

unwinding of carry trades ahead. Remaining uncertainties about the stress 

test should continue to support EGBs and this week’s auctions were 

relatively easily digested, helping intra-EMU spreads to consolidate further 

despite the downgrade of Portugal by Moody’s from Aa2 to A1. Irish spreads 

were under pressure following the news that Ireland may announce a deficit 

for 2010 of almost 17% of GDP as EUR 8.3bn capital given to AIB could be 

requalified and included, adding 5.25pp to a projected 11.5% deficit. 

In Japan, last weekend's election defeat for the DPJ-led ruling coalition 

meant a loss of its majority in the upper house. With many party insiders 

attributing the poor showing to Prime Minister Naoto Kan's bungled handling 

of the consumption tax debate, there are fears that the government's fiscal 

rebuilding efforts might now need to be put on hold for the time being. 

Yoshimi Watanabe – leader of Your Party, which won ten of the seats 

contested in Sunday's election – wants the government and the Bank of 

Japan to target an inflation rate of +2%, which suggests to us that political 

pressures may force the central bank to take additional easing measures in 

the relatively near future. 

Massive untapped demand among domestic investors continues to support 

JGBs, with dip-buying helping to limit the market's overall reaction to the 

recent rally in stock prices. Short-covering in the super-long sector has 

driven a significant flattening of the yield curve, but we expect to see an 

easing or partial reversal of this flattening bias ahead of next Thursday's 

20yr auction. 

Pro-cyclical and 

commodity currencies to 

remain supported medium 

term 

In FX markets, while fears of a renewed slowdown may cause some nearterm 

volatility, we expect global investor sentiment to be supported by the 

apparent readiness of monetary authorities to take prompt action, 

suggesting that the pro-cyclical and commodity currencies will remain 

supported over the medium term. Indeed, the Fed highlighting downside 

risks and the softer data from China are currently overshadowing the strong 

corporate earnings data, putting equity markets under pressure and 

triggering a broad position unwinding in currency markets – with the USD 

selling off. USD weakness is likely to be most emphasised against the yen, 

given the continued sensitivity of USD/JPY to US data and developments in 

the US yield curve. 

However, we believe that the current moves will provide another opportunity 

to establish medium-term bullish strategies in the commodity currencies. 

Indeed, members of the FOMC have expressed their willingness to take 

action if the outlook deteriorates further, while China has reaffirmed its 

commitment to sustaining growth. Hence, although some further volatility is 

expected in the near term, we would look to buy the AUD in particular as 

long as overall Chinese growth is maintained and global liquidity remains 

ample. 

Further near-term upside 

on EUR and GBP 

Some further near-term gains are expected for the EUR and GBP in the 

current environment as position unwinding persists. However, once again 

this will provide an opportunity to establish medium-term strategic positions, 

with the EUR and GBP expected to become vulnerable to significant moves 

lower again as the full extent of the negative impact from fiscal tightening will 

likely become apparent in the weeks ahead. We look to take advantage of a 

EUR/AUD rebound over the coming week to establish a medium-term 

bearish position. 

Cyril Beuzit 16 July 2010 


3 


Where Have You Gone, Joe DiMaggio? 

• The debate on more stimulus in the US has 

heated up with a stutter in economic growth and 

falling core inflation. 

Chart 1: Fiscal Concerns Have Driven Policy 

Tightening 

• The prospect of additional unconventional 

measures has risen. Given our forecasts – 

especially for core inflation – QE2 looks likely, 

though the form it would take is uncertain. 

• In contrast, the ECB is set on the exit from 

unconventional measures. Different tracks for 

the two central banks could have a big impact 

on markets and currencies. 

The tone of the global recovery has shifted 

notably in recent months and debates are 

underway as to whether more policy stimulus is 

needed to keep the recovery on track 

The tone of the global recovery has shifted notably in 

recent months. The European fiscal crisis spurred a 

rout in risky assets and a round of fiscal tightening 

measures that will limit growth in the next several 

years. More recently, a softening in economic data in 

the US and China has raised further questions about 

the staying power of the rebound, and debates are 

underway as to whether more policy stimulus is 

needed to keep the recovery on track. 

There was considerable disagreement on the need 

for more stimulus at the G20 meetings in June, with 

European policymakers arguing for fiscal restraint to 

shore up credibility and the US arguing for further 

deficit-financed stimulus to spur activity. However, 

even in the US, the political will for more fiscal 

stimulus appears to have evaporated, with aid to 

cash-strapped states and unemployment benefits 

having recently been nixed by Congress. 

This leaves monetary policy, although here the 

options are again limited. Short-term rates are 

already hovering just above zero, leaving the 

duration of zero rates and central bank balance 

sheets as the only remaining tools. While Euro area 

monetary policymakers have been dragged kicking 

and screaming into measures supporting sovereign 

funding markets, the Fed proactively shifted its 

language in June in a way that pushed back market 

expectations for policy tightening. Ultimately, we 

think monetary policymakers will be pushed into 

delivering more stimulus to prevent a debt 

deflationary dynamic from derailing the recovery. 


Chart 2: The US Recovery is Weakest in Post- 

War Period 


There seem to be constraints on how much more 

fiscal stimulus can be delivered in the US, and 

even the more robust European economies with 

the ability to engage in further stimulus have 

opted for fiscal austerity 

The best outcome on the fiscal side would be further 

temporary stimulus measures – say, aid to states to 

help ease the downward adjustment in spending and 

more tax credits for house purchases, coupled with 

measures that address the longer-term fiscal outlook. 

These should include things that address the 

structural deficit from social security and Medicare 

such as implementing a near-term ramping up of the 

retirement and Medicare eligibility ages. This doesn’t 

appear a realistic option, however, given the political 

appetite for tackling the US ageing issues. Extending 

the Bush tax cuts, at least partially, is a possibility 

although this does not provide much stimulus. 

Rather, it forestalls tightening so it doesn’t really 

Julia Coronado and Paul Mortimer-Lee 16 July 2010 


4 


arrest the slow growth dynamic we seem to be falling 

into. The recent failure of a USD 140bn stimulus bill 

that included aid to states and unemployment benefit 

extensions to pass the Senate highlights the lack of 

political will for further deficit spending. This is not a 

philosophical or theoretical issue, but a clear 

message from voters to Congress in an election 

year. It appears US voters don’t necessarily object 

strongly to the Japan-like scenario of slower growth. 

This could shift if economic conditions deteriorate 

much further but there seem to be constraints on 

how much more fiscal stimulus can be delivered in 

the US. 

The situation is different in Europe. Countries in the 

periphery have to tighten fiscal policy hard in order to 

try to restore credibility and overcome a potential 

inability to sell debt. Ideally, in these circumstances, 

we would have liked to have seen the countries with 

better fiscal conditions refrain from tightening, or 

even supplying a bit of temporary stimulus in order to 

support overall aggregate demand. In fact, the 

reverse is happening with Germany intent on 

tightening policy to set an example. Our view is that 

Germany’s expansion owes far too much to exports 

and far too little to aggregate demand. A bit of fiscal 

push – or a lack of brake – when the momentum in 

the traded goods sector was strong could have 

helped the recovery spread more broadly to the nontraded 

sector. However, that was not to be. Overall, 

the fiscal tightening, together with the effects of the 

fiscal crisis (lower confidence, likely less willingness 

to supply credit by banks) led us to halve our growth 

forecast for the eurozone in 2011 to 0.6%. 

The choices for monetary policy are also very 

difficult 

The choices for monetary policy are also very 

difficult. In general, it is easier to be aggressive and 

creative when you are addressing liquidity crises or 

the potential for a second Great Depression and 

much harder when the scenario is a Japan-like 

outcome of slow growth and no inflation. There are a 

few easy first steps. The Fed already took the first 

step toward lengthening the horizon for zero rates in 

June by citing financial tightening and acknowledging 

the downward trend in inflation. It could further 

strengthen its language around the inflation and 

employment conditions that would lead to both 

further easing as well as tightening. Beyond rhetoric, 

the Fed could easily announce that it will re-invest 

the MBS rolling off, a decision that would forestall a 

decline in its balance sheet of USD 100bn-150bn per 

year that would otherwise begin in H2. This would be 

a signal that it is willing to maintain the current easy 

stance of policy and wouldn’t require a new facility or 

the re-initiation of an expired facility. Doing so would 

imply it would absorb 40-60% of net new mortgage 

supply at current rates. It could also lower the 

Chart 3: Core Prices are Decelerating 


interest it is paying on reserves from 25bp to zero, 

although this could lead to dysfunction in overnight 

funding markets (hence leaving it at 25bp and 

keeping a target for fed funds as a range between 

zero and 25bp even at the height of the crisis). 

Further expansion in central bank balance sheets 

would be predicated on a worsening in economic 

and financial conditions from here 

Phase two of quantitative easing, which is to say a 

further expansion in the Fed’s balance sheet, would 

be predicated on a worsening in conditions from here 

that could include deterioration in the labour market, 

further pronounced deceleration in inflation that 

appears to be leading to deflationary expectations 

(one could argue we are getting close with 

Treasuries where they are), indications that housing 

is slipping back into dangerous territory, or more 

pronounced financial market distress. 

Housing is still a source of systemic risk as a further 

significant leg-down in prices could produce a wave 

of strategic defaults and bank losses. This could 

prompt the Fed to invoke 13.3 (acting in “unusual 

and exigent circumstances”) and add another 

tranche of MBS purchases. While buying Treasuries 

is the purest form of quantitative easing – and the 

ease of exit is certainly something that recommends 

it – these purchases would likely raise political and 

market concerns that the Fed is monetising the debt. 

The Treasury purchase programme was widely 

viewed as ineffective by the Fed and certainly 

Treasuries are the asset class least in need of 

support. QE II would thus more likely be based on a 

serious worsening in conditions that would facilitate 

the invocation of 13.3 and further credit easing. 

There is a scenario in between that does not have 

an easy policy prescription – the muddle-through 

scenario we are currently in 

Beyond committing to zero rates and a stable 

balance sheet, it seems difficult to announce a bold 



5 


new expansion of the Fed balance sheet without a 

notable deterioration in the outlook. And it is not 

obvious that more mortgage purchases would be 

effective in stimulating aggregate demand, which is 

to say it is not clear the balance sheet can be 

effective in fine-tuning the outlook. In a speech in 

May 2003, then Fed Chairman Alan Greenspan gave 

three policy prescriptions to cure the Japanese 

deflation and stagnation. He said the Bank of Japan 

should commit to a price level rather than an inflation 

rate, thus signalling it would allow a period of 

reflation, or inflation temporarily above its target. He 

also suggested the Bank of Japan should purchase 

securities without consideration of the potential 

balance sheet losses realised down the road. Finally, 

he suggested that the federal government and the 

central bank engage in a one-time tax cut financed 

by the central bank’s printing of money. This seems 

to be an action expressly prohibited by the Federal 

Reserve Act and one that would be unwelcome in the 

current political environment. 

Eurozone on a different path 

The Fed has stopped adding to its balance sheet for 

the last several months, keeping the stock of 

purchased assets at high levels, and is now mulling 

whether to engage in further unconventional 

measures. The ECB’s policy in unconventional space 

has seen more variation. 

Aside from a tiny amount of covered-bond 

purchases, the ECB’s policy in unconventional space 

was until May not the outright purchase of assets but 

rather supplying liquidity in the money market. That 

has had two dimensions – supplying fixed rate 

money at an amount to be decided by the banks, not 

the ECB (fixed rate, full allotment), and supplying that 

money for longer periods than usual (i.e. through 3-, 

6- and 12-month Long Term Refinancing Operations 

or LTROs). Exit from this policy had already started 

with adjustments to duration – there have been no 

further 12-month LTROs since December last year. 

Despite the clear signs of financial stress in Greece – 

widening CDS and government bonds spreads, 

increased reliance by Greek banks on Bank of 

Greece funding – the ECB continued with its exit 

strategy, scrapping the 6-month LTRO after April and 

announcing that the 3-month LTRO would be a 

variable rate tender from April. 

The eurozone sovereign debt crisis put a stop to the 

exit in early May, with the ECB (i) reintroducing 

another 6-month fixed rate full allotment LTRO; (ii) 

18 

16 

14 

12 

10 

8 

6 

4 

2 

0 

Chart 4: ECB Government Bond Purchases 

(EURbn) 

Source: ECB 

ECB Purchases under the 

Securities Markets Programme (EURbn) 

1 2 3 4 5 6 7 8 9 

Weeks from the start of the Programme 

committing to further 3-month fixed rate full allotment 

LTROs until September; and (iii) buying limited 

amounts of peripheral government debt. 

The lack of enthusiasm for the latter course is 

illustrated by the public dissent expressed by Mr 

Weber at the instigation of the sovereign debt 

purchases and also by the scaling back we have 

seen in the quantity of those purchases over recent 

weeks (see Chart 4). This trend down in purchases 

shows that the ECB is continuing with the exit policy 

as is also clear from the fall in excess reserves and 

increase in money market rates following the 

expiration of the first 12-month repo on 1 July. 

Overall then, the Fed is contemplating a further 

round of QE in order to stabilise the economy and 

avoid a shift down in inflation expectations while the 

ECB seems to be continuing, albeit with a blip, its 

policy of trying to exit unconventional policies. It is 

quite possible that, in coming months, we see the 

ECB continuing to exit while the Fed institutes some 

form of QE2. The impact of this on the markets will 

depend on the speed of the ECB exit, the macro 

backdrop and exactly what measures the Fed 

chooses to pursue and on what scale. In underlying 

philosophy, there is a big gap between the Fed – do 

everything possible to avoid bad outcomes – and the 

ECB – do as little as possible and hope for the best. 

There is also a difference in terms of response to 

developments in the real economy, with the ECB 

being much less activist and eschewing ‘fine-tuning’. 

Thus it is quite possible that we see very different 

policy moves in coming months on the two sides of 

the Atlantic, which would have important implications 

for bonds, spreads and currencies. 



6 


US Housing: A Cold Summer 

• After the expiry of the first-time 

homebuyers’ tax credit at the end of April, 

housing starts in May plunged by 10.0% m/m, 

existing home sales declined by 2.2%, pending 

home sales fell 30.0%, and new home sales 

plummeted by 32.7%. 

• It is clear that much of the stabilisation in 

housing demand over the past year was a 

pulling forward of demand through low rates 

and the tax credit, leaving the outlook for 

housing highly uncertain. 

• Weekly data on mortgage applications to 

purchase indicate buyers’ interest declined 

further in June and early July after falling 

considerably in May – suggesting housing 

demand will remain depressed throughout the 

summer. 

2000 

1750 

1500 

1250 

1000 

750 

500 

Chart 1: Housing Starts to Remain Weak 

250 

May Aug Nov Feb May Aug Nov Feb May Aug Nov Feb May Aug Nov Feb May 

06 07 08 09 10 


Building Permits (lagged 1 month, k) 

Housing Starts (k) 

Chart 2: Pending Home Sales Plunge in May 

• As we move into the second half of the year, 

residential investment is likely to weigh again 

on economic growth. 

• In Q2, part of this weakness should have 

been offset by strength in brokers’ 

commissions, as total housing sales were better 

supported in April. 

• We have revised our forecast for residential 

investment down to 11.5% q/q AR for Q2 and to 

a decline of 5.0% in Q3. 

The recent data point to a notable softening in 

economic growth. Residential construction is 

one sector showing weakness 

Economic data softened notably in June, suggesting 

the recovery has lost some momentum. Housing 

demand has fallen more sharply than expected after 

the expiry of the homebuyers’ tax credit; the outlook 

for H2 is uncertain but likely to be a neutral at best 

for growth. Housing starts plunged by 66k (10% m/m) 

to 593k annualised units in May, erasing 80% of the 

gains recorded so far this year. Worryingly, 

weakness was concentrated in the single-family 

sector of the market, where builders broke ground on 

17.2% fewer projects in May compared to the 

previous month. 

Building permits fell for the second consecutive 

month in May, declining by 5.9% m/m after a 10.9% 

contraction in April, suggesting the pace of new 

construction is likely to remain depressed over the 

summer. Given that permits lead housing starts by 


Chart 3: No Demand for New Homes 


one to two months, the May decline in permits points 

to more weakness in new construction over the near 

term (Chart 1). Indeed, we expect housing starts to 

decline by another 13k to 580k in the June report 

next week. The weakness dovetails with a recent 5- 

point decline in the National Association of Builders 

Yelena Shulyatyeva 16 July 2010 


7 


confidence index, as builders reported that prospects 

for single family sales deteriorated in June. 

Existing home sales should drop sharply in June 

following a smaller decline the previous month. In 

May, existing home sales declined by 2.2% m/m and 

we expect they will drop by 12% in June as pending 

home sales plummeted 30% in May (Chart 2). New 

home sales plunged 32.7% m/m in May, supplying 

further evidence that prospective homebuyers pulled 

out of the market en masse after the government 

homebuyers’ tax credit expired in April. We expect 

new home sales to remain weak in June at 310k 

annualised units, rebounding by just 3.3% from the 

30-year low (Chart 3). Housing is slipping back into 

dangerous territory and a further extension of the tax 

credit could be beneficial. However, the recent failure 

of a stimulus bill that included aid to states and 

unemployment benefit extensions to pass the Senate 

highlights the lack of political will for further deficit 

spending. 

The bill signed into law on 2 July only extends 

the deadline for closing transactions 

The Homebuyer Assistance and Improvement Act of 

2010, signed by President Obama on 2 July, 

recognises that an estimated 180,000 prospective 

new homeowners were not able to meet the 30 June 

closing deadline for the tax credit that expired in April 

due to red tape involving mortgage lenders and 

guarantors. The new legislation extends the closing 

deadline from 30 June to 30 September for eligible 

homebuyers. The law thus provides any homebuyer 

who entered into a contract on a home by 30 April 

but was unable to go to closing within the required 60 

days, an additional 90 days to close and qualify for 

the credit. The legislation is great news for those 

homebuyers who were unable to close before 30 

June. However, it does not extend the deadline for 

homebuyers to sign a contract for a home. Therefore, 

while the new law will likely smooth the projected 

path of declines in existing home sales, it will not 

help revive the demand for housing. 

Mortgage applications have plunged recently, 

suggesting housing demand will remain subdued 

Mortgage applications to purchase a home declined 

by 22% m/m in May and another 11.5% in June, to 

their lowest level since 1996 – suggesting 

prospective buyers are already pulling back sharply 

and helping underpin our belief that housing demand 

will remain sluggish in the summer months (Chart 4). 

We have revised our forecast for residential 

investment down to 11.5% q/q AR for Q2 and to 

negative 5.0% in Q3 

We previously estimated more of a boost from the 

tax credit programme and the pullback to be more 

Chart 4: Mortgage Applications Plunged in May 


Chart 5: Broker Commissions to Support 

Residential Investment in Q2 


muted. We had projected residential investment to 

grow 17.0% q/q AR in Q2 and 5% in Q3. However, 

recent developments suggest less growth in Q2 and 

point to a contraction in Q3. In Q2, part of this 

weakness should have been offset by strength in 

brokers’ commissions, as total housing sales jumped 

by 8.5% m/m in April. The latest FOMC minutes 

made a note that “on net, the upswing in the volume 

of real estate transactions in recent months was 

likely to boost the brokers’ commissions component 

of residential investment in the second quarter”. 

Indeed, while new home sales plummeted by 32.7% 

m/m in May, demand for newly built homes currently 

accounts for a mere 5% of the market, while sales of 

previously owned homes dominate demand. In this 

respect, while existing home sales declined by 2.2% 

m/m to 5.66mn annualised units in May, the 

weakness was not enough to offset a healthy 8.0% 

gain in April. Brokers’ commissions on the sale of 

residential structures currently represent 18.6% of 

residential investment, and were supportive of overall 

growth (Chart 5). However, a 30% m/m plunge in the 

pending home sales index, which leads existing 

home sales by one to two months, points to less of a 

contribution from brokers’ commissions in Q2 than 

we previously estimated. Against this background, 



8 


we expect residential investment to grow by 11.5% 

q/q AR and contract by 5.0% in Q3. 

Subdued outlook 

The Freddie Mac 30-year fixed mortgage rate hit a 

new low of 4.57% last week (Chart 6). Fresh lows in 

mortgage rates should provide some support to 

housing demand. However, the bigger effect should 

be on mortgage applications to refinance. We look 

for only a modest improvement in housing demand 

through the remainder of the year. Consequently, 

there is likely to be downward pressure on housing 

prices. As the FOMC minutes noted: “House prices 

declined somewhat in recent months, reversing some 

of the modest increases that occurred in the spring 

and summer of 2009”. Home prices will likely remain 

sluggish throughout this year. 

Chart 6: Mortgage Rates at Historical Bottom 




9 


UK Inflation: Mind the Gap 

• Recent changes in the inflation measure 

used to index benefits and pensions have 

attracted attention to the difference between CPI 

and RPI inflation. 

Chart 1: Contributions to CPI-RPI Difference 

• We examine here exactly what drives the 

difference between CPI and RPI inflation and 

how the gap is likely to evolve. 

• We expect the gap to narrow temporarily 

over the coming year, before widening sharply 

during 2012 when Bank Rate begins to rise. 

The switch in the gauge of inflation that is used to 

benchmark private sector pension schemes has 

generated considerable attention in the differences 

between CPI and RPI inflation. The move, intended 

to boost consistency, follows the announcement in 

the Emergency Budget that public sector pensions 

and benefits will now rise in line with CPI inflation 

rather than RPI inflation. Given this, we have 

provided a guide to what the differences in the two 

indices are and secondly, how we expect the gap 

between the two to evolve. 

Difference between CPI and RPI 

The CPI and RPI are compiled using the same 

underlying price data. However, there are a number 

of differences: 

• The CPI excludes a number of RPI series, in 

particular, council tax, mortgage interest 

payments, housing depreciation and 

buildings insurance; 

• The CPI includes a number of series that are 

not included in the RPI. In particular, 

university accommodation fees, foreign 

students’ university fees and stockbrokers’ 

charges; 

• The weights applied to some components of 

the CPI are a little different from the weights 

applied to the equivalent component of the 

RPI; and 

• The CPI uses the geometric mean to 

combine the individual prices while the RPI 

uses the arithmetic mean. 

Note that RPIX is the RPI excluding mortgage 

interest payments. 

Source: Reuters EcoWin Pro, BNP Paribas 

Recent developments in the CPI-RPI differential 

The experience of the last 18 months provides a very 

good illustration of what typically determines the 

differential between CPI and RPI inflation. 

By far the biggest difference between CPI and RPI 

inflation is the inclusion of housing related 

components in the RPI but not the CPI (Chart 1). In 

turn, mortgage interest payments (MIPs) and house 

price inflation tend to be the biggest contributors. 

By way of example, the gap between CPI and RPI 

inflation exploded to over 3 percentage points during 

2009. RPI inflation plunged to a low-point of 

-1.6% y/y while CPI inflation only slowed to 1.1%. 

RPI inflation slumped owing to a combination of 

falling house prices and interest rate cuts. More 

specifically, the BoE slashed Bank Rate from 5.75% 

to 0.5%. This caused the MIPs component to plunge 

by 45% y/y. Given a weight of around 5% in the RPI 

index, that subtracted over 2pp from RPI inflation. 

Similarly, the house price inflation component of the 

RPI slumped to a low point of -13% y/y. With a 

weight of 5% in the index, that subtracted over 0.5pp 

from headline RPI inflation. 

Over the last year the differential has reversed i.e. 

RPI inflation has gone from around 3pp below CPI 

inflation, to 2pp above CPI inflation. The bulk of that 

change has reflected an unwinding of the influences 

that provoked last year’s undershoot. More 

specifically, since mortgage rates are no longer 

falling, the near 45% y/y decline in the MIPs 

component has recovered to +5%. That 50pp move 

in itself has added almost 2.5pp to RPI inflation since 

the trough. Likewise, house price inflation has 

Alan Clarke 16 July 2010 


10 


ebounded from -13% y/y to +8%. That has added 

another percentage point to headline RPI inflation. 

These developments have neutralised the 

contribution from housing and explain why RPI 

inflation is no longer below CPI inflation, but not why 

RPI inflation is now above CPI inflation. There are 

two main reasons for the near 2pp overshoot of RPI 

inflation relative to CPI inflation. 

The first is the formula effect i.e. the different 

averaging technique used in calculating the index. 

This is pretty stable through time at around 0.5pp, 

though currently accounts for 0.8pp of the differential. 

The other key contributor to the current gap is 

differences in weights between the two series. A 

good example of this is alcohol and tobacco. In the 

CPI this component has a weight of 4%, while it is 

more than double that (9.1%) in the RPI. Alcohol and 

tobacco inflation has been accelerating much more 

quickly than average over the last year, which, given 

the higher weight in the RPI helps to explain why RPI 

inflation has risen by more than CPI inflation. 

Which way now? 

We expect the gap between RPI and CPI inflation to 

narrow over the next 12 months to almost zero 

before widening again during 2012. More specifically, 

we expect a slowdown in the components such as 

alcohol that have accounted for much of the current 

gap between RPI and CPI inflation. Similarly, slowing 

house price inflation should bear down on RPI 

inflation, also contributing to the narrowing gap with 

CPI inflation. 

Thereafter we expect interest rate hikes during 2012 

to drive a wedge between the two series. Given the 

extremely low level of mortgage rates, a small 

interest rate hike is likely to have a big effect on RPI 

inflation. 

By way of example, the current level of the average 

mortgage rate according to the BoE is around 3½%. 

If the BoE were to hike Bank Rate to 2% by end- 

2012 (i.e. in line with market expectations), given the 

typical 70% passthrough to mortgage rates, that 

would represent a 30% increase in the MIPs 

component. In turn, that would add around 1.5pp to 

RPI inflation. 

from the MIPs component and hence the gap 

between RPI and CPI inflation. Unless Bank Rate 

continues to rise for ever, that contribution from rising 

mortgage rates should at some point begin to fade – 

2014 in our view. Although we would envisage the 

gap narrowing at that point the formula effect should 

ensure that the gap between CPI and RPI inflation 

stabilises at around 0.5-0.75pp. 

Changes to the index 

One potential additional influence on this gap is the 

inclusion of some measure of house price inflation in 

the CPI. When this does happen, it should help to 

narrow the gap between RPI and CPI inflation. 

However, this change has been a long time coming 

and we gather is unlikely before 2012. 

Conclusion 

Over the longer run, the gap between RPI and CPI 

inflation is likely to narrow relative to current levels to 

reside closer to 0.5pp y/y. However, over the shorter 

term, the gap is likely to remain variable not least 

when the BoE eventually begins to raise Bank Rate. 

While this presents a potential headache for private 

sector pension funds in adjusting to the new rules, 

the adoption of the CPI for indexing public sector 

pensions was a master stroke by the Chancellor. It is 

likely to save the government around GBP 6bn per 

year by 2014-15. 

Clearly, there has been some discontent expressed 

by those who will be receiving less from their state 

pensions. However, few (if any) have acknowledged 

that this year’s increase was well above RPI inflation. 

September is the reference month for public sector 

pensions and benefits. Last September, RPI inflation 

was around -1½% y/y. However, because of the 

2.5% floor applied to public sector pensions this 

year’s increase was 4pp above RPI inflation. The 

bottom line is that public sector pension payments 

may well miss out on the boost to RPI inflation (of up 

to 4pp) once Bank Rate begins to rise. However, we 

suspect a spell of amnesia will block out memories of 

the RPI increase awarded in April 2010. 

Alan Clarke 16 July 2010 


11 


Denmark: The Tide is Turning 

• Given excess liquidity in the eurozone, 

higher money market rates in Denmark led to an 

appreciation of the krone earlier in 2010. 

Chart 1: 3m Interbank & Official Rate Spreads 

• The krone, however, has been depreciating 

vis-à-vis the euro in recent weeks. 

• This seems to be driven by lower excess 

liquidity in the eurozone and thus higher money 

market rates. 

• Given these recent developments, we no 

longer expect rate cuts from the central bank. 

• There is some evidence that the Danish 

central bank already started to draw on its FX 

reserves to defend the currency. 

• We expect it to continue to do so as long as 

the weakening trend continues. Only if this 

proves unsuccessful and reserves fall too 

much, policy rates would be raised. 

Lower rates so far this year… 

Since the beginning of this year, the Danish central 

bank has cut its policy rate by a total of 15bp to 

1.05%. The interest rate on certificates of deposit has 

been cut even more, by 45bp to 0.5%. These 

reductions were a “consequence of further purchases 

of foreign exchange in the market”. The 

strengthening of the currency was a tightening of 

monetary conditions, with the accumulation of 

reserves an attempt to prevent this. But continued 

appreciation pressures had to be reflected in an 

easing in another aspect of monetary conditions, 

namely official interest rates. 

As we have highlighted before (see Denmark: 

Surprise, Surprise, Market Mover, 15 January 2010), 

as there is excess liquidity in the eurozone, the rate 

determining eurozone market rates is the deposit 

rate (0.25%) rather than the ECB’s refi rate (1%). On 

the other hand, the Danish central bank does not 

leave excess liquidity in the banking system. Instead, 

it supplies the liquidity banks want (full allotment) but 

then mops up with certificates of deposit (now at 

0.5%). This certificates of deposit/deposit rate 

differential, which explains higher money market 

rates in Denmark compared to the eurozone (Chart 

1), led to hot-money inflows. This in turn 

strengthened the Danish krone vis-à-vis the euro and 

prompted the Danish central bank to cut rates. 

…as the DKK gained ground 

The last two deposit rate cuts from the Danish central 



Chart 2: EUR/DKK 

bank (in May) were also driven by these factors. 

Given the intensification of stress in financial markets 

due to fiscal jitters in the eurozone, the ECB 

announced measures to enhance liquidity in the 

system. This also had implications for Denmark. For 

example, a eurozone bank with excess liquidity could 

put the money in Denmark at 0.7% (before the two 

rate cuts in May) rather than getting 0.25% in the 

eurozone. 

These rate differentials in turn led to an appreciation 

of the krone vis-à-vis the euro. In mid-June, 

EUR/DKK reached its lowest level since the 

beginning of 2005. 

But recently EUR/DKK has been moving higher 

very quickly… 

Since mid-June, however, EUR/DKK has been 

trending higher (Chart 2). On 13 July, EUR/DKK 

reached its highest level since October 2008, a 

period when the Danish central bank was increasing 

rates to bolster the krone. 

Gizem Kara 16 July 2010 


12 


At first glance, this latest development is puzzling. A 

current account surplus and changes in capital flows 

mean Denmark is still running a basic balance 

surplus, pointing to a stronger currency. Also, there is 

still a 25bp gap between the interest rate on 

certificates of deposit in Denmark and the ECB 

deposit rate – hence arbitrage opportunities continue. 

Chart 3: Use of Deposit Facility at the ECB & 

EUR/DKK 

So what is driving the recent depreciation of the DKK 

vis-a-vis the EUR? 

…driven by developments in the eurozone policy 

There seems to be a relationship between the use of 

the deposit facility at the ECB and developments in 

EUR/DKK over the past couple of months (Chart 3). 

The depreciation of the DKK could be partially driven 

by lower excess reserves in the eurozone, which 

could suggest lower flows into the DKK. 

Since the end of June, short-term money market 

rates in the euro area have also been drifting higher. 

The 1-week and 3-month Euribor rates have risen 

10-15bp over the past three weeks and are now back 

at their levels of June and August last year, 

respectively. The recent changes to refinancing 

operations at the ECB, including the expiry of the first 

1-year long-term refinancing operation, have reduced 

the excess liquidity in the system. This is pushing 

money market rates higher. Also, at the press 

conference after the rate decision last week, the ECB 

hinted at backing away from its unconventional 

measures. We believe the ECB should commit to 

take whatever action is necessary, given the 

problems in the eurozone sovereign debt markets 

and banks. But the ECB seems to be pushing on with 

the exit strategy, leading to expectations of higher 

rates (although the ECB has asserted that the 

increase in short-term rates should not be interpreted 

as a policy signal). 

In the meantime, Danish money market rates have 

been hovering around their all-time lows. With EUR 

rates now pushing up, money market spreads are 

trending lower. For example, given lower excess 

liquidity now in the eurozone, the Danish overnight 

rate spread vis-à-vis the eurozone has even turned 

negative (Chart 4). This is leading to outflows from 

the DKK into the EUR. 

The implications for Danish monetary policy 

We had expected the Danish central bank to cut its 

policy and deposit rates further as rate differentials 

with the eurozone were leading to an appreciation of 

the krone. But the recent depreciation of the DKK visà-vis 

the EUR suggests rate cuts are now unlikely, 

leading us to change our view. 

There is already some evidence that the central bank 


Chart 4: O/N Rate Spread (%) & EUR/DKK (% y/y) 


Chart 5: Foreign Exchange Reserves 


started to draw on its FX reserves to defend the 

currency (EURDKK ticked down on 14 July and 

pushing lower at the time of writing). 

Our assumption is that the ECB will further extend its 

liquidity provision, although likely divisions on the 

Governing Council could delay the implementation of 

such policies. Given this, the Danish central bank is 

likely to continue to draw on its FX reserves in the 

short term to support the currency. Only if such 

action fails, and reserves fall too much, the bank will 

need to hike rates. 

Gizem Kara 16 July 2010 


13 


China: House Price Controls to Continue 

• Since April 17, China has tightened policy in 

order to control housing prices, focusing on 

suppressing investment and speculative 

demand. 

50 

45 

Chart 1: Property Investment Continues 

Accelerating (% YTD) 

• Housing transactions have fallen 

substantially but a significant correction in 

house prices has not yet taken place. 

• As China’s economic growth momentum 

has weakened significantly, the market is 

starting to speculate that housing policy will be 

relaxed while banks are starting again to extend 

mortgage loans for third houses and more. 

• Our argument that there will be no relaxation 

is underscored by government actions, with 

three authorities reiterating that the policies to 

rein in house prices are unchanged and that the 

objective of controlling prices is intact. 

• We expect the correction in house prices to 

gain momentum; the housing industry may have 

bottomed out by the end of the year. 

Commercial banks in Shanghai, Nanjing, Hangzhou, 

Shenzhen and Beijing are reported to have quietly 

resumed the extension of mortgage loans for third 

houses or more but with a deposit of more than 50% 

and at a rate of more than 110% of the policy rate. 

There has been much speculation that the authorities 

will relax house price controls given the general 

weakening in economic growth momentum and the 

government's increasing concerns of ‘overcooling’. 

The authorities said earlier this week that the 

measures to control prices are not being rescinded. 

The Ministry of Housing and Rural-Urban 

Development reiterated that the government will 

continue to implement the policies set out by the 

state council on 17 April, and remains determined to 

suppress investment and speculative demand in 

housing. The ministry, however, supports increased 

investment in the construction of ordinary and public 

housing. 

The CBRC, for its part, has clearly stated that there 

is no change in mortgage loan policy for second 

house and more, with all commercial banks required 

to strictly abide by financial rules and regulations. 

The State Asset Administration Commission (SAAC) 

denied the reports saying it was requiring property 

developers in state-owned enterprises (SOEs) to 

aggressively acquire more land, restating that the 

40 

35 

30 

25 

20 

15 

10 

5 

0 

04 05 06 07 08 09 10 

Source: NBS, BNP Paribas 

Residential property investment 

Property investment 

SAAC is demanding 76 central SOEs for which 

property development is not their core business to 

sell off their property development arms. 

House price controls to continue 

In fact, the objective of controlling house prices is far 

from being achieved. Since 17 April, when the state 

council announced its intention to stop housing 

prices from rising too far too fast in some cities, 

housing transaction have fallen substantially. 

However, in tier-1 cities in particular, the correction in 

house prices has not yet occurred – at most, it has 

just started. This can be seen from the indicators of 

property performance below. 

Property investment growth continues to accelerate: 

it came in at 39.6% y/y in Q2, up from 35.1% in Q1 

(H1: 38.1% y/y). Residential housing investment, 

which accounts for 69.3% of property investment, 

accelerated from 33% y/y in Q1 to 35.1% in Q2 (H1: 

34.4% y/y). Property space under construction 

increased by 28.7% y/y in H1, but newly started 

property space surged by 67.9% y/y. However, 

completed property space increased by only 18.2% 

y/y, and residential housing space completed rose by 

15.5% (Chart 1). 

Property transactions have fallen. Property sales 

amounted to 394 million sqm in H1 10, up by 15.4% 

y/y, but growth slowed from 35.8% y/y in Q1 to 5.4% 

in Q2. Residential housing sales rose 12.7% y/y in 

H1, but growth plunged from 34.2% in Q1 to 2.2%. 

Sale values rose 25.4% y/y in H1 10, but the growth 

rate also dropped sharply – from 57.7% y/y in Q1 to 

10.1%. Housing sales increased by 20.3%, with 

growth slowing to 4.4% in Q2 from 55.2% (Chart 2). 

Xingdong Chen 16 July 2010 


14 


But property prices have barely corrected… 

The property price index increased 11.4% y/y in June, 

compared to 12.4% in May, 12.8% in April and 

11.7% in March. The index actually dropped 0.1% 

m/m in June, the first m/m decline recorded for 17 

months. The housing price index was up 14.1% y/y in 

June, but was flat in m/m terms (Chart 3). 

…because property developers are not short of 

funding 

Property investment capital supply rose 45.6% y/y in 

H1. Capital supply is equivalent to 178% of property 

investment. Capital borrowed from banks increased 

by 34.5% y/y (compared to overall lending growth of 

19.2%), property developers’ self-raised funds 

surged by 50.9%, and other funds were up by 47.9%. 

Property developers are thus not under pressure to 

cut house selling prices for cash flow purposes 

despite housing inventory rising, even stepping up 

the pace of investment and construction (Charts 4 

and 5). 

Controlling house prices has become a political 

game between the central government and property 

developers. Local governments are waiting for the 

central government to change policy. In our view, 

house price controls will not be changed for the time 

being. If the government relaxes current policy in any 

way, house prices could start to rise again and the 

authorities would lose credibility. 

In fact, if the government relaxes controls at this 

stage, the property industry could in the longer term 

suffer even more than it would if policy is left 

unchanged. It is a critical time for both the 

government and property developers. As long as 

house prices fall by 10-15%, social expectation will 

be satisfied, the government will relax the controls 

and the property industry will be able to return to 

normal growth. If the government continues with its 

existing policies, the correction in house prices will 

gather momentum and the policy objective could be 

achieved in Q4 this year. 

In terms of policy, we expect the government to strike 

a better balance between propping up growth and 

economic restructuring at the upcoming summer 

meeting; we do not expect a general easing. Rather, 

we expect selective easing: a delay or scaling down 

of the measures to rectify local government financing 

vehicles; the easing of policies designed to tackle 

excessive capacity and pollution; and the alleviation 

of measures to tighten corporate liquidity. 

Chart 2: Property Transactions have Declined 

Substantially (% YTD) 

90 

80 

70 

60 

Property sales value 

50 

40 

30 

20 

10 

0 

Property sales volume 

-10 

-20 

-30 

00 01 02 03 04 05 06 07 08 09 10 


Chart 3: House Price Correction has Only Just 

Started 

114 

112 

110 

108 

106 

104 

102 

100 

(Dec 08 = 100) 

Property price index 

98 

Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 


Chart 4: Housing Inventory is Rising (% YTD) 

70 

60 

50 

40 

30 

20 

10 

0 

-10 

Floor space completed 


-20 

00 01 02 03 04 05 06 07 08 09 10 


80 

70 

60 

50 

40 

30 

20 

Chart 5: Newly Started Property Space May 

have Peaked (% YTD) 

Floor space started 


10 

0 

-10 

-20 

00 01 02 03 04 05 06 07 08 09 10 


Xingdong Chen 16 July 2010 


15 


Japan: Post-Election Outlook for Tax Reform 

• The Kan Government’s election defeat was 

not due to its talk of a sales tax hike but to 

comments that tax hikes would boost growth. 

This smacked of ‘big government’ and put off 

independent voters. 

• Since the pro-reform camp within the DPJ is 

sure to be under pressure from the antireformists 

to take responsibility for the election 

defeat, fiscal reform will likely be stalled in the 

near term. 

• From a longer-term perspective, fiscal 

restructuring will stay on track because the two 

largest parties both recognise the need for 

reform (including tax rises). 

• Until the DPJ’s leadership election in 

September (when Kan’s fate as leader will be 

determined), we expect the Kan government to 

horse-trade with other parties to secure the 

cooperation or alliances needed for stable 

governance. 

Election setback was not due to tax hike talk 

Did the Kan government lose Sunday’s Upper House 

election (and with it, the ruling bloc’s majority in that 

chamber) because of its forward-looking stance on 

fiscal restructuring and a consumption tax hike? The 

LDP also advocated fiscal reform and a consumption 

tax hike, yet it gained seats. Clearly, much of the 

electorate now understands that unless fiscal reform 

also includes higher taxes, the nation’s public debt 

will snowball out of control. One reason voters chose 

the LDP over the DPJ is probably that Prime Minister 

Kan has been anything but forthcoming on the 

reason for the consumption tax hike. 

With Kan’s pre-election comments about a tax hike 

bolstering economic growth, many voters feared that 

the tax hike would not just be used to improve the 

state finance and reform social security but it would 

also go on new spending programmes under the 

guise of ‘growth strategies’. In other words, Kan’s 

comments smacked of ‘big government’, and this put 

off the majority of independent voters. In any event, if 

the prime minister sees a tax hike as a means of 

bolstering economic growth via greater state 

involvement (spending) in the private sector, he is 

grossly mistaken (see accompanying article, Japan: 

PM Kan’s Dubious Economics). 

Chart 1: Composition of Upper House 

Ruling 

110 

People's New 

Party and 

others (4) 

DPJ(106) 

Source: BNP Paribas 

LDP84) 

Total242 

Opposition 

132 

Others (18) 

New Komeito 

(19) 

Your Party 

(11) 

Short-term slowdown in pace of tax reform 

What is the outlook for fiscal restructuring following 

the government’s election setback? Will tax reform 

be sidetracked? One reason Japan’s long-term 

interest rate has edged lower this past month is 

because the two largest political parties, the ruling 

DPJ and the opposition LDP, were both advocating 

accelerated fiscal reform in their election campaigns 

(of course, the main reason was downward pressure 

on the global equilibrium real interest rate from 

weakening growth expectations for the US and EU). 

Now, with the pro-reform camp within the DPJ likely 

to be under pressure from the anti-reformists to take 

responsibility for the election defeat, the result will 

likely be a compromise in both the tempo and 

content of tax reform proposals at least until the 

DPJ’s leadership election in September. 

Consequently, there could be some increase in the 

fiscal risk premium. Even so, we doubt that the longterm 

rate will show any pronounced nominal increase 

because private sector demand for funds is unlikely 

to pick up owing to Japan’s deflation and falling 

growth expectations. 

Fiscal reform to stay on track over long haul 

From a longer-term perspective, however, we do not 

think that the latest election results will necessarily 

derail fiscal reform. As pointed out above, the DPJ 

and LDP both recognise the need for fiscal reform. 

Thus, even though the Diet will likely continue to be 

divided (the Upper House is controlled by the 

opposition, the Lower House by the ruling camp), it is 

important that a majority of lawmakers, regardless of 

party affiliation, now acknowledge the need for fiscal 

consolidation and tax reform. What is more, this shift 

in opinion in the Diet was brought about not because 

Ryutaro Kono 16 July 2010 


16 


political leaders persuaded the public but because 

politicians reacted to the public’s own realisation of 

the nation’s worsening fiscal predicament. Even if 

bickering within the ruling camp somewhat slows the 

pace of fiscal restructuring, the divided Diet will, 

ironically, ensure that reforms are not derailed 

entirely (this is one of the merits of the gradualistic, 

consensus-based decision making in a bicameral 

system). 

Fiscal reform has wide support 

Issues such as pension reform and fiscal reform are 

national problems, so a supra-partisan approach is 

certainly the best way to go. Indeed, the recent fiscal 

restructuring programmes of Germany and the UK 

were decided by coalition governments. It might 

therefore be fortunate that the Kan government’s 

recently unveiled fiscal management strategy only 

deals with the big picture (objectives, targeted 

timeframes). The lack of specifics should make it 

easier for parties to collaborate, as they are starting 

with a blank slate that can be filled in together – 

rather than a detailed programme that must be 

haggled over. Each party naturally has its own vision 

for Japan and the optimal tax system, but the 

country’s dire fiscal situation should make nonpartisan 

cooperation on reform possible. 

But hurdles exist 

That said, there are high hurdles that must be 

overcome in order to achieve cooperation with the 

opposition. The LDP has indicated that it is prepared 

to engage in multiparty talks on the tax reform issue, 

on the condition that the DPJ scrap spending 

programmes that it promised in its manifesto for last 

year’s Lower House election (e.g. child-rearing 

allowances). Many reform-minded DPJ lawmakers, 

including cabinet ministers, would probably be 

amenable to amending the campaign promises in 

order to advance discussions on tax reform. However, 

the camp (led by Ichiro Ozawa) that is lukewarm on 

tax reform is adamant that promises must be kept. If 

the reformists move to get their way by force, 

acceding to the demands to forgo campaign 

promises, there is a chance that the internal divisions 

in the DPJ could split the party in two. 

Link-ups with like-minded smaller parties? 

As for other opposition parties, the policy ideas of 

small parties such as New Komeito and Your Party 

are similar to those of the DPJ; incorporation into the 

ruling coalition is thus not inconceivable. New 

Komeito is the most like-minded in that it recognises 

the necessity of tax reform (including an increased 

consumption tax) in order to prop up the tottering 

social welfare systems. 

However, an outright link-up with the DPJ looks 

unlikely, as New Komeito fought fiercely against the 

party in the Upper House election campaign, 

slamming the DPJ for its money scandals (Hatoyama, 

Ozawa) and ineffective leadership, and arguing that 

the DPJ-led coalition should be kicked out of office. 

New Komeito, moreover, is still closely linked with 

the LDP (they cooperated in the recent election by 

not fielding candidates against each other). 

Meanwhile, Your Party, a newcomer on the scene 

(created in 2009 by LDP defectors) which emerged 

as the biggest winner in the Upper House election (it 

gained 10 seats), advocates fiscal restructuring via 

spending cuts and accelerated growth; it is opposed 

to raising taxes. The DPJ would therefore find it 

difficult to secure cooperation on tax reform from this 

party, although the two might be able to cooperate on 

other issues. 

Behind-the-scenes horse-trading until after DPJ’s 

leadership election 

At this juncture, it is hard to gauge what kind of 

framework the government will adopt in running the 

Diet and formulating policies, including tax reforms. 

The DPJ has indicated that it intends to engage in 

policy-based cooperation with other parties, but 

stronger links with a specific party will be needed for 

stable governance. On the surface, not much is likely 

to happen until after the DPJ’s leadership election in 

September (when Kan’s fate as leader will be 

decided), but behind the scenes the Kan government 

is likely to horse-trade with other parties to win closer 

cooperation, or an alliance. 



17 


Japan: PM Kan’s Dubious Economics 

• Prime Minister Kan has said that tax hikes 

and increased government spending can boost 

economic growth. We fundamentally disagree 

with this assertion. 

• Kan might feel that there will be a relatively 

high fiscal multiplier if the government 

increases spending now, at a time when there 

are still substantial idle resources, on the 

assumption that taxes will be hiked when the 

economy is sustainably expanding. But that is 

just a case of macro-stabilisation, which can 

only temporarily support a falling growth rate. 

• There is little evidence that tax money spent 

by the government in the name of promoting 

growth is effective. In any event, because 

Japan’s huge public debt must be repaid some 

day, the fiscal multiplier should, from a longterm 

perspective, be deemed less than 1. 

• While many might support the proposition 

that tax hikes to increase government spending 

on healthcare and nursing would boost 

economic growth, the root problem in 

nursing/healthcare in Japan is not the lack of 

money but unnecessary regulation that prevents 

the provision of services that people want. 

• Although talks on tax hikes will probably 

stall over the short term now that the 

government has lost its Upper House majority, 

the Kan government needs to change its 

thinking on taxes and growth if history is not to 

judge its policies harshly. 

Kan’s strange contention 

Barely one month has elapsed since the Kan 

government was born and its de facto election mode 

from the very outset means its policies so far have 

just a generalised sense of direction and little 

content; this makes a critique all but impossible. 

Nevertheless, we comment here on something that 

troubles us: Kan’s contention that a tax hike 

(specifically the consumption tax) can lead to 

economic growth. Is the tax hike meant to repair the 

state finances or to reform the nation’s social welfare 

systems? Or is it to supply revenue for financing 

some other objective (a growth strategy)? Our 

apprehension springs from Kan’s vagueness on this 

point. If Kan sees a tax hike as a “growth strategy,” 

namely as a means of securing revenue to stoke 

domestic demand with more government spending, 

he is fundamentally mistaken in our view. 

Government has the correct three objectives 

but… 

When the Kan Government was inaugurated, the 

prime minister stated that the goal of his government 

would be to achieve a “strong economy, robust public 

finances and strong social security system”. At that 

time, we argued that, because these objectives are 

contingent upon each other, their simultaneous 

pursuit could indeed be the right path for achieving 

the ultimate objective of bettering the economic 

welfare of the Japanese people, or, in other words, 

achieving a higher level of consumption on the back 

of increased and sustainable income growth. We 

also warned, however, that focusing just on one 

objective, say social security, might lead to a 

momentary jump in consumption but the health of the 

economy and state finances would suffer because 

future generations would have to pay a larger bill. 

Admittedly, simultaneously pursuing all three 

objectives is easier said than done. But stopping the 

potential growth rate from falling, avoiding a debt 

crisis and correcting the defects in social security are 

all grave structural problems that Japan cannot 

ignore. Having long argued for the necessity of 

quickly addressing these problems, we lauded the 

Kan government for making them top priorities. 

Additionally, when the Kan government unveiled its 

strategy for fiscal restructuring with the Upper House 

election just weeks away, we saw it as both correct 

and courageous. The prime minister’s subsequent 

comments, however, have been less encouraging, 

especially those linking a tax hike with economic 

growth – which suggests that he deems the former as 

a means of bolstering the latter. 

One frequently hears about tax cuts, not hikes, 

bolstering economic growth. Indeed, such a view has 

long been advocated both in economic circles and by 

business. The contention is that cuts in income taxes 

boost work incentives, while lower corporate taxes 

improve profits ratios and encourage capital 

formation, both then translating into some degree of 

improvement in the potential growth rate. The basic 

argument here is that tax increases and/or heavy tax 

burdens stifle economic activity. 



18 


…average fiscal multiplier is 1, at best 

Prime Minister Kan did not say that taxes would be 

raised so that fiscal consolidation would bolster 

economic growth (non-Keynesian effect!). His 

assertion is that the government will hike taxes in 

order to increase public spending to boost economic 

growth. But does such rhetoric really hold up against 

logic and experience? First, logic tells us that 

economic entities whose income has been 

appropriated by the government via higher taxes will 

naturally cut back on spending. Assuming the 

government does not squander the money 

appropriated, the increased spending by the 

government will have zero effect (the plus of 

government spending will just offset the minus of 

reduced spending by the taxed economic entities). 

The balanced budget multiplier is 1. In truth, however, 

the multiplier is probably lower as the government’s 

ability to use tax money more efficiently than the 

private sector is questionable. 

Advocating more macro-stabilisation? 

Now, if the government increases spending at a time 

when there are substantial idle resources due to 

recession, with the assumption being that taxes will 

be hiked when the economy is expanding, the fiscal 

multiplier would be higher. This could be what Kan 

has in mind. But this is just a case of macrostabilisation, 

which can temporarily support a falling 

growth rate. Bolstering the potential growth rate is a 

different matter completely. The prime minister’s 

argument seems to mix up macro-stabilisation and 

policies to correct structural defects. 

Even if it is macro-stabilisation, there is little evidence 

that the tax money spent by the government with the 

aim of promoting economic growth is spent 

effectively. In any event, because Japan’s huge 

public debt must be repaid sometime in the future, 

the fiscal multiplier should, from a long-term 

perspective, be deemed less than 1. That is why we 

are so adamant that, except for emergencies, fiscal 

policy should never be used as economic stimulation. 

Since Japan’s growth rate is low not just for cyclical 

reasons but also because of structural problems, 

macro-stabilisation is not the right response. The 

lesson from Japan’s experience over the past twenty 

years, in our view, is that repeated use of macrostabilisation 

depresses the long-term performance of 

the economy. 

Will spending on social infrastructure bolster 

potential growth? 

Of course, the potential growth rate can be boosted if 

the government supplies the infrastructure that 

private economic entities cannot. In cases of market 

failure, if the government uses income appropriated 

from the private sector via tax hikes to complete 

needed social infrastructure, the potential growth rate 

can be raised thanks to the resulting improved 

convenience and return on capital for the private 

sector. But can such public investment projects really 

be implemented? Unfortunately, more often than not, 

the government errs in selecting projects, with the 

result that the authorities’ heavy meddling in the 

private sector leads to reduced return on capital for 

private economic entities – in turn weighing on the 

potential growth rate. There certainly are necessary 

public investment projects that are never 

implemented, but the reason seems not to be the 

lack of money. Consequently, there is no guarantee 

that tax hikes would actually translate into the 

creation of social infrastructure that bolsters potential 

growth. 

Will spending on nursing/healthcare yield greater 

economic growth? 

Rather than government spending in general, let’s 

consider the specific case of expenditure on 

nursing/healthcare. Most people would probably 

support the assertion that “tax hikes to increase 

government spending on healthcare and nursing 

would boost economic growth”. Since we have long 

argued that a big reason why Japanese save rather 

than spend is due to anxieties about the future, 

linked to Japan’s deficient social welfare systems, we 

do not want to reject this proposition outright. But we 

have one misgiving. The overriding problem in the 

nursing and healthcare sector is not the lack of 

money but unnecessary government regulation that 

prevents the provision of nursing and healthcare 

services that people want. Thus, since the problem is 

in the design of these systems, increasing 

government spending alone won’t result in the 

provision of better services. What is needed is 

deregulation. Without it, more government spending 

will just waste more money, while also weakening the 

nation’s economic welfare. 

Problem is unnecessary regulations, not the lack 

of resources 

Nursing and healthcare will not be growth industries 

if they become public services funded by tax money. 

Growth industries are born when service providers 

appear that supply the services people are willing to 

pay for. In the case of nursing/healthcare, only those 

actually consuming the service are in a position to 

know if they are getting value for money; the 

government should not make such decisions. If the 

problem is deemed to be insufficient resources and 

government spending is increased, as pointed out 

earlier, the economic effect will be zero, as the plus 

from increased spending in nursing/healthcare will 

just offset the minus of reduced spending by the 

economic entities that have had income taken away 



19 


through higher taxes. Given the problem of 

inefficiency whenever the government gets involved, 

the multiplier is surely less than 1. The same holds 

for the other sectors that the Kan government has 

identified in its growth strategy. 

Correct growth strategy is deregulation 

We have long been saying that the source of 

sustainable growth is the freedom to discover and 

innovate. Innovation leads to the goods and services 

that people are willing to pay for. At the same time, 

the value-added that is thereby created leads to 

improved labour productivity and a sustainable 

increase in income for the people involved. 

The most effective way to encourage innovation is 

free economic activity, not the expansion of the 

government’s sphere of influence. While there are 

areas where government involvement is needed to 

address market failure, the authorities should 

basically leave the private sector alone. Thus, 

deregulation is the most effective growth strategy. 

‘Policy failure’ can be more harmful than ‘market 

failure’ 

History has shown that government intervention 

aimed at fostering the development of a particular 

industry will not only deprive other (growing) 

industries of valuable economic resources but it will 

also end up removing the ‘sheltered’ industry’s 

potential to grow by undermining all incentives to 

innovate. When government gives support to a 

company, industry or geographical area, it usually 

ends up depriving the recipient of its ability to stand 

on its own feet. Thus, people who support 

government involvement to address cases of market 

failure should not forget that ‘policy failure’ can have 

more damaging effects. 

Kan’s fundamentally flawed assertion 

To conclude, the Kan Government has lofty goals of 

achieving a “strong economy, robust public finances 

and strong social security system”. But if it deems tax 

hikes and increased government spending to be the 

way to boost economic growth, the nation’s potential 

to grow could be further damaged and improving 

Japan’s fiscal condition could be further delayed. 

With the DPJ having lost an Upper House majority, it 

now seems likely that the debate on tax hikes will 

slow, making it difficult for discussions on new 

spending to even begin (see accompanying article, 

Post-Election Outlook for Tax Reform). In any event, 

the Kan government should change this way of 

thinking to prevent its policies being harshly judged 

by history. 



20 


US: 10y Range Trade with a Receiver Fly 

• Investors are increasingly comfortable with 

the prospect of the 10y rate hovering around 

3% in the near term, without a strong 

directional trend. 

• The range trade lends itself to selling 

volatility, but there is a strong preference to 

limit the downside in any trade. 

Chart 1: 10y Swap Rate and the Breakeven 

Levels of the 3m10y Swaption Fly 

4.5 

4 

3.5 

• STRATEGY: Buy a 3m10y receiver fly, 

struck ATMF+15bp, ATMF-10bp, ATMF-35bp. 

The maximum payout ratio is 3.6:1. 

3 

2.5 

Breakeven levels 

2 

With the economic reports showing a slowdown in 

the pace of recovery lately, there is a broader 

acceptance of the spectre of low rates not just in 

terms of monetary policy but also in terms of term 

rates. With the risk of ever lower inflation down the 

road, it appears rather unlikely that rates will spike 

higher in the next few months. Nor is there much 

chance of a strong rally from current levels absent a 

flight-to-quality event, as investors find it difficult to 

stomach a sub-3% rate on 10s and sub-4% on 30s – 

after all, the deflationary mindset is slow to seep into 

the collective consciousness. This backdrop bodes 

well for range trades, and as an extension, for selling 

volatility. 

Being cognisant of the strong preference investors 

have for trades with a well-defined downside, we 

analyse swaption butterflies (rather than selling 

strangles, or 1x2 trades) to express the range-trading 

view. The idea is to buy a butterfly that brackets the 

most recent range of the underlying rate. Scouring 

the field for a good combination, we find that the 10y 

tail offers a good opportunity, especially with 3m and 

6m expiries. While the premise is the same and the 

6m trades have a higher expiry payout ratio, the 3m 

version is preferable in our opinion, thanks to the 

speed at which the payout can be realised over the 

next three months. More specifically, we recommend 

buying the ATMF+15bp, ATMF-10bp and ATMF- 

35bp 3m10y receiver fly (the centre leg, ATMF-10bp, 

is chosen to match 10y spot to mitigate any 

directional bias in the trade). 

Chart 1 shows the recent range of the 10y swap rate. 

The breakeven levels of the butterfly trade, also 

shown on the same chart, cover the range that had 

prevailed since the downward adjustment of the 

prognosis for US economic growth and inflation, 

along with rate hike expectations, began in June. It is 

clear from the chart that the upper breakeven level 

7/15/09 

8/15/09 

9/15/09 


10/15/09 

11/15/09 

12/15/09 

Chart 2: Performance of the Fly over Different 

Horizons (in bp) 

200 

150 

100 

50 

0 

-50 

-100 

sits at the bottom of the rate range before that 

change in outlook. More to the point, that level acted 

as a floor for rates when the economy was perceived 

as recovering handsomely. Given that the 10y rate 

has broken that support level and seems to have 

settled into a lower range, it is conceivable that it will 

break back up to the upside unless the macro picture 

changes materially. 

Chart 2 shows the PnL of the trade over different 

horizons, expressed in bp. At inception the cost of 

the structure is 48bp. For reference, at expiry the 

trade can generate about 171bp of profit, which 

translates to a 3.6:1 payout ratio. 

1/15/10 

-30 -20 -10 0 10 20 30 


2/15/10 

3/15/10 

4/15/10 

now 

2m 

5/15/10 

1m 

6/15/10 

expiry 

Bulent Baygun 16 July 2010 

Market Mover, Non-Objective Research Section 

21 


US: TSY Switches for Yield/Duration Pick-Up 

• Many are envisioning a range-trading 

summer, setting the market up for a yield-grab 

as investors look to extend duration. We focus 

on specific switches that have cheapened 

recently. 

• A Z-score approach to ASWs helps identify 

RV opportunities between neighbouring Tsy 

issues in various sectors of the curve. 

• STRATEGY: Look to switch between 

relatively rich and cheap issues (or consider 

RV spread trades) as per the recommendations 

below. 

` 

We first examine 30, 60, and 90 day asset swap 

spread Z-scores, which represent the number of 

standard deviations from the mean. Rather than 

drawing broad conclusions about a particular sector’s 

rich/cheapness, we look for relative rich/cheapness 

between neighbouring issues. We also keep in mind 

that the goal is to generally extend duration and seek 

yield pick-up (although this isn’t always the case), 

while also limiting the directional/curve exposure. 

The resulting trades are spread across the maturity 

spectrum, as shown in Table 1. None of the issues 

listed in the Table appear to be trading special in 

repo, which would have partially explained their 

richness. 

4.375% Aug-12s vs 4.125% Aug-12s (Chart 1) 

This is a switch from an old 10yr to an old 5yr note, 

and with 15 days of curve. We estimate the fair value 

of the curve to be around 1.5bp in this sector, making 

the yield pick-up of 4.5bp look compelling (the Z- 

score methodology suggests this is 2.8bp too high). 

Chart 1 shows that the spread is also near the top 

end of its range. 

2.5% Mar-13s vs 1.75% Apr-13s (Chart 2) 

This is a switch from an old 5yr to an old 3yr note, 

and with 15 days of curve. Again we estimate the fair 

value of the curve to be around 1.5bp in this sector, 

and the yield pick-up of around 10bp is the highest 

amongst the various switches we show (although in 

this case there is no duration pick-up). Chart 2 shows 

that the spread is also near the top end of its range. 

Table 1: Selection of Switches That Look 

Attractive on Z-Score 

Rich Issue Relative To 

90d Z-Score 

Spread 

BP 

Cheapness 

Duration 

Pickup 

Yield 

Pickup 

4.375 08/15/12 4.125 08/31/12 0.3 2.8 0.04 4.5 

2.5 03/31/13 1.75 04/15/13 0.4 3.0 0.00 10.2 

3.25 05/31/16 5.125 05/15/16 0.7 3.2 0.29 -3.9 

2.75 02/15/19 3.125 05/15/19 0.9 2.2 0.27 7.1 

7.875 02/15/21 8.125 05/15/21 0.4 0.8 0.34 4.2 


7 

6 

5 

4 

3 

2 

1 

0 

-1 

Chart 1: 4.375% Aug-12s vs 4.125% Aug-12s 

-2 

-4 

Jul-09 Oct-09 Jan-10 Apr-10 Aug-10 


12 

11 

10 

9 

8 

7 

6 

Yield Spread 

Chart 2: 2.5% Mar-13s vs 1.75% Apr-13s 

5 

Apr-10 May-10 Jun-10 Jul-10 


ASW Diff (RHS) 

Yield Spread 


5 

4 

3 

2 

1 

0 

-1 

-2 

-3 

11 

10 

9 

8 

7 

6 

5 

4 

3 

2 

3.25% May-16s vs 5.125% May-16s (Chart 3) 

In this case we are shortening the maturity by 15 

days, although there is still a duration pick-up. 

Instead of moving to a higher yield there is actually a 

Suvrat Prakash 16 July 2010 


22 


give-up because we’re switching from an old 7yr to 

an old 10yr which will tend to trade richer. However 

as Chart 3 shows, the old 10yr has almost always 

traded richer than the current 4bp, and two months 

ago traded as rich as 10bp. (Z-score methodology 

suggests the spread should be 3.2bp lower) 

2.75% Feb-19s vs 3.125% May-19s (Chart 4) 

This switch is amongst the more liquid issues, since 

both are fairly recent 10y notes. In Chart 4 it looks as 

if this spread has gradually grinded higher so the 

mean-reversion qualities may not be as compelling 

(although Z-scores suggest the pick-up should be 

closer to 5bp than the current 7bp). Still, the current 

shape of the yield curve does not suggest that the 

spread could roll any higher, since the spread 

between older 10yr notes is fairly constant at 7bp. 

Chart 3: 3.25% May-16s vs 5.125% May-16s 

0 

1 

0 

-2 

-1 

-4 

-2 

-3 

-6 

-4 

-8 

-5 

-10 Yield Spread 

-6 


-7 

-12 

-8 



7.875% Feb-21s vs 8.125% May-21s (Chart 5) 

In the sector of old bonds, there is a fairly steep 

rolldown as old 30yrs roll into the 10y sector. This 

makes it attractive to extend maturity for those 

holding issues in the 10-11y sector. Chart 5 shows 

that the pick-up has risen to the top end of its range 

recently, and the current spread of 4bp appears to be 

rolling flat when compared to shorter-maturity old 

bonds. 

8 

7 

6 

5 

4 

3 

2 

1 

Chart 4: 2.75% Feb-19s vs 3.125% May-19s 

Yield Spread 


6 

5 

4 

3 

2 

1 

0 

0 

-1 

-1 

-2 

-2 

-3 



Chart 5: 7.875% Feb-21s vs 8.125% May-21s 

5 

5 

4 

4 

3 

3 

2 

2 

1 

Yield Spread 

1 


0 

0 



Suvrat Prakash 16 July 2010 


23 


US: Corporate Issuance and Swap Spreads 

• Summer doldrums: USD high grade 

corporate bond issuance tends to be lowest in 

the months of July and August, averaging USD 

48bn (5.6%) and USD 58bn (6.7% of total 

issuance for the year), respectively, over the 

past five years (Chart 3). Despite predictions 

by some analysts of an increase in corporate 

issuance for the summer of 2010, July 

issuance so far is right on trend at USD 33 

billion, and will likely slow through the 

remainder of the month as US earnings season 

enters high gear. 

• Distortions in 2008 and 2009: Corporate 

issuance trends in 2008 and 2009 were deeply 

affected by (a) the burgeoning economic crisis, 

peaking with the failure of Lehman in Sept 

2008, which practically shut out financials from 

the market for a time; and (b) a huge rebound 

in issuance due to both FDIC guarantees 

(Chart 3) and a surge in Yankee bonds (Chart 

1) as a favourable move in the cross currency 

basis made the US markets more attractive. 

• 2010 trends: On a cumulative basis, 2010 

high grade corporate issuance appears in line 

with 2006 and 2007 (Chart 2). On a sector 

basis, Yankee bonds have dominated issuance 

YTD (Chart 1), having surged in January-April, 

while US financial issuance appears to be 

lagging. We expect a moderate pick-up in 

issuance as blackouts due to earnings season 

and summer wane. However, impending 

changes in debt and capital composition due 

to financial reform combined with only USD 34 

billion of USD 330 billion outstanding of FDIC 

guaranteed debt maturing through year-end 

may restrain offerings from the financials. We 

expect total high grade issuance for 2010 may 

hover around USD 850 billion. 

• STRATEGY: Expect swap spreads to be 

pressured tighter as issuance increases 

through the fall. Although corporate supply is 

typically a second-order effect on spreads, 

there has been a diminished influence of 

mortgage hedging and the slope of the yield 

curve in the current environment. This opens 

the door to corporate issuance possibly having 

an outsize effect. 

Swap spread regression models 

There is a rich and evolving academic literature on 

what drives swap spreads. Standard models are 

typically multivariate linear regressions which assess 

Chart 1: High Grade Corp Issuance (by sector) 

Amount (blns) 

1,400 

1,200 

1,000 

800 

600 

400 

200 

0 

163 

287 

86 

Yankees 

Financials 

Utilities 

Industrials 

238 

364 

248 242 

416 400 

166 199 205 

the correlations between swap spreads and the 

following known empirical driving factors (roughly in 

order of importance in the pre-crisis environment): 

• the slope of the yield curve and the level of rates; 

• the refinancability of the mortgage market (to 

capture the influence of mortgage hedging, 

understanding that this factor is of course correlated to 

the first two); 

• liquidity premium; 

• Treasury supply; and 

• corporate debt issuance (where fixed-rate debt is 

often rate-locked ahead of issuance and then 

swapped back to floating, resulting in a tightening bias 

on spreads). 

Technical note: most swap spread models are run on 

spreads only up to the 10-year. The 30-year swap 

spread across currencies has long been 

acknowledged as something of an anomaly, with a 

dominant factor being the hedging needs of exotics 

options desks and therefore volatility. It has only been 

with the recent use of the swap spread multifactor 

541 

375 

274 

270 

94 

87 

2005 2006 2007 2008 2009 YTD 2010 

Source: Informa Global Markets, BNP Paribas 

Chart 2: Corp Issuance (cumulative by year) 

Amount (in billions) 

1,400 

1,200 

1,000 

800 

600 

400 

200 

- 

2005 

2006 

2007 

2008 

2009 

2010 

~195b (16%) of 

2009 iss FDIC gtd 

JAN FEB MA R APR MAY JUN JUL AUG SEP OCT NOV DEC 

Source: Informa Global Markets, BNP Paribas 

Mary Beth Fisher 16 July 2010 


24 


term structure models mentioned below that 30-year 

spread dynamics have been incorporated with some 

success into the standard framework. 

One of the drawbacks to linear regression models is 

that they can’t capture any tendency for the influence 

of the factors to vary over time or operate across 

different horizons. For example, the effect of corporate 

issuance on swap spreads acts as a rather short-term 

effect – e.g. the swapping of a fixed rate issue to 

floating exerts tightening pressure on spreads on the 

day the issue is swapped. Corporate issuance also 

tends to exhibit seasonal patterns, as evidenced in 

Chart 3. A pick-up in Treasury supply tends to be a 

more fundamental economic signal, and its “normal” 

tightening bias on swap spreads has been shown to 

act over longer periods of time. 

Of course the current economic environment has 

turned many of these “normal” factors on their heads. 

The enormous amount of Treasury supply hasn’t 

appeared to exert much pressure on front end 

spreads, and the impact of convexity hedging of 

mortgage portfolios – which used to be a dominant 

factor correlating 5y and 10y swap spreads to the level 

of rates – has dropped off dramatically. 

Swap spread term structure models 

These changes in the economic environment and 

clear alterations in the strength of various correlations 

have increased the use of full blown term structure 

models to analyse the term structure of swap spreads. 

These stochastic models attempt to capture the 

variability of economic factors, curve and volatilities on 

swap spreads over time. 

An excellent example of this approach is detailed in 

the December 2008 paper, “Modeling Swap Spreads 

in Normal and Stressed Environments”, by Vineer 

Bhansali, Yonathan Schwarzkopf and Mark Wise. 

Although a complete synopsis of this paper and their 

approach is beyond the scope of this article, it is worth 

repeating several of the conclusions. 

“...a robust model of swap spreads... should capture the key factors 

we know that describe the movement of swap spreads. These 

factors include the level and shape of the sovereign yield curves, the 

relative supply of risky to riskless debt, the activity of mortgage 

hedgers (convexity hedging), and the movements in credit spreads. 

(pg 2) 

It has been shown that one of the drivers of the swap spread is the 

slope of the yield curve. [The] value of the 10 year swap spread was 

regressed versus the yield curve slope for data spanning January 

1997 to August 2003. As the slope of the yield curve the author used 

the difference between the 10 year and 2 year rates and the linear 

regression coefficient was calculated to be −0.19. The negative 

value of the coefficient implies that the swap spread tightens as the 

curve steepens. This coincides with the intuition that as the yield 

curve steepens market players prefer to be the fixed-rate receiver in 

a swap and commercial banks will be less inclined to hedge their 

short term variable rate deposits reducing the demand to be a fixed 

rate payer. This will reduce the demand for swaps and as a result 

will decrease the swap rates and tighten the spread... 

Interestingly, the negative dependence of the swap spread on the 

slope of the yield curve breaks down around the summer of 2007... 

Starting at around June 2007 the swap spread widens as the slope 

of the yield curve steepens. ... This behavior seems to be associated 

with a breaking of the usual dependence of the swap spread on the 

slope of the yield curve.” 

Corporate issuance and swap spreads 

As the paper points out and the markets have 

experienced, swap spreads traversed a period, and 

may still be in it, where the slope of the curve is not a 

dominant driver. Our experience over the past year, 

since the paper was published, also points to the 

diminishing effect of mortgage hedging activity and 

Treasury supply on spreads. 

So what’s left? Clearly the liquidity premium – which in 

some sense can become a “catch all” factor – appears 

to be dominating front end spread dynamics. 

Historically corporate issuance was a second-order 

influence on spreads. Now that corporate issuance 

patterns appear to be normalizing somewhat from the 

event-driven patterns of 2008 and 2009, it’s possible 

that the supply of risky debt may become more 

influential on spreads. 

Although we expect only a moderate pick-up in high 

grade issuance as we exit the summer doldrums, we 

think this might have a more concentrated than normal 

tightening effect on swap spreads – particularly in the 

front end – given the absence of influence from the 

other “normal” drivers. 

Chart 3: US High Grade Corporate Issuance (monthly, since 2005) 

Amount (in billions) 

180 

160 

140 

120 

100 

80 

60 

~30% in Jan09 FDIC gtd 

~20% FDIC gtd 

~36% FDIC gtd 

2005 

2006 

2007 

2008 

2009 

2010 

Lehman failed Sept 08 

~100b (86%) of Dec 08 

issuance w as FDIC guaranteed 

40 

20 

- 

JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC 

Source: Informa Global Markets, FDIC, BNP Paribas 

Mary Beth Fisher 16 July 2010 


25 


MBS: Higher Coupons Could Speed Up Later 

• Refi risk in current coupon mortgages 

could cause them to trade to shorter empirical 

durations. Due to this factor, we maintain a 

neutral outlook on mortgages. 

• Higher coupon prepays could pick up over 

coming months as the credit impaired nature 

of such borrowers might have delayed 

processing. 

80% 

70% 

60% 

50% 

40% 

Chart 1: Empirical Durations 

4.0s Empr 4.0s Trader 4.5s Empr 4.5s Trader 

5.0s Empr 5.0s Trader 5.5s Empr 5.5s Trader 

30% 

20% 

As shown in Chart 1, mortgages had been trading to 

longer durations (empirical) through June, when the 

market rallied but recently these durations have 

declined. As the low-yield scenario persisted in June, 

the demand for incremental yield intensified, helping 

mortgage spreads to tighten in the rally, leading to 

longer durations. Another way of looking at this is 

that, since the market trend was mostly a one-way 

rally train in June and prepayments were expected to 

be low, mortgages were trading with positive 

convexity. 

In the selloff that came after (preceding the most 

recent rally), empirical durations started coming off. 

Wednesday’s rally however led mortgages to widen, 

continuing the declining duration trend despite a rally. 

We think that for lower coupons, the refi risk, 

especially in the 08 and also 09 vintages is 

considerable as demonstrated in the recent prepay 

report, and may be contributing to this trend; indeed, 

it may have been a game changer. Note how as we 

go up in coupon the empirical durations seem to be 

ticking up. 

We expect the continued market sentiment of a 

slower economic recovery to push yields lower. This 

could increase demand for incremental yield, helping 

mortgage spreads to tighten. But the sceptre of 

higher prepays in current coupons makes us neutral 

on the basis, and we may consider selling mortgages 

on strength, should they tighten considerably in a 

rally. 

Even after the mortgage primary rate reached 

another all time low last week, the refi index actually 

declined. Borrowers are clearly not getting the full 

benefit of low rates. But the newer lower coupons 

that define the current coupon mortgage basis as 

such are callable, even though the mortgage 

universe as a whole may not be all that much 

callable. It is from the basis perspective that we 

10% 

0% 

2-Apr-10 23-Apr-10 14-May-10 4-Jun-10 25-Jun-10 


ZV OAS 

Chart 2: Current Coupon OAS and ZV OAS 

85 

80 

75 

70 

65 

60 

55 

50 

03-May-10 24-May-10 14-Jun-10 05-Jul-10 

Source: Yield Book 

ZV OAS 

OAS 

expect 4s and 4.5s to trade to shorter durations in a 

rally. 

Since MBSPP proceeds are not reinvested, 

increased prepays increase the net supply to the 

market, which is negative for mortgages. Otherwise, 

the Fed put to bed any imminent expectations of 

MBS sales in its latest minutes and re-iterated that 

monetary tightening will take place first before assets 

sales begin. The Fed also left the door open to more 

accommodative policy if the economy gets worse, 

but extending mortgage purchases is only a 

probability at this point. Overall, these factors also 

favour a neutral outlook. 

Along the coupon stack we continue to like 5 and 

5.5s, which have not completely recovered from the 

levels before the Fed started its coupon swap 

activities. As we have mentioned in the past, the Fed 

was selling rolls so as to not force dealers to deliver. 

However, system-wide fails had persisted despite the 

selling of rolls, and should continue despite coupon 

16 

14 

12 

10 

8 

6 

4 

2 

0 

-2 

-4 

OAS 

Anish Lohokare/Olurotimi Ajibola 16 July 2010 


26 


swaps. The overall volume of USD 9.2 bn was small 

compared to the system-wide fails. Granted, a chain of 

fails can show up as an artificially high number but the 

magnitudes are clearly a multiple. While convexity is a 

concern in these coupons, the limited response to lower 

rates and the reduced float will only serve to exacerbate 

the squeeze in the coupons. 

Could refi's on higher coupons pick up in coming 

months? 

In a pre-prepay note, we had discussed that banks 

may have processed applications quicker in June to 

save capital by converting loans to MBS. This may 

have caused elevated June supply, possibly causing 

prepays to come in higher than expected (June 

borrowing prepays from July). Prepays on lower 

coupons did come in faster than expected but those 

on higher coupons didn’t. However, if banks did 

indeed process applications quicker, those with 

cleaner credit would have likely been processed 

more easily. This may explain the sharp discrepancy 

in prepays in the coupon stack. 

In fact based purely on the relationship between the 

refi index and prepays (adjusted for business days), 

it appears that the lag between prepays and the refi 

index was shorter than the typical 45 days (Chart 3). 

This could have essentially been magnified in lower 

coupons at the expense of higher coupons. 

In Figure 4, we show how prepays ramped in late 

2008-early 2009. It shows that higher coupons took 

more time in ramping up than lower coupons. Chart 5 

shows that the acceleration of CPR for the 6.5% 

coupon is lagging the 5%, 5.5% and 6% coupons 

during the December 2008 spike. The best way to 

compare it is to use the following calculation: 

CPR_month_(t-1) – 2 x CPR_month_(t) + 

CPR_month_(t+1). As clearly shown in the table, the 

acceleration of CPR for 6.5% coupon is much lower 

in the month of December and it is the only positive 

one in January. 

Chart 3: 4-Week Moving Average Change in Refi 

Index for Different Lag Periods 

Refi Index( Chg) 

80% 

60% 

40% 

20% 

0% 

-20% 

-40% 

-60% 

Feb-09 May-09 Aug-09 Nov-09 Feb-10 May-10 

Source: Bloomberg, BNP Paribas 

45 Day Lag 4 Week Average 

30 Day Lag 4 Week Average 

Chart 4: Prepayment Speeds by Coupon 

CPRs 

40 

35 

30 

25 

20 

15 

10 

5 

0 

Nov- 

08 

Dec- 

08 

Source: eMBS, BNP Paribas 

Jan- 

09 

Feb- 

09 

Mar- 

09 

Apr- 

09 

May- 

09 

5 

5.5 

6 

6.5 

Jun- 

09 

Chart 5: Acceleration of Prepayment Speeds by 

Coupon (CPR_month_(t-1) – 2 x CPR_month_(t) 

+ CPR_month_(t+1)) 

Coupon Feb-09 Jan-09 Dec-08 

5.0 -8.7 -4.6 8.9 

5.5 -9.9 -6.6 10 

6.0 -6.8 -4.1 6.3 

6.5 -7.6 2.8 3.8 

Source: eMBS, BNP Paribas 

This effect may be particularly magnified this time 

around, given that the GSEs seem to be pursuing 

reps and warrants, including the repurchase of loans 

not underwritten to their standards. Prepays on 

higher coupons may thus surprise to the upside over 

the coming months. Also note that negative 

seasonals come into play for delinquencies, a fact 

reflected better in the FG delinquency numbers last 

month. 

Anish Lohokare/Olurotimi Ajibola 16 July 2010 


27 


EUR: Eonias to Push Up Further 

• Excess liquidity continues to fall. Along with 

less demand at the ECB’s liquidity providing 

operations, this is pushing eonias up. 

Chart 1: Liquidity Provided Started to Decline 

• Figures at the early stage of the current 

reserve period highlight further tensions ahead 

on eonias. 

• STRATEGY: Keep paying interest on eonias 

for the November and December ECB meetings. 

Liquidity continues to decline 

The expiry of the 1y tender had reduced liquidity 

provided by open market operations by around EUR 

200bn, from more than EUR 900bn to just above 

EUR 700bn. This was enough to trigger limited 

upward pressures on eonias. But liquidity has 

continued to fall. Demand at last week’s MRO was 

EUR 45bn below the total maturing. Demand this 

week fell again, with EUR 195.7bn allotted for EUR 

229bn expiring. The rise in demand at the 28day 

tender (up EUR 17.6bn) did not offset the EUR 

33.4bn drop at the MRO. As a result, liquidity 

provided by open market operations declined further 

and now stands at EUR 620.5bn, slightly more than 

EUR 50bn above average needs for the current 

reserve maintenance period. This is particularly low, 

especially at the early stage of the reserve period. 

Indeed, reserve requirements (EUR 214.3bn for the 

current reserve maintenance period from 14 July to 

10 August) are calculated as an average during the 

period. Usually, banks put significantly more in their 

current accounts at the ECB than this average at the 

start of the period, in order to be ahead of the 

required level. This allows banks to lower the level of 

reserves gradually during the period and therefore 

avoid the risk of having to find cash at the end of the 

period, which would fuel severe upward pressures on 

rates. For many months, liquidity was ample enough 

to allow banks to put more than EUR 100bn in 

excess reserves at the start of the period while 

keeping excess liquidity above EUR 100bn in the 

market. In that context, eonias were stuck to lows 

and immune from any upward pressures. 

Eonias to rise further 

As liquidity is now only EUR 50bn above needs, 

banks are unable to put significantly more than 

required in their current accounts. According to the 

ECB, current account holdings were at EUR 240bn 

the first day of the period, i.e. EUR 26bn above the 

average level. Such level of excess reserves is quite 

low compared to the levels seen for many months 


Chart 2: Eonias are Pushing Closer to the Refi 


(above EUR 100bn). And this reduces the available 

excess liquidity in the market to below EUR 25bn. At 

this level, it is impossible to see eonia easing to the 

levels prevailing at the start of recent reserve 

periods. The 0.444% for the first day is 10bp above 

the level the same day of the previous period. 

Moreover, the situation is far from being 

homogeneous. It is clear that fewer banks have stillcomfortable 

levels of excess liquidity and are putting 

far more than required in their accounts, while an 

increasing number of banks are probably short of 

cash. This means that tensions on eonias will not 

ease during the current period, and could even gain 

momentum: the upward trend for eonias is now 

established. This is far from being priced in by 

forwards for the end of the year, with ECB November 

and December meetings at 0.70% and 0.73% 

respectively. 

Strategy: Keep paying interest on eonias for the 

November and December ECB meetings. 

Patrick Jacq 16 July 2010 


28 


EUR: Deflation Macro Hedge Via Options 

• The probability of a Japan-style collapse in 

forward rates and the term structure has 

increased in line with a 75bp drop in 5Y5Y since 

the start of this year. 

• STRATEGY: Buy 2.9%-2.0% 5Y5Y receiver 

spreads at zero cost and positive carry. 

The process of adjustment towards a lower 

equilibrium long-term rate has been ongoing since 

the start of this year. We have made the case for 

lower 5Y5Y rates in a series of research notes (e.g. 

“EUR: Long-Term Equilibrium Rates”, 5 March, and 

“EUR: Equilibrium Rates Revisited”, 4 June). Here, 

we provide ways to play this theme with controlled 

downside risk. 

Since the start of this year, EUR 5Y5Y has declined 

by 75bp, reflecting a combination of rallying Bunds 

and flatter term structure. Outright bullish strategies 

such as 2.50% 5Y5Y receivers have performed very 

well on the back of this underlying dynamic (+75%). 

The main argument for such a strategy is based on 

long-term fundamental projections (Table 1). Our 

macro scenario implies another 50-55bp of decline in 

5Y5Y rates (based on long-term average growth, 

inflation and term premium). However, if we 

substitute our forecast with realised inflation and 

growth in Japan from the 1992-2002 sample, the 

argument for receiving 5Y5Y rates is even more 

compelling, as the equilibrium rate declines to around 

1.4%. Note that JPY 5Y5Y ended 2002 at around 

1.5%. 

Chart 1: ECB and Long-Term Rates 

4.50 

5.50 

4.00 

ECB (LHS) 

EUR 5Y5Y 

5.25 

3.50 

5.00 

3.00 

4.75 

2.50 

4.50 

2.00 

4.25 

1.50 

1.00 

4.00 

0.50 

3.75 

0.00 

3.50 

2003 2004 2005 2006 2007 2008 2009 2010 


Table 1: Estimating Equilibrium Rates 

Equilibrium Rates - BNP Paribas Scenario 

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Average 

GDP 1.2 0.6 1.0 2.2 1.0 1.5 1.5 1.5 1.2 1.2 1.3 

CPI 1.6 1.4 0.7 1.8 1.5 1.5 1.5 1.5 1.5 1.5 1.5 

Term premium 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 

Long term rate equilibrium 3.24 

EUR 5Y5Y live 3.83 

Equilibrium Rates - Japan 1992-2002 Scenario 

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Average 

GDP 0.3 0.1 2.4 3.2 -0.3 -1.5 -0.2 2.6 -1.6 1.7 0.7 

CPI 1.0 0.7 -0.3 0.6 1.8 0.6 -1.1 -0.1 -1.1 -0.3 0.2 

Term premium 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 

Long term rate equilibrium 1.35 

EUR 5Y5Y live 3.83 

JPY 5Y5Y End 2002 1.50 


Chart 2: EUR 5Y5Y volatility 

90.0 

0.50 

EUR 5Y5Y ATM normal vol 

85.0 EUR 5Y5Y SABR Alpha (RHS) 

0.45 

80.0 

0.40 

Strategy: We propose two investment ideas based 

on the same underlying philosophy, i.e. a controlled 

downside macro deflation hedge: 

75.0 

70.0 

65.0 

0.35 

0.30 

0.25 

1) Buy EUR 5Y5Y 3.00% – 2.00% 1x1 receiver 

spread at the cost of 80 cents. Buying 

outright receivers is quite expensive due to 

the strong performance of 5Y5Y forwards. 

Also, the still-elevated level of ATMF vol and 

alpha (vol of vol) makes outright solutions 

relatively expensive (Chart 2). 

60.0 

0.20 

55.0 

0.15 

50.0 

0.10 

2003 2004 2005 2006 2007 2008 2009 2010 


2) Buy EUR 5Y5Y 2.90% – 2.00% 1x2 receiver 

spread at zero cost. Strategy delivers 

negative P&L only below 1.1% at expiry. 

Strategy has positive carry of 8 cents after 

one year and 30 cents after two years. 

Alessandro Tentori 16 July 2010 


29 


EUR: Yet Another Volatility Deflation Trade 

• With the exception of severe dislocations at 

the height of the credit crisis, the 10y10y skew 

has undergone flattening and steepening 

pressures with rising rates and falling rates, 

respectively. 

• STRATEGY: Buy the EUR 10y10y 

3.50%-2.75%-1.00% swaption receiver ladder. 

Historically, there has been a negative relationship 

between the steepness of the swaption implied 

volatility skew and the level of rates. This makes 

intuitive sense: everything else being equal, at higher 

levels of rates, deep out-of-the-money swaption 

receivers are more attractive than deep out-of-themoney 

payers. The opposite holds when rates are 

low. 

2.0 

2.5 

3.0 

3.5 

4.0 

4.5 

5.0 

5.5 

Chart 1: Evolution of EUR 10y10y Pay/Rec 

Implied Volatility Spread 

10y swap 

6.0 

2003 2004 2005 2006 2007 2008 2009 2010 


200bp out Pay/Rec Implied Volatility Spread (RHS) 

Chart 2: EUR 10y10y Smile vs JPY 10y10y 

Smile 

6 

4 

2 

0 

-2 

-4 

-6 

Chart 1 plots the long-term evolution of the EUR 

200bp wide implied volatility spread against the 

10-year swap. With the exception of severe 

dislocations at the height of the credit crisis, the 

10y10y skew has undergone flattening and 

steepening pressures with rising rates and falling 

rates, respectively. 

It is worth comparing the current shape of the EUR 

10y10y smile with its Japanese counterpart. Both 

smiles are plotted in Chart 2: note the much steeper 

JPY smile! It is worth highlighting that the twentyyear 

range on the JPY 10y10y swap rate is between 

1.39% and 4.18%. The current rate at 2.42% is still in 

the first quartile. Clearly, if the Euro economy 

continues to head towards a deflationary state, we 

should expect the implied volatility skew to steepen 

ahead. 

Accordingly, in “EUR: Deflation Macro Hedge Via 

Options” in this issue of Market Mover, we show two 

downside macro deflation hedges via swaption 

receiver spreads which generate positive PnL in the 

event of a cheapening of the receiver skew. 

Alternatively, the deflation risk can be played via 

swaption receiver ladders which put additional weight 

on the dynamics of out-of-the-money receivers. Chart 

3 plots the terminal payoff of the EUR 10y10y 

3.50%-2.75%-1.00% swaption receiver ladder (the 

10y swap rate is currently around 2.89% versus the 

10y10y swap rate at 4.14%). The trade costs 38bp 

(indicative). At expiry, the trade generates losses if 

the 10y swap settles below 30bp! For comparison the 

JPY 10y swap attained its all-time low of 43bp mid- 

June 2003. More importantly, the position carries 

1.20% 

1.10% 

1.00% 

0.90% 

0.80% 

0.70% 

0.60% 

0.50% 

0.40% 

EUR 10y10y smile 

JPY 10y10y smile 

0.30% 

0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 


7.0 

6.0 

5.0 

4.0 

3.0 

2.0 

1.0 

0.0 

-1.0 

-2.0 

-3.0 

Chart 3: Terminal Payoff of EUR 10y10y 

3.50%-2.75%-1.00% Receiver Ladder 

-4.0 

0.00 1.00 2.00 3.00 4.00 5.00 


positively with the expected total return over the 

coming year (next two years) estimated at around 

8% (22%). Exposure to the skew dynamics is 

reflected by SABR Rho around EUR 10,000. 

Terminal max pay-out ratio is 1:14. 

Matteo Regesta 16 July 2010 


30 


EUR: SAS Diversification to Enhance Yields 

• In this analysis, we look at strategies to 

enhance yields in a low-rate environment. The 

steepness of SAS curves has increased 

recently, which is well-suited to our scenario. 

• STRATEGY: Sell KFW Apr 15 vs buy CADES 

Apr 20; Sell CADES Apr 12 vs buy Apr 15 or 20; 

Switch from NETHER Jul 20 to CADES Apr 20. 

70 

65 

60 

55 

50 

45 

Chart 1: Developments in 2/10s ASW 

40 

Assume a low interest rates, low inflation, low growth 

environment that lasts for more than a policy relevant 

period of two years. The relevant question for fixed 

income investors will be about maintaining a more or 

less constant risk/return profile. In order to achieve 

this goal, one possible strategy is to diversify funds 

across different types of AAA categories (e.g. from 

core EUR govvies into agencies). Another strategy, 

equally viable, is to ‘diversify’ into longer duration 

buckets. This strategy is especially suitable in a 

steep yield curve environment. We analyse this 

second strategy, concentrating on SAS space (we 

have already discussed the issue of duration 

extension on the swap curve in previous research). 

Analysis 

As Chart 1 shows, we are in a particularly steep 

curve environment. Thus, now is a good time to enter 

longer-duration trades. 

CADES has the steepest curve of the main three 

agencies, hence offering the best pick-up for 

duration-extension strategies (Chart 2). 

For example, CADES 2/5s is worth 39bp and 2/10s is 

68bp. By comparison, similar curve segments on EIB 

are worth 37bp and 59bp, respectively. The KFW 

curve is the flattest of the three analysed here, 

sporting 2/5s at 32bp and 2/10s at 52bp. 

However, the KFW curve merits some RV 

considerations. As Chart 2 shows (circled), there are 

some distortions on the KFW curve, which should 

only be temporary (we don’t see any fundamental 

reasons behind them). In particular, there is a 25bp 

ASW differential between KFW Jul 14 (cheap) and 

KFW Jun 13 (rich). 

Trade Ideas 

1) Investors holding KFW should consider switching 

into CADES for a better pick-up: sell KFW Apr 15 vs 

buy CADES Apr 20 (49bp). 

2) The slope of the CADES curve is at historical 

highs over the 1y horizon (Chart 2): sell CADES Apr 

12 vs buy CADES Apr 15 or 20. 

35 

30 

Aug 09 Oct 09 Dec 09 Feb 10 Apr 10 Jun 10 

KFW EIB CADES 


Chart 2: CADES Offer the Steepest Curve 

40 

30 

20 

10 

0 

0y 2y 4y 6y 8y 10y 12y 

-10 

-20 

-30 

-40 

KFW 

EIB 

CADES 


Chart 3: CADES versus Govvies (asw Space) 

40 

35 

30 

25 

20 

15 

10 

5 

0 

Feb 10 Mar 10 Apr 10 May 10 Jun 10 Jul 10 

CADES 4 1/4 04/20 FRTR3 1/2 04/25/20 NETHER 3 1/2 07/20 


3) The cheapening of French government bonds 

relative to Netherlands since the start of the year 

pushed the 10y ASW differential of CADES versus 

Netherlands government bonds to a significantly high 

level (Chart 3): switch from NETHER Jul 20 into 

CADES Apr 20 for a high pick-up (24bp). 

Camille de Courcel 16 July 2010 


31 


JGBs: Fiscal Austerity – Not an Easy Task 

• Since Kan’s “third way to growth” that puts 

emphasis on the social welfare is nothing more 

than “big government”, markets will worry 

about the growing fiscal burden of an ageing 

population. 

• Now that the Upper House elections are 

over, financial markets will again take note of 

the various difficulties in restructuring 

government finances. The JGB market’s 

attempts to test the upside have ended and 

steepening pressures are growing. 

LDP 

84 

New 

Komeito 

19 

Chart 1: Parties’ Diet Standings 

The Upper 

House 

242 seats 


Your Party 11 

DPJ 

106 

LDP 

116 

The Lower 

House 

480 seats 

New Komeito 21 

DPJ 

306 

Fiscal restructuring remains difficult 

The DPJ suffered a crushing defeat in the 11 July 

Upper House elections, losing the majority it held 

with its coalition ally NPP. As a result, the DPJ will 

need to collaborate with the New Komeito Party and 

Your Party, on each economic policy measure. Thus 

it has become difficult for the DPJ to pursue fiscal 

austerity independently. A consumption tax hike has 

become a politically delicate subject, particularly 

now, since the election defeat is deemed due to PM 

Kan’s comments on a hike in the rate. 

Under the current circumstances, fiscal restructuring 

remains difficult, even with the ten seats won by Your 

Party, which is the only party that respects the 

market mechanism. Instead, the left wing of the DPJ 

that stresses correcting economic disparities — the 

Kan-Edano policy line — has become even more 

prominent and their policy affinity with the New 

Komeito is growing. Since Kan’s “third way to growth” 

that puts emphasis on the social welfare is nothing 

more than “big government,” markets will worry about 

the growing fiscal burden of an ageing population. 

Not easy to implement the Scandinavian model 

The Scandinavian model that combines significant 

welfare benefits with a sizeable tax burden is being 

re-evaluated, in part because of the stable economic 

performance of northern European nations. However, 

other factors have also played a role in their success: 

small populations of several million individuals help 

explain the high average levels of education, high 

labour mobility and great trust in governments. It 

would not prove easy to implement successfully this 

model in Japan, a nation with a rapid rise in the 

average age of the population of 130 million. 

Incidentally, consumption tax (VAT) rates are around 

25% in northern European countries. If Japan were 

to raise its consumption tax rate incrementally from 

the current 5% to 25%, this would take twenty years 

if the rate was hiked by 1% per annum or ten years if 

increased 2% annually. Since memories of the 

sizeable impact that past consumption tax hikes have 

had on the Japanese economy are still fresh, it is 

unrealistic to hike this tax continuously without regard 

to the state of the economy. This implies that once 

the government has started to go down the road of 

raising the consumption tax, it will find the going long 

and hard. 

Steepening pressures are growing 

Now that the Upper House elections are over, 

financial markets will again take note of the various 

difficulties in restructuring government finances: 1) 

talk of hiking the consumption tax has again proven 

to be a headwind for the ruling bloc and the 

consumption tax ‘trauma’ will linger among 

lawmakers; 2) despite PM Kan’s stress on fiscal 

discipline, a coalition government makes it hard to 

implement all policy measures; and 3) apart from 

future consumption tax changes, the government has 

to start the compilation of the FY2011 budget. 

The JGB market’s attempts to test the upside have 

ended and steepening pressures are growing. Not 

only will uncertainty over the eurozone financial 

system abate but implementing fiscal austerity will 

not be an easy task. After the Upper House election 

and bank stress tests, we should focus on the real 

economy. With the economy resilient, the earnings 

environment for financial institutions is not 

unfavourable. Hence we recommend that investors 

carefully evaluate the fundamentals rather than 

rushing into the market. 

Koji Shimamoto 16 July 2010 


32 


Global Inflation Watch 

June CPI in Focus 

The final release of the eurozone HICP for July 

showed a marginal rise in core inflation (from 0.85% 

y/y to 0.92%) offset by a slowdown in energy 

inflation, as a modest fall in energy prices over the 

month (-0.4%) was exacerbated by base effects. The 

modest acceleration in prices of clothing and 

recreational items probably reflects the impact of the 

weaker euro. Spanish data also revealed some passthrough 

from the VAT hike. We expect more in July 

but, with the main retailers announcing that they have 

not transferred it to their customers, the overall 

impact of the tax hike should remain limited (we 

assume a 40% pass-through, implying a boost to 

Spanish core inflation of around 0.6pp). 

All in all, neither the euro weakening nor the VAT 

increases implemented in some countries appears to 

be sufficient to halt the underlying downward trend in 

core inflation that we expect to resume from July, 

with aggressive discounts putting downward pressure 

on the prices of goods such as clothing and furniture. 

The picture was slightly different in the UK, where the 

CPI/RPI releases surprised once again to the upside. 

Upward pressures were seen in a number of servicerelated 

components, with core CPI inflation matching 

its all-time high of 3.1% y/y. We remain of the view 

that inflation will slow over the next few months, as 

the impact of the GBP weakness fades, while growth 

in disposable income slows from the robust pace 

seen recently. Recent data and some creep in 

inflation expectations (Chart 2) highlight the risk that 

the downward trend turns out to be slower than we 

currently anticipate. 

The next focus is Friday’s release of the US CPI. The 

headline CPI is expected to fall by 0.1% m/m. Pump 

prices fell throughout June – the lagged response to 

weaker crude oil prices in May. As a result, after 

seasonal adjustment, the energy CPI should fall by 

1.4% m/m in June. The core CPI, meanwhile, should 

be unchanged m/m, pulling the y/y rate down to 

0.85% from 1.0% y/y previously – closer to its 1961 

all-time low of 0.7% y/y. If there is a risk, it is that 

state and local governments raise taxes on tobacco 

and other goods to help redress budget deficits – as 

they did in May. However, the clear trend in US core 

inflation is downwards. Indeed, one of the key trends 

in the US since the start of the year has been the 

broadening of disinflationary trends within core 

inflation. 

Chart 1: Eurozone HICP (% y/y) 


Chart 2: UK Inflation Expectations vs. CPI 


Chart 3: US Core CPI (% y/y) 


Luigi Speranza/Eoin O’Callaghan 16 July 2010 


33 


Table 1: BNP Paribas' Inflation Forecasts 

Eurozone 

France 

US 

Headline HICP Ex-tobacco HICP 

Headline CPI 

Ex-tobacco CPI 

CPI Urban SA CPI Urban NSA 

Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y index % m/m % y/y Index % m/m % y/y Index % m/m % y/y 

2009 108.1 - 0.3 107.9 - 0.2 119.3 - 0.1 118.0 - 0.1 214.5 - -0.3 214.5 - -0.4 

2010 (1) 109.9 - 1.6 109.5 - 1.5 121.2 - 1.6 119.9 - 1.6 218.2 - 1.7 218.2 - 1.7 

2011 (1) 111.5 - 1.5 111.1 - 1.4 123.0 - 1.4 121.5 - 1.4 220.4 - 1.0 220.4 - 1.0 

Q3 2009 108.0 - -0.4 107.8 - -0.5 119.4 - -0.4 118.1 - -0.4 215.4 - -1.6 215.7 - -1.6 

Q4 2009 108.6 - 0.4 108.4 - 0.3 119.7 - 0.4 118.4 - 0.3 216.8 - 1.5 216.2 - 1.4 

Q1 2010 108.6 - 1.1 108.3 - 1.0 120.3 - 1.3 119.0 - 1.2 217.6 - 2.4 217.0 - 2.4 

Q2 2010 (1) 110.0 - 1.5 109.7 - 1.4 121.3 - 1.6 120.0 - 1.5 217.3 - 1.8 218.2 - 1.8 

Q3 2010 (1) 109.9 - 1.8 109.6 - 1.7 121.4 - 1.7 120.1 - 1.7 218.5 - 1.4 218.8 - 1.4 

Q4 2010 (1) 110.9 - 2.1 110.6 - 2.1 121.8 - 1.8 120.5 - 1.8 219.5 - 1.2 218.8 - 1.2 

Q1 2011 (1) 110.7 - 2.0 110.4 - 1.9 122.2 - 1.6 120.8 - 1.5 219.8 - 1.0 219.2 - 1.0 

Q2 2011 (1) 111.6 - 1.5 111.2 - 1.4 123.1 - 1.4 121.6 - 1.4 220.1 - 1.3 221.0 - 1.3 

Jan 10 108.1 -0.8 1.0 107.75 -0.8 0.9 119.7 -0.2 1.1 118.32 -0.2 1.0 217.6 0.2 2.7 216.69 0.3 2.6 

Feb 10 108.4 0.3 0.9 108.10 0.3 0.8 120.4 0.6 1.3 118.99 0.6 1.2 217.6 0.0 2.2 216.74 0.0 2.1 

Mar 10 109.4 0.9 1.4 109.09 0.9 1.3 120.9 0.5 1.6 119.58 0.5 1.5 217.7 0.1 2.4 217.63 0.4 2.3 

Apr 10 109.9 0.5 1.5 109.58 0.4 1.4 121.3 0.3 1.7 119.90 0.3 1.6 217.6 -0.1 2.2 218.01 0.2 2.2 

May 10 110.0 0.1 1.6 109.71 0.1 1.5 121.4 0.1 1.6 120.04 0.1 1.6 217.2 -0.2 2.0 218.18 0.1 2.0 

Jun 10 (1) 110.0 0.0 1.4 109.70 0.0 1.3 121.4 0.0 1.5 120.02 0.0 1.4 217.1 0.0 1.2 218.27 0.0 1.2 

Jul 10 (1) 109.5 -0.4 1.6 109.19 -0.5 1.6 121.0 -0.3 1.7 119.68 -0.3 1.6 217.9 0.3 1.4 218.50 0.1 1.5 

Aug 10 (1) 110.0 0.4 1.7 109.62 0.4 1.6 121.7 0.5 1.7 120.32 0.5 1.6 218.5 0.3 1.4 218.74 0.1 1.3 

Sep 10 (1) 110.3 0.3 2.0 109.98 0.3 1.9 121.6 -0.1 1.9 120.24 -0.1 1.8 219.0 0.2 1.4 219.03 0.1 1.4 

Oct 10 (1) 110.7 0.4 2.1 110.37 0.4 2.0 121.7 0.1 1.9 120.37 0.1 1.8 219.3 0.1 1.4 219.23 0.1 1.4 

Nov 10 (1) 110.9 0.1 2.1 110.53 0.1 2.1 121.8 0.1 1.8 120.43 0.1 1.8 219.5 0.1 1.2 218.95 -0.1 1.2 

Dec 10 (1) 111.2 0.4 2.2 110.92 0.4 2.1 122.0 0.2 1.7 120.65 0.2 1.7 219.7 0.1 1.1 218.28 -0.3 1.1 

Jan 11 (1) 110.3 -0.9 2.0 109.89 -0.9 2.0 121.7 -0.3 1.7 120.22 -0.4 1.6 219.7 0.0 1.0 218.82 0.2 1.0 

Feb 11 (1) 110.6 0.3 2.1 110.28 0.3 2.0 122.3 0.5 1.6 120.88 0.5 1.6 219.8 0.0 1.0 219.01 0.1 1.0 

Mar 11 (1) 111.3 0.6 1.8 110.97 0.6 1.7 122.7 0.3 1.4 121.23 0.3 1.4 219.9 0.0 1.0 219.86 0.4 1.0 

Apr 11 (1) 111.6 0.2 1.6 111.23 0.2 1.5 123.0 0.2 1.4 121.54 0.3 1.4 220.0 0.1 1.1 220.43 0.3 1.1 

May 11 (1) 111.7 0.1 1.5 111.29 0.1 1.4 123.1 0.1 1.4 121.68 0.1 1.4 220.1 0.1 1.3 221.02 0.3 1.3 

Jun 11 (1) 111.7 0.0 1.5 111.23 -0.1 1.4 123.1 0.0 1.5 121.69 0.0 1.4 220.3 0.1 1.4 221.42 0.2 1.4 

Updated 

Next 

Release 

Jul 15 

Jul HICP Flash (Jul 30) 

Jul 14 

Jul CPI (August 13) 

Jul 08 

Jun CPI (Jul 16) 

Source: BNP Paribas, (1) Forecasts 

Chart 4: Eurozone HICP (% y/y) 

Chart 5: US Shelter Prices Drive Core CPI Down 


Core inflation is forecast to continue grinding lower, as excess 

capacity and the ongoing structural adjustment in a number of 

economies limit firms’ pricing power. 


Inflation in core goods has eased sharply in recent months, 

following a temporary boost from a series of tobacco tax hikes and 

a sharp contraction in vehicle inventories. As a result, the 

moderation in core inflation has broadened significantly. 



34 



Japan 

UK 

Sweden 

Core CPI SA 

Core CPI NSA 

Headline CPI RPI 

CPI CPIF 

Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y 

2009 100.3 - -1.3 100.3 - -1.3 110.8 - 2.1 213.7 - -0.5 299.7 - -0.3 191.2 - 1.9 

2010 (1) 99.3 - -1.0 99.3 - -1.0 114.3 - 3.1 223.4 - 4.5 303.9 - 1.4 195.0 - 2.0 

2011 (1) 98.9 - -0.3 98.9 - -0.3 116.5 - 2.0 229.7 - 2.8 310.6 - 2.2 197.7 - 1.3 

Q3 2009 99.9 - -2.3 100.1 - -2.3 111.3 - 1.5 214.4 - -1.4 299.5 - -1.2 191.6 - 1.6 

Q4 2009 99.7 - -1.8 99.9 - -1.8 112.1 - 2.1 216.9 - 0.6 301.3 - -0.4 193.2 - 2.3 

Q1 2010 99.7 - -1.3 99.3 - -1.2 112.9 - 3.2 219.3 - 4.0 301.2 - 1.0 194.0 - 2.6 

Q2 2010 (1) 99.2 - -1.3 99.2 - -1.3 114.4 - 3.4 223.5 - 5.1 302.8 - 1.1 194.9 - 2.1 

Q3 2010 (1) 98.9 - -1.0 99.2 - -0.9 114.5 - 2.9 224.6 - 4.8 303.6 - 1.4 194.8 - 1.7 

Q4 2010 (1) 99.2 - -0.5 99.4 - -0.5 115.2 - 2.7 226.0 - 4.2 308.1 - 2.2 196.4 - 1.7 

Q1 2011 (1) 99.0 - -0.7 98.6 - -0.7 115.5 - 2.3 227.3 - 3.7 306.7 - 1.8 195.8 - 0.9 

Q2 2011 (1) 98.9 - -0.3 98.9 - -0.3 116.5 - 1.8 229.2 - 2.6 309.4 - 2.2 197.5 - 1.3 

Jan 10 99.6 -0.1 -1.3 99.2 -0.6 -1.3 112.4 -0.2 3.4 217.9 0.0 3.7 299.8 -0.6 0.6 193.0 -0.2 2.6 

Feb 10 99.8 0.2 -1.2 99.2 0.0 -1.2 112.9 0.4 3.0 219.2 0.6 3.7 301.6 0.6 1.2 194.2 0.6 2.7 

Mar 10 99.8 0.0 -1.2 99.5 0.3 -1.2 113.5 0.5 3.4 220.7 0.7 4.4 302.3 0.2 1.2 194.7 0.3 2.5 

Apr 10 99.3 -0.5 -1.5 99.2 -0.3 -1.5 114.2 0.6 3.7 222.8 1.0 5.3 302.4 0.0 1.0 194.8 0.0 2.2 

May 10 99.3 0.0 -1.2 99.3 0.1 -1.2 114.4 0.2 3.3 223.6 0.4 5.1 302.9 0.2 1.2 195.0 0.1 2.1 

Jun 10 (1) 99.1 -0.2 -1.1 99.2 -0.1 -1.1 114.5 0.1 3.2 224.1 0.2 5.0 303.0 0.0 0.9 195.0 0.0 1.9 

Jul 10 (1) 98.9 -0.2 -1.1 99.0 -0.2 -1.1 114.2 -0.3 3.0 223.8 -0.1 4.9 302.7 -0.1 1.3 194.2 -0.4 1.6 

Aug 10 (1) 98.9 0.0 -0.9 99.2 0.2 -0.9 114.7 0.5 3.0 225.0 0.5 4.9 302.2 -0.2 0.9 194.5 0.1 1.5 

Sep 10 (1) 98.9 0.0 -0.9 99.3 0.1 -0.9 114.7 0.0 2.9 225.1 0.1 4.6 305.9 1.2 1.9 195.8 0.7 1.8 

Oct 10 (1) 99.2 0.3 -0.5 99.6 0.3 -0.5 114.8 0.1 2.8 225.5 0.2 4.4 308.3 0.8 2.4 196.5 0.3 1.8 

Nov 10 (1) 99.3 0.1 -0.5 99.4 -0.2 -0.5 115.0 0.2 2.7 225.8 0.1 4.2 307.2 -0.4 2.1 196.5 0.0 1.8 

Dec 10 (1) 99.1 -0.2 -0.6 99.2 -0.2 -0.6 115.6 0.5 2.7 226.7 0.4 4.0 308.6 0.5 2.3 196.3 -0.1 1.5 

Jan 11 (1) 99.0 -0.1 -0.6 98.6 -0.6 -0.6 115.2 -0.4 2.5 226.3 -0.2 3.9 305.0 -1.2 1.7 195.0 -0.7 1.0 

Feb 11 (1) 99.0 0.0 -0.8 98.4 -0.2 -0.8 115.6 0.3 2.4 227.4 0.5 3.7 307.3 0.8 1.9 195.8 0.4 0.8 

Mar 11 (1) 99.0 0.0 -0.8 98.7 0.3 -0.8 115.8 0.2 2.0 228.1 0.3 3.4 307.7 0.2 1.8 196.7 0.5 1.0 

Apr 11 (1) 99.0 0.0 -0.3 98.9 0.2 -0.3 116.2 0.3 1.8 228.7 0.2 2.7 309.4 0.5 2.3 197.3 0.3 1.3 

May 11 (1) 98.9 -0.1 -0.4 98.9 0.0 -0.4 116.6 0.3 1.9 229.4 0.3 2.6 309.2 -0.1 2.1 197.5 0.1 1.3 

Jun 11 (1) 98.8 -0.1 -0.3 98.9 0.0 -0.3 116.6 0.1 1.8 229.5 0.1 2.4 309.5 0.1 2.2 197.6 0.0 1.3 

Updated 

Next 

Release 

Jun 25 


Jul 13 

Jul CPI (Aug 17) 

Jul 08 



Chart 6: Japanese CPI (% y/y) 

Chart 7: UK CPI (% y/y) 


Prices are expected to continue falling but the pace of decline is 

easing as the economy recovers. 


We expect inflation to remain above target for the remainder of the 

year, although trending down. 



35 



Canada Norway Australia 

CPI Core CPI Headline CPI Core 

CPI 

Core 

Index % q/q % y/y Index % q/q % y/y Index % q/q % y/y Index % q/q % y/y Index % q/q % y/y Index % q/q % y/y 

2009 114.4 0.3 113.6 1.8 125.7 2.2 118.4 2.6 167.8 - 1.8 - - 3.7 

2010 (1) 116.5 1.8 115.8 1.9 128.8 2.4 120.2 1.6 173.2 - 3.2 - - 2.8 

2011 (1) 118.6 1.8 117.8 1.7 131.1 1.8 122.3 1.7 179.0 - 3.3 - - 2.9 

Q3 2009 114.7 0.5 -0.9 113.9 1.2 1.6 125.8 0.0 1.8 118.5 0.0 2.4 168.6 1.0 1.3 - - 3.5 

Q4 2009 114.9 0.6 0.8 114.4 1.9 1.6 126.6 0.6 1.4 119.3 0.7 2.3 169.5 0.5 2.1 - - 3.4 

Q1 2010 115.4 2.0 1.6 114.9 1.6 1.9 128.4 1.4 2.9 119.4 0.1 2.0 171.0 0.9 2.9 - - 3.1 

Q2 2010 (1) 116.3 3.0 1.5 115.6 2.7 1.9 129.1 0.6 2.6 120.3 0.8 1.5 172.3 0.8 3.2 - - 2.7 

Q3 2010 (1) 116.9 2.2 1.9 116.2 2.0 2.1 128.5 -0.5 2.1 120.3 0.0 1.5 174.2 1.1 3.3 - - 2.6 

Q4 2010 (1) 117.4 1.5 2.2 116.6 1.2 1.9 129.2 0.6 2.1 120.9 0.4 1.3 175.2 0.5 3.5 - - 2.7 

Q1 2011 (1) 117.8 1.6 2.1 117.0 1.6 1.9 129.6 0.3 1.0 121.1 0.2 1.4 176.7 0.9 3.3 - - 2.7 

Q2 2011 (1) 118.3 1.7 1.7 117.5 1.7 1.6 131.0 1.0 1.5 122.4 1.0 1.7 178.0 0.8 3.3 - - 2.8 

Updated 

Next 

Release 

Jun 22 


Jul 09 


Jun 17 

Q2 CPI (Jul 28) 


Chart 8: Canadian Total vs. Core CPI 

Chart 9: Australian CPI (% y/y) 


Wage pressures appear subdued, suggesting underlying inflation 

should remain close to the BoC's 2% target. 


Near-term inflation pressures should be muted but, with the limited 

spare capacity in the labour market being eroded, underlying 

inflation is likely to settle near the top of the RBA's target range. 

CPI Data Calendar for the Coming Week 

Day GMT Economy Indicator Previous 

BNPP 

F’cast 

Consensus Comment 

Fri 16/07 12:30 US CPI m/m : Jun -0.2% -0.1% -0.1% 

12:30 CPI y/y : Jun 2.0% 1.2% 1.2% 

12:30 Core CPI m/m : Jun 0.1% 0.0% 0.1% Subdued core 

12:30 Core CPI y/y : Jun 0.9% 0.9% 0.9% 

Release dates and forecasts as at c.o.b. prior to the date of publication: See Daily Economic Spotlight for any revision 




36 


Inflation: Sell 30y in the UK & US 

• GLOBAL: Stocks are hot but CPIs are not. 

Chart 1: OATei22/20 Too Steep vs OATei & OAT 

• EUR: Long OATei22/20 RY Spd. Short Vol. 

30 

OATEI22 / OATEI20 Real 

OATEI40 / OATEI20 Nominal Rhs 

90 

• USD: 10/20y to react to nominals & supply. 

85 

• GBP: Short UKTi-40 BE post CPI reform 

and into supply. 

25 

80 

75 

20 

70 

EUR: The OATei auction went well: EUR 1.8bn was 

issued (top of the range), of which 0.6bn of OATi-19 

(premium of 15 cents, bid cover of 2.4) and 1.2bn of 

OATei-22 (18c premium, 1.9 b/c). We entered a long 

OATei-22 / OATei-20 real yield flattener at 26.5bp, 

targeting 19bp by the end of the month. The spread 

looks steep in the real and nominal curves (Chart 1) 

while the trade should benefit from the payment of 

the 10bn BTANei-10, 4bn of coupons and the 0.4y 

index extension at the end of the month. Overall, we 

keep a neutral/negative bias on breakevens into 

BTPei supply, favouring 5 and 10y maturities 

(benchmarks) over 2 and 30y. In addition, inflation 

volatility is starting to come off, after having reached 

and traded at expensive levels last week. Today, the 

10y inflation swap breakeven is still at 2% while 

clients can sell 10y 0% y/y EURxt floor for a premium 

of 350bp (against 600bp last week). Chart 2 

compares the annualised premium to current inflation 

forwards and BNPP’s long-term inflation forecasts. 

The trade is attractive for clients who can deal with 

volatility in P&L. 

USD: The market has benefited from the strong 

results of the 10y TIPS auction and the recovery in 

stocks and oil in July. However, ahead of CPI and 

post weak PPI, 10y real yields are back to their 

historical low, which should slow, if not reverse, the 

rally in breakevens. The focus will gradually switch 

towards the auction of the 30y TIPS on 23 August, 

i.e. only 11 days before the tap of the 10y TIPS. This 

accumulation of supply at this level of real yield has 

little chance of being well received by dealers, who 

are probably still long from the largest auction ever. 

We still prefer 2 and 10y maturities to 5 and 20y+ 

ones. For a time, the 10/20y real yield spread looked 

rather steep versus nominal but this is no longer the 

case (Chart 3) and we expect 20y+ breakevens to 

underperform versus 10y in the coming weeks. 

GBP: The switch from the RPI to CPI seems to have 

triggered more fuss amongst analysts than fund 

managers. Indeed, after initially dropping by up to 

15bp, 30y cash breakevens have recovered fully and 

are actually above 7 July levels, i.e. the close before 

Mr Webb’s announcement, and we saw a reasonable 

15 

14-May 29-May 13-Jun 28-Jun 13-Jul 

Chart 2: 10y 0% y/y EURxt Inflation Floor 

Premium vs Inflation Forwards & Forecasts 

% 

2.5 

2 

1.5 

1 

0.5 

0 

-0.5 

0 1 2 3 4 5 6 7 8 9 10 

ZC Fwds 

GBP 1.2bn auction of the UKTI-22 with a 1.5bp 

premium. As detailed in the following article “GBP: 

Market Downplays Shift to CPI”, on the one hand the 

reform should affect 40 to 80% of members of 

defined benefit pension funds and the RPI/CPI 

spread is volatile while the DMO still has to issue 

around GBP 25bn of RPI-linked UKTi before April 

2011. On the other hand, breakevens are relatively 

low and there is no obvious alternative market for 

pent-up LDI demand, which could also benefit from 

falling deficits. Still, we think there is enough material 

to send breakevens through the bottom of their 

recent range and we entered a short UKTI-40 

breakeven at 3.40%, targeting 3.20% or below into 

supply. 

BNP 

Floor 

Chart 3: TIPS 10/20y Real & Nominal Spreads 

80 

75 

70 

65 

60 

55 

50 

45 

40 

35 

TIIJAN19 / TIIJAN29 Real 

30 

15-Apr 16-Jul 16-Oct 16-Jan 18-Apr 19-Jul 19-Oct 

Source: BNP Paribas, Bloomberg 

TIIJAN19 / TIIJAN29 Nominal Rhs 

65 

60 

105 

100 

95 

90 

85 

80 

75 

70 

Herve Cros / Shahid Ladha 16 July 2010 


37 


P ric in g D a te 

Repo Rate 

EUR DRI 

FRF DRI 

S e tt. D a te 

Table 1: BNP Paribas Carry Analysis 

EUR 

15-Jul-10 

Term 1 

Term 2 

3m 

6m 

12m 

0.48% 

0.51% 

0.56% 0.67% 

0.82% 

109.65968 

109.71000 

109.70000 109.45618 

110.46848 

111.26655 

119.98581 

120.04000 120.02000 

120.07228 

120.40630 

121.62372 

20-Jul-10 

01-Aug-10 

01-Sep-10 

20-O ct-10 

20-Jan-11 

20-Jul-11 

Real BE Real BE Real BE Real BE Real BE Real BE 

BTPEI Sep-10 1.30% -0.45% 58.8 54.2 333.0 310.7 #VALUE! #VALUE! - - - - 

O ATEI Jul-12 -0.65% 1.48% 0.4 -0 .2 -5 .4 -7 .7 -2 8 .3 -3 2 .7 4.2 -1 .8 -3 .2 -1 .9 

BTPEI Sep-12 0.75% 1.20% 2.6 0.3 3.1 -5 .2 -7 .7 -2 6 .1 47.6 8.7 121.2 26.1 

BO BLEI Apr-13 0.02% 0.84% 1.2 0.7 -0.9 -2.6 -13.4 -16.8 18.5 13.8 37.2 35.7 

BTPEI Sep-14 1.54% 1.19% 2.1 0.0 4.0 -3 .2 1.5 -14.2 33.8 2.0 72.3 3.5 

O ATEI Jul-15 0.59% 1.29% 1.0 0.0 0.9 -2 .8 -4 .0 -1 1 .8 15.9 0.5 31.5 1.5 

BUNDEI Apr-16 0.60% 1.23% 0.9 0.0 0.9 -2 .3 -3 .4 -1 0 .1 13.9 1.0 26.9 2.4 

BTPEI Sep-17 2.22% 1.36% 1.6 -0 .2 3.6 -2 .6 3.6 -9 .7 24.9 -1 .8 50.5 -4 .3 

BTPEI Sep-19 2.53% 1.48% 1.4 -0 .2 3.4 -2 .2 3.8 -8 .1 21.8 -2 .2 43.7 -4 .3 

BUNDEI Apr-20 1.01% 1.57% 0.7 -0 .1 1.1 -2 .0 -0 .9 -7 .3 10.7 -1 .9 20.3 -3 .8 

O ATEI Jul-20 1.20% 1.79% 0.8 -0 .2 1.3 -2 .2 -0 .3 -7 .9 11.7 -3 .2 22.6 -6 .5 

BTPEI Sep-23 2.76% 1.75% 1.1 -0 .3 2.7 -2 .2 3.3 -7 .1 17.0 -3 .8 33.5 -8 .2 

G G BEI Jul-25 8.69% 1.24% 3.0 -0 .5 9.5 -3 .4 17.8 -10.1 47.3 -9 .7 97.6 -18.1 

G G BEI Jul-30 6.92% 3.14% 1.9 -1 .6 5.8 -6 .9 10.3 -17.0 29.2 -26.7 59.3 -53.9 

O ATEI Jul-32 1.32% 2.19% 0.4 -0 .3 0.8 -1 .8 0.0 -5 .5 6.4 -4 .1 12.2 -8 .2 

BTPEI Sep-35 2.51% 2.54% 0.6 -0 .5 1.4 -2 .4 1.6 -6 .6 9.1 -7 .2 17.5 -14.8 

O ATEI Jul-40 1.36% 2.23% 0.3 -0 .3 0.6 -1 .5 0.0 -4 .3 4.7 -3 .8 8.8 -7 .5 

BTPEI Sep-41 2.79% 2.32% 0.6 -0 .4 1.5 -2 .1 1.8 -5 .8 8.8 -6 .3 16.9 -12.5 

FRF 

O ATI Jul-11 -0.43% 1.06% 1.3 0.7 -10.0 -11.9 -23.6 -26.3 -41.2 -30.8 - - 

O ATI Jul-13 -0.15% 1.29% 0.8 -0 .1 -2 .0 -4 .9 -4 .1 -1 0 .1 -2 .8 -1 3 .6 19.1 1.0 

O ATI Jul-17 0.72% 1.66% 0.8 -0 .3 0.7 -3 .0 1.7 -6 .2 5.9 -9 .6 21.5 -8 .9 

O ATI Jul-19 0.99% 1.79% 0.7 -0 .3 0.9 -2 .7 2.1 -5 .6 6.3 -9 .0 20.2 -9 .7 

O ATI Jul-23 1.20% 2.07% 0.6 -0 .3 0.9 -2 .3 2.0 -4 .8 5.6 -7 .8 16.4 -9 .5 

O ATI Jul-29 1.19% 2.29% 0.4 -0 .3 0.7 -2 .1 1.5 -4 .4 4.2 -7 .4 12.3 -10.1 

USD 



USD DRI 


15-Jul-10 

218.09077 

16-Jul-10 

Term 1 

0.22% 

218.17800 

01-Aug-10 

Term 2 

0.22% 

218.26695 

01-Sep-10 

3m 

6m 

12m 

0.22% 0.23% 

0.31% 

218.63089 

219.07293 

220.75389 

18-O ct-10 18-Jan-11 18-Jul-11 

Yield BE Real BE Real BE Real BE Real BE Real BE 

TIPS Jan-11 0.37% -0.17% 10.2 10.4 26.8 27.7 117.3 120.4 - - 

TIPS Apr-11 0.37% -0.08% 6.7 6.3 16.2 15.0 58.5 55.6 218.1 209.1 - - 

TIPS Jan-12 -0.12% 0.56% 1.8 1.1 2.8 0.7 13.0 8.8 27.7 17.8 161.6 138.9 

TIPS Apr-12 0.00% 0.47% 1.8 1.2 3.3 1.3 13.0 8.7 27.2 17.3 123.1 101.2 

TIPS Jul-12 -0.14% 0.67% 1.3 0.6 1.9 -0 .2 9.1 4.7 18.0 8.2 79.1 57.8 

TIPS Apr-13 -0.09% 0.89% 1.0 0.0 1.5 -1 .3 6.7 0.7 12.7 -0 .4 46.6 18.0 

TIPS Jul-13 -0.01% 0.96% 1.1 -0 .1 1.8 -1 .6 7.0 0.0 13.4 -1 .5 46.0 13.1 

TIPS Jan-14 0.19% 0.99% 1.1 -0 .1 2.3 -1 .5 7.6 -0 .3 14.7 -1 .9 45.3 8.9 

TIPS Apr-14 0.12% 1.17% 1.0 -0 .3 1.9 -1 .9 6.5 -1 .5 12.3 -4 .6 37.9 1.4 

TIPS Jul-14 0.22% 1.13% 1.0 -0 .3 2.2 -1 .9 6.8 -1 .4 13.2 -4 .0 39.1 2.0 

TIPS Jan-15 0.42% 1.18% 1.1 -0 .3 2.5 -1 .8 7.3 -1 .6 14.1 -4 .4 39.3 -0 .2 

TIPS Jul-15 0.47% 1.28% 1.1 -0 .4 2.4 -2 .0 6.8 -2 .1 13.2 -5 .3 36.0 -3 .3 

TIPS Jan-16 0.57% 1.38% 1.1 -0 .5 2.5 -2 .1 6.7 -2 .6 13.1 -6 .1 34.7 -5 .8 

TIPS Jul-16 0.61% 1.47% 1.0 -0 .6 2.4 -2 .3 6.4 -2 .9 12.5 -6 .8 32.5 -7 .7 

TIPS Jan-17 0.75% 1.51% 1.1 -0 .5 2.5 -2 .2 6.6 -2 .9 12.7 -6 .7 32.5 -8 .0 

TIPS Jul-17 0.77% 1.55% 1.0 -0 .6 2.4 -2 .2 6.2 -2 .9 12.0 -6 .6 30.4 -8 .3 

TIPS Jan-18 0.89% 1.59% 1.0 -0 .5 2.4 -2 .1 6.1 -2 .8 11.9 -6 .4 29.5 -8 .3 

TIPS Jul-18 0.91% 1.69% 0.9 -0 .6 2.3 -2 .3 5.8 -3 .3 11.2 -7 .3 27.6 -10.5 

TIPS Jan-19 1.02% 1.75% 1.0 -0 .5 2.4 -2 .0 6.0 -2 .9 11.6 -6 .4 28.1 -8 .8 

TIPS Jul-19 1.06% 1.84% 0.9 -0 .6 2.3 -2 .3 5.7 -3 .4 11.1 -7 .4 26.7 -11.1 

TIPS Jan-20 1.12% 1.81% 0.9 -0 .6 2.2 -2 .2 5.5 -3 .4 10.7 -7 .5 25.6 -11.5 

TIPS Jan-25 1.56% 1.93% 0.8 -0 .7 2.0 -2 .3 4.8 -3 .8 9.4 -8 .0 21.5 -13.6 

TIPS Jan-26 1.61% 1.95% 0.8 -0 .6 1.9 -2 .1 4.6 -3 .5 8.9 -7 .3 20.3 -12.4 

TIPS Jan-27 1.66% 1.93% 0.7 -0 .6 1.9 -2 .0 4.5 -3 .4 8.8 -7 .1 20.0 -12.1 

TIPS Jan-28 1.69% 1.96% 0.7 -0 .6 1.8 -2 .0 4.2 -3 .5 8.1 -7 .4 18.4 -12.7 

TIPS Apr-28 1.75% 1.96% 0.8 -0 .5 2.0 -1 .7 4.8 -2 .7 9.2 -5 .8 20.6 -9 .4 

TIPS Jan-29 1.71% 2.03% 0.7 -0 .6 1.8 -1 .9 4.2 -3 .1 8.2 -6 .5 18.6 -11.0 

TIPS Apr-29 1.77% 1.97% 0.8 -0 .5 2.0 -1 .7 4.6 -2 .7 9.0 -5 .7 20.1 -9 .4 

TIPS Apr-32 1.77% 2.02% 0.7 -0 .5 1.7 -1 .8 4.0 -3 .0 7.8 -6 .2 17.3 -10.7 

TIPS Feb-40 1.78% 2.19% 0.5 -0 .5 1.3 -1 .6 2.9 -2 .8 5.6 -5 .9 12.6 -10.4 

GBP 


15-Jul-10 Term 1 Term 2 

3m 

6m 

12m 


0.54% 

0.55% 

0.61% 

0.64% 

0.74% 


16-Jul-10 

01-Aug-10 01-Sep-10 18-O ct-10 

17-Jan-11 

18-Jul-11 

Yield BE Real BE Real BE Real BE Real BE Real BE 

UKTi Aug-11 -0.09% 0.66% 9.9 9.7 -5 .2 -5 .7 36.4 38.5 110.6 135.2 - - 

UKTi Aug-13 -1.25% 2.46% 1.8 0.6 -7.1 -10.6 0.1 -6.8 2.6 -11.8 20.9 -9 .6 

UKTi Jul-16 0.19% 2.37% 2.0 0.4 -0 .4 -5 .3 6.8 -2.8 15.3 -4 .3 40.0 -0 .2 

UKTi Nov-17 0.37% 2.62% 2 .5 0 .9 5.6 0.6 7 .5 -2.4 14.7 -5 .3 36.7 -4 .0 

UKTi Apr-20 0.76% 2.63% 1.6 0.0 0.6 -4 .2 6.1 -3.3 13.2 -5 .8 31.3 -7 .0 

UKTi Nov-22 0.93% 2.75% 1.8 0.3 4.2 -0 .2 6.0 -2.7 11.7 -5 .7 27.4 -7 .4 

UKTi Jul-24 1.14% 2.77% 1.3 -0 .1 0.8 -3 .3 5.2 -3.0 10.9 -5 .4 25.5 -7 .0 

UKTi Nov-27 1.01% 3.06% 1.3 0.1 3.0 -0 .7 4.4 -3.0 8.5 -6 .1 19.6 -9 .5 

UKTi Jul-30 0.96% 3.21% 1.0 -0 .1 0.5 -2 .8 3.8 -2.7 8.0 -4 .9 18.6 -7 .0 

UKTi Nov-32 0.90% 3.27% 1.0 -0 .1 2.3 -1 .0 3.3 -3.2 6.4 -6 .4 14.8 -10.8 

UKTi Jan-35 0.88% 3.32% 0.7 -0 .3 0.3 -2 .7 2.8 -3.3 5.8 -6 .1 13.4 -10.0 

UKTi Nov-37 0.79% 3.40% 0.8 -0 .2 1.9 -1 .1 2.6 -3.2 5.1 -6 .4 11.6 -11.0 

UKTi Nov-42 0.72% 3.47% 0.7 -0 .3 1.5 -1 .2 2.1 -3.3 4.0 -6 .6 9.1 -11.7 

UKTi Nov-47 0.64% 3.54% 0.6 -0 .3 1.3 -1 .2 1.8 -3.2 3.4 -6 .4 7.9 -11.5 

UKTi M ar-50 0.63% 3.55% 0.5 -0 .3 1.2 -1 .3 1.6 -3.2 3.1 -6 .4 7.1 -11.6 

UKTi Nov-55 0.58% 3.58% 0.5 -0 .3 1.1 -1 .1 1.6 -3.0 3.0 -5 .9 6.9 -10.6 

JPY 



JPY DRI 


15-Jul-10 

99.235 

21-Jul-10 

Term 1 Term 2 

0.12% 

0.12% 

99.300 

99.200 

10-Aug-10 

10-Sep-10 

3m 

0.12% 

99.071 

21-O ct-10 

6m 

0.13% 

12m 

0.14% 

99.529 98.900 

21-Jan-11 

21-Jul-11 

Yield BE Yield BE Yield BE Real BE Real BE Real BE 

JG BI-1 M ar-14 1.13% -0.93% 4.5 4.4 4.1 3.8 4.7 4.1 26.4 25.2 27.0 24.6 

JG BI-2 Jun-14 1.35% -1.13% 4.5 4.4 4.7 4.3 5.9 5.2 27.8 26.3 32.6 29.4 

JG BI-3 Dec-14 1.17% -0.88% 3.7 3.5 3.5 2.9 4.0 3.0 21.6 19.5 21.9 17.3 

JG BI-4 Jun-15 1.36% -1.01% 1.5 1.2 1.5 0.9 2.5 1.2 21.3 18.7 21.6 16.0 

JG BI-5 Sep-15 1.34% -0.98% 3.4 3.1 3.5 2.8 4.4 3.1 20.2 17.5 22.6 16.8 

JG BI-6 Dec-15 1.25% -0.86% 3.2 2.9 3.1 2.3 3.7 2.3 18.2 15.4 19.1 13.0 

JG BI-7 M ar-16 1.34% -0.93% 3.1 2.8 3.2 2.4 4.0 2.5 18.3 15.4 20.2 13.8 

JG BI-8 Jun-16 1.41% -0.96% 3.1 2.7 3.2 2.4 4.1 2.6 18.2 15.0 20.6 13.9 

JG BI-9 Sep-16 1.40% -0.92% 3.0 2.6 3.1 2.2 3.9 2.3 17.4 14.1 19.5 12.6 

JG BI-10 Dec-16 1.38% -0.87% 2.8 2.5 2.9 2.0 3.7 2.0 16.5 13.1 18.2 10.9 

JG BI-11 M ar-17 1.46% -0.92% 2.8 2.4 3.0 2.1 3.9 2.1 16.6 13.0 19.1 11.4 

JG BI-12 Jun-17 1.54% -0.96% 2.8 2.4 3.1 2.1 4.1 2.2 16.6 12.8 19.6 11.7 

JG BI-13 Sep-17 1.44% -0.82% 2.6 2.2 2.8 1.7 3.6 1.6 15.3 11.3 17.3 8.9 

JG BI-14 Dec-17 1.45% -0.79% 2.5 2.1 2.7 1.6 3.5 1.4 14.8 10.7 16.7 8.0 

JG BI-15 M ar-18 1.48% -0.78% 2.5 2.0 2.7 1.6 3.5 1.4 14.6 10.4 16.6 7.7 

JG BI-16 June-18 1.61% -0.87% 2.5 2.0 2.8 1.7 3.8 1.6 15.1 10.7 18.1 8.7 


Herve Cros / Shahid Ladha 16 July 2010 


38 


GBP: Market Downplays Shift to CPI 

• Government’s shift to CPI indexation in 

pensions causes uncertainty over impact on 

private schemes given their complexity. 

• Limited market impact given underlying 

ALM gap. But changes are material enough to 

trigger a significant correction in our view. 

• STRATEGY: Sell 30y BE at 3.40% into 30y 

syndication – Target 3.10%. Favour 10/30y cash 

BE flatteners. 

DWP Statement on moving to CPI for Pensions 

“On 8 July the Minister of State for Pensions, Steve 

Webb MP, made a Written Ministerial Statement to 

Parliament which announced the Government’s 

intention to move to using the Consumer Price Index 

(CPI) as the measure of price inflation for the 

purposes of regulating occupational pension 

schemes. A statutory minimum requirement will 

continue to apply to the revaluation and indexation of 

pension rights. 

The proposed changes will affect how many deferred 

pensions are revalued in future, and how pensions in 

payment are increased. The changes apply to 

defined benefit rights in occupational pension 

schemes, and certain defined contribution rights in 

occupational pension schemes. The changes will 

affect the statutory minimum requirement for 

revaluation and indexation; occupational pension 

schemes will still have the freedom to pay more than 

the statutory minimum. 

In broad terms, a revaluation order is made each 

year which sets out the minimum rate at which 

occupational pension schemes should generally 

revalue deferred pension rights and pay increases on 

pensions in payment. 

For deferred pension rights, the order tabulates an 

overall revaluation percentage relating to each 

possible number of complete years between the end 

of someone’s pensionable service and their normal 

pension age. The order that is in use for any year will 

use data on price inflation up to September of the 

previous year. For example, the order in use for 2010 

uses data on price inflation to the year ending 30 

September 2009 based on RPI. The order which will 

be in use in 2011 will use data on price inflation to 

the year ending 30 September 2010 based on CPI. 

The overall percentage that will apply to deferred 

pension rights which have been deferred for at least 

two complete years, where the relevant years 

straddle the change from RPI to CPI, will therefore 

be calculated as a combination of percentages based 

on RPI and then CPI. 

The order in use for 2011 will also be used to 

calculate annual increases on pensions in payment 

for 2011, and these will be in line with CPI. The 

Government expects to publish the order in 

November or December 2010. 

The Government will bring forward legislation at the 

earliest opportunity to ensure that other references to 

price inflation in pensions law are consistent with 

using CPI as the measure of price inflation from 2011 

or as soon thereafter as Parliamentary time allows. 

For example, the Guaranteed Minimum Pension 

Increase Order that will come into effect in 2011 will 

be made on the basis of the CPI figures for the year 

to 30 September 2010. 

Examples: 

The following generalised simplified examples are 

provided for illustrative purposes only. 

These examples illustrate how these changes could 

apply to future calculations of the revaluation and 

indexation applying to pension rights, if a pension 

scheme adopted the statutory minimum approach. 

They would not affect pension payments already 

received. They do not deal with issues arising from 

contracting out from the State Second Pension. The 

detailed rules on revaluation and indexation vary 

between pension schemes and can be higher than 

the minimum. They also depend on when the 

pensionable service took place. Other factors may 

affect an individual’s pension entitlement depending 

on that scheme’s rules. 

A is a pensioner member of a pension scheme. His 

pension has been in payment for three years, and he 

has been receiving increases related to RPI. From 

2011 his future increases will be calculated in relation 

to CPI. This does not affect his previous increases. 

B is a deferred member of a pension scheme. She 

left pensionable service five years ago. When she 

reaches normal pension age, her rights will be 

revalued in relation to RPI in respect of the first five 

years after she left pensionable service, and then in 

relation to CPI until normal pension age. Once her 

pension has been put into payment, she will receive 

annual increases calculated in relation to CPI. 

Herve Cros/Shahid Ladha 16 July 2010 


39 


C is an active member of a pension scheme. He is 

continuing to accrue new rights. If he continues in 

pensionable service until he reaches normal pension 

age in (for example) 2015, revaluation will not apply. 

Once his pension is in payment, he will receive 

annual increases calculated in relation to CPI. 

D is an active member of a pension scheme. She will 

leave pensionable service in 2013, and will reach her 

normal pension age in 2020 and begin to receive her 

pension at that time. From 2013 to 2020 her rights 

will be revalued in relation to CPI. Once her pension 

is put into payment, she will receive annual increases 

calculated in relation to CPI.” 

Limited market impact of public pension 

indexation change… 

Public pension funds are believed to be in the order 

of around GBP 1trn (on a gilt-discounted basis) and, 

to the extent they are largely unfunded and 

unhedged, have limited impact on the RPI market 

with future PF obligations paid from public coffers. 

Local authorities, in contrast, do hold assets against 

their PF liabilities but are much smaller (20%) whilst 

their index-linked holdings are thought to be relatively 

small (< GBP 10bn). Future inflation hedging demand 

by these entities will most likely manifest itself in CPI 

space, not RPI. 

… But complexity over impact on private PFs 

The statutory minimum indexation benefit for PF 

members, also known as ‘general level of prices in 

Great Britain’ – published annually will use CPI not 

RPI from September 2010. The impact (on private 

pension fund solvency and RPI linked assets) is 

highly uncertain as different indexation rules apply to 

deferred pensions, pensioners and Guaranteed 

Minimum Pensions. Chart 1 illustrates the distribution 

of member types according to the Pensions 

Regulator. Equally important is the precise proportion 

of private sector defined-benefit (DB) pension funds 

that are linked to the ‘general level of prices’ without 

explicit reference to RPI (or LPI) which is currently 

unknown. Individual corporate pension funds will 

likely be examining their trust deeds and potentially 

holding trustee meetings to analyse the impact of the 

proposed changes on their members’ benefits and 

solvency levels. 

The DWP communiqué on 12 July does provide 

some clarity following Steve Webb’s written 

statement to the House of Commons regarding the 

shift to CPI. It illustrates that, with respect to deferred 

members, the proposed changes will only apply to 

future valuations. A report by actuaries Lane, Clarke 

& Peacock suggests most deferred pensions refer to 

the ‘general level of prices’ and thus would be 

impacted by the switch to CPI indexation but this is 

subject to reference in the Trust Deed. Pensioners 

Chart 1: Distribution of Member Types 

Pensioners, 

36% 

Active 

Members, 21% 

Deferred 

Members, 43% 

Active Members 

Deferred Members 

Pensioners 

Chart 2: Aggregate Private PF Assets, 

Liabilities, Surplus (PPF7800) and Potential 

Impact of Legislative Change 

200000 

150000 

100000 

50000 

0 

-50000 

-100000 

-150000 

-200000 

Surplus 

Assets £m Rhs 

Liabilities £m Rhs 

Potential Range 

of Impact on 

Agg. PF Surplus 

-250000 

Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 

Sources: Purple Book 2009 The Pensions Regulator, BNP Paribas 

1200000 

1000000 

800000 

600000 

400000 

200000 

will switch to CPI indexation as soon as the law is 

implemented (likely start in 2011 based on Sep-10 

CPI y/y) if there is no explicit reference to RPI (or LPI 

linkage) in the trust deed which is not thought to be 

the average case. Active members’ liabilities are 

linked to salaries, which are typically modelled as 

RPI + x% and the proposed legislation does not 

change this unless there is a consensual move to 

CPI + y% (which may introduce basis risk). At 

retirement or deferment, PFs are treated as 

described above. We do not purport to provide a 

complete overview of pension fund legislation 

changes here and would suggest affected 

counterparties consult professional legal and pension 

fund advice. In this context, we have used a report 

titled ‘Red Views – Changes to Pension Indexation’ 

by Reddington (Consultants) as an information 

source. 

As of end June-10, aggregate Private PF assets 

totalled GBP 901bn vs. liabilities of GBP 923bn, 

leaving PF in an aggregate deficit of GBP 21.8bn 

based on PPF7800 data – Chart 1. The PPF’s Purple 

Book 2009 found the aggregate funding position 

would deteriorate by 0.9-1% for each 0.1% rise in 

inflation – See Table 1. The RPI/CPI spread is 

volatile and very cyclical due to the housing 

components, specifically MIPS and Housing 

depreciation (Chart 3), whilst RPI’s arithmetic 

0 



40 


averaging introduces sizable upside bias (0.5%) 

relative to the ‘geometric’ CPI. Over 10 years, we find 

the RPI/CPI spread averages 71bp vs. 54bp over the 

past 20 years but is very sensitive to the start 

date/period. Assuming CPI is 0.75% below RPI (on 

average) and all private sector pension funds switch 

to CPI (unlikely) – we see a maximum impact on the 

net funding position in the region of £70bn (which 

would be similar to the benefit from PPF’s actuarial 

changes in Oct-09). With many private pension funds 

unlikely to be included in CPI indexation bracket, at 

least in the current state of legislation, the use of 

AER (instead of SVR) in MIPS and the encapsulation 

of housing related prices eventually in CPI suggest 

the gap could be lower over time (subject to a likely 

lower bound of 0.50% from formula effect). We 

expect the realised impact on aggregate PFs’ net 

asset/liability to be closer to half this amount (around 

£30-40bn). However, optionality in indexation of 

pensions (caps and floors) and maximum of (CPI, 

RPI and cap) in cases where the Trust Deed 

specifies RPI but is subject to the statutory minimum 

requirement (CPI), complicates the issue and under 

certain assumptions could even increase pension 

fund liabilities (according to Redington). 

Market downplays Risk of Switch to CPI 

Understandably, the announcement from Steve 

Webb triggered a correction in (long-end) 

breakevens. Uncertainty over the impact on private 

sector PFs could cause LDI programmes to be 

scaled back or placed on hold, weighing further on 

breakevens (and liquidity) near-term as sovereign 

supply continues. That said, greater net asset/liability 

positions (lower deficits/higher surpluses) tend to 

encourage LDI hedging and as a consequence are 

associated with higher long-end breakeven levels – 

Chart 4. In fact, certain LDI related counterparties 

have actually increased RPI exposure following the 

initial setback against our expectations although 

flows are reversing after the UKTi-22 auction. 

In Table 2, we estimate LDI demand using the 

duration gap (or shortfall) between aggregate PF 

assets and liabilities (from PPF data) using typical 

actuarial assumptions and liabilities. With respect to 

supply, we duration-weight the total market 

capitalisation of GBP sovereign and corporate bonds 

for both nominal and index-linked markets. Finally, 

we combine our demand/supply analysis to gauge 

the adequacy of inflation supply to meet pension 

funds’ requirements. Relative to the market 

capitalisation of outstanding GBP linkers (all RPIlinked), 

demand outstrips outstanding market 

capitalisation by more than 3 times (compared to 

1.15 for nominals). We estimate at least GBP 110bn 

(or 57%) of the GBP linker market (by market 

capitalisation) is held by DB pension funds (at end- 

March 2009) based on Purple Book 2009 – Table 3. 

Table 1: Sensitivities of PF Deficits to Changes 

in Assumptions & Market Prices 

20 

15 

10 

5 

0 

-5 

-10 

Change in Asumption 

Impact (as of Mar-09) 

Approximate Cash 

Impact on Deficit 

↑ Longevity by 2y ↑ 5% in Liabilities ~ £45bn 

↑ Inflation by 0.1% ↑ 1% in Liabilities ~ £9bn 

↓ Discount Yield by 0.1% ↑ 2% in Liabilities ~ £18bn 

↓ Discount Yield by 0.1% ↑ 0.4% in Assets ~ £3.5bn 

↓ Equities by 1% ↓ 0.4% in Assets ~ £4.4bn 

1% ? Discount Yield = 40% ? in Equities 

Chart 3: UK RPI – CPI y/y vs. Housing RPI 

% RPI-CPI yoy 

% 

25 

4 

RHS 

RPI Housing yoy 

-15 

Jan-90 Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 

Chart 4: Aggregate Private PF Surplus vs. 15y+ 

UK Cash Breakeven 

200000 

160000 

120000 

80000 

40000 

0 

-40000 

-80000 

-120000 

-160000 

-200000 

Aggregate PF Surplus (PPF, 7800) 

15y+ Gilt BE 

-240000 

Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 

Table 2: UK PF ALM Gap vs. Bond Market 

UK Private Pension A/L Structure 

Assets (£, bn) Liabilities (£, bn) Surplus / (Deficit) (£, bn) 

Duration 5 18 

Nominal (bn) 901 923 -21.8 

Risk 4507 16619 

Duration Gap -12112 

Hedge 20y Equivalent 673 

Mkt Cap 20y Equiv. (Nominal) 

Demand/Supply Ratio 

582 

(Sov + Corp Nominal Bonds) 

116% 

Mkt Cap 20y Equiv. (Linkers) 

Demand/Supply Ratio 

212 

(Sov + Corp Index-linked Bonds) 

318% 

Table 3: PF Asset Allocation & BNPP Estimates 

Asset Allocation 2007 2008 2009 

Equities 59.5% 53.6% 46.4% 

Gilts & Fixed Interest 29.6% 32.9% 37.1% 

Insurance Policies 0.8% 1.1% 1.4% 

Cash & Deposits 2.3% 3.0% 3.9% 

Property 5.2% 5.6% 5.2% 

Other Investments 2.5% 3.8% 4.5% 

Detail Equity & Bond Holdings 

Weighted Average Share 

(2009) 

Approximate 

Holdings 

3 

2 

1 

0 

-1 

-2 

-3 

-4 

4.0 

3.6 

3.2 

2.8 

2.4 

2.0 

Proportion of 

Mkt Cap. 

Gilts & Fixed Interest 

UK Gilts 29.0% 98.6 16.8% 

Corporate Bonds 38.3% 130.2 28.2% 

Index-linked Gilts 32.6% 110.8 57.1% 

Equities 

UK Equities 44.2% 

Overseas Equities 53.8% 

Sources: Purple Book 2009, The Pensions Regulator, BNP Paribas 



41 


The legislative changes to CPI indexation from 

RPI could potentially impact 80% of defined 

benefit pension fund members but is likely to be 

much lower due to explicit RPI indexation in trust 

deeds (40%?). The market impact of the news has 

been very limited with 30y cash breakevens now 

close to/above levels seen on 7 th July. We expect to 

see breakeven weakness in the summer as the 

implications of the legislative change to CPI are 

calculated and supply continues. Nevertheless, there 

is no liquid UK inflation hedging alternative to RPI 

currently – RPI/CPI basis quoted at -5/-50bp (-30bp 

mid) following the announcement. Furthermore, 

given the size of the remaining ALM gap with respect 

to inflation, we do not expect LDI demand for RPIlinked 

assets to fall dramatically. Rather, the nature 

of future UK inflation hedging demand will likely 

evolve over time and become index specific 

assuming the creation of a CPI-linked market. 

Sell 30y BE, but i-40s Supply will be the Real Test 

Beyond structural uncertainties, mid-summer months 

typically exhibit limited LDI demand, particularly 

August with (long) 30y BE total returns negative for 

each of the past five years – Table 4. That said, 2010 

is not a typical year given the abnormally poor Q2 

performance of breakevens. Summer discounting 

should limit the potential for further upside surprises 

to UK inflation data, although June RPI surprised to 

the upside yet again. 

Ongoing uncertainty may limit appetite for RPI-linked 

assets while the UK DMO still has to issue £26bn of 

RPI linkers this fiscal year. With long-end breakevens 

returned to their levels pre-announcement, we see a 

material risk of a long-end breakeven correction 

ahead. We expect a break below their 3.30-3.80% 

‘normal’ range on 30y cash (Chart 6), if not targeting 

3% (range is typically 20bp higher in swap). We enter 

a new trade: Sell UKTi-40 breakeven at 3.40% 

targeting 3.10% with a stop at 3.46%. Carry 

of-0.6/-2.2/-3.2bp at 1/2/3m. The syndicated UKTi-40 

issue in the second half of July will be the main test. 

This said with GBP 34bn every year, the UK DMO 

can build up a CPI-linked programme, in addition to 

its RPI lines. RPI-linked assets remain the only 

available liquid solution and the correlation between 

RPI and CPI, whilst unstable, is 70% since 1990. 

Finally, real yields are historically low but the same is 

true for nominal yields and (at least) cash inflation 

breakevens compare relatively well with past history 

on RPI and long-term inflation expectations from our 

economists (both around 3% y/y). At 2.60-70%, 10y 

breakevens look even cheaper after the concession 

into the decent £1.2bn UKTi-22 tap and we like 

10/30y BE flatteners into 30y supply – Chart 7. 

Real/nominal ASW discounts have proved volatile 

and the very flat/inverted discount surface suggest 

most value up to 20y maturities (Chart 8). 

3.46 

3.44 

3.42 

3.40 

3.38 

3.36 

3.34 

5: 30y UKTi RY & BE around Announcement 

3.32 

01- 

Jul 

02- 

Jul 

30y UKTi BE 

30y UKTi RY 

03- 

Jul 

04- 

Jul 

05- 

Jul 

06- 

Jul 

Steve Webb CPI 

Announcement 

07- 

Jul 

08- 

Jul 

09- 

Jul 

10- 

Jul 

DWP provides 

more details 

Table 4: 30y BE Total Return (Dur-adj) by Qtr 

11- 

Jul 

12- 

Jul 

13- 

Jul 

14- 

Jul 

15- 

Jul 

0.84 

0.82 

0.8 

0.78 

0.76 

0.74 

0.72 

0.7 

0.68 

0.66 

0.64 

16- 

Jul 

UKTI35 BE Tot Ret 

Dur Adj 

Apr May Jun Jul Aug Sep Oct Nov Dec 

2003 0.3% -1.4% 2.4% 1.7% -1.0% 0.0% 2.0% -0.3% 1.4% 

2004 2.7% 1.1% -1.3% -1.5% -1.1% -0.8% -1.5% -1.1% 1.7% 

2005 -3.2% -2.9% -0.3% 1.1% -1.0% 2.1% 0.6% -2.0% -0.9% 

2006 2.1% -1.6% 2.5% 0.3% -1.9% -0.7% -0.7% 0.6% 1.9% 

2007 1.1% 1.4% 4.5% -3.2% -1.0% 2.2% -2.1% -0.1% -0.5% 

2008 3.3% 3.7% 6.3% -6.1% -1.6% -4.4% -5.7% -12.0% -5.6% 

2009 4.2% 10.0% -3.8% 1.2% -9.5% -1.5% 5.2% -1.2% 8.3% 

2010 -3.6% -5.8% -3.8% 

5y Avg (ex. 2010) 1.5% 2.1% 1.8% -1.3% -3.0% -0.5% -0.6% -2.9% 0.6% 

4.40 

4.00 

3.60 

3.20 

2.80 

2.40 

110 

100 

90 

80 

70 

60 

50 

40 

30 

20 

10 

0 

70 

60 

50 

40 

30 

20 

10 

% of + ve Ret 80% 60% 60% 60% 0% 40% 40% 20% 40% 

2.00 

1.60 

1.20 

0.80 

0.40 

Chart 6: 30y UKTi RY, NY & BE 

30y Generic UK RY 

30y Generic UK NY 

30y Generic UK BE 

0.00 

Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 

Chart 7: UKTi Real, Nom ASW & Discount 

20 

10 

0 

-10 

-20 

-30 

-40 

-50 

UKTI22 / UKTI37 Real 

UKTI22 / UKTI37 Nominal Rhs 

UKTI22 / UKTI37 Breakeven 

-60 

Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 

8: Front, 10y & 30y Real/Nom ASW Discount 

0 

Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 

Sources: BNP Paribas 

UKTI13 R/N ASW Discount 



5.20 

4.80 

4.40 

4.00 

3.60 

3.20 

70 

60 

50 

40 

30 

20 

10 

0 



42 


Europe ITraxx Credit Indices 

• Outright: MAIN remains wide vs. equity and 

volatility and 110 acts as a strong resistance. It 

could be broken if the earnings’ season is 

sufficiently strong to make bears throw the 

towel; not a done deal given the poor outlook 

given by the latest macro numbers. Best 

strategy for the moment: play the 110-120 range. 

• SUB vs. SEN: This strategy remains quite 

hazardous for us but the very short-term could 

help FIN SEN to further outperform MAIN. To 

play the outperformance of Banks vs. MAIN, we 

propose a basket of four SUB CDS (BACR, 

RABO, ACAFP and ISPIM) against MAIN; the 

trade has a more upside, less downside and 

same carry. 

• SUB vs. SEN: There is no momentum in this 

trade but 1/ our expectation that systemic risk 

will further decrease and 2/ the street position 

on (callable) LT2 make us expect further 

decompression FIN SEN / SUB. We keep our 

“Long risk FIN SEN x1.5 / Short risk FIN SUB”. 

• HVL vs. MAIN: We stick to our view that 

there is little to do with HVL. For those who want 

to play ‘free’ options on Cyclicals, prefer playing 

it via our basket of single-names vs. MAIN or 

NON-FIN indices which did not underperform 

this week despite the rally. 

• XO vs. MAIN: Nothing to do here except for 

bulls who can play long risk XO / short risk 

MAIN with an aggressive ratio (2 or 3); bears 

should stay away from the pair-trade and buy 

protection on XO outright. 

• Curves: Indices’ curves continue to steepen 

and offer now limited value beyond the carry, 

which remains substantial; the only exception is 

FIN SEN, which is trading 3-4bp too flat relative 

to the 5y. We keep all our 5/10 steepeners on. 

Outright: 

Although we are ending this week not far from where 

we were at the end of last week, we managed to test 

110, the bottom of the recent range in the middle of 

the week but never managed to close tighter 113. 

Actually, buyers emerged every time we approached 

what could become soon a strong resistance level. 

Relative to equities, MAIN has shown a stronger 

enthusiasm to follow equities on the bearish side 

than on the bullish one. 

Table 1: Curves’ levels and changes 

5y 5/10y 1W Chg 1M Chg 

MAIN s13 113 +4.5 +1.5 +6 

MAIN s12 109 +9 +2 +6 

SEN s13 132 +4 +1 +4 

SEN s12 129 +6 +3 +2 

SUB s13 203 +2 +2 +6 

SUB s12 198 +3 +2 +3 

HVL s13 171 +6 +11 -2 

HVL s12 152 +10 +15 -3 

XO s13 514 -15 +10 +15 

XO s12 476 -10 +15 +10 


Chart 1: MAIN vs. EUROSTOXX 600 since 1-Apr 

140 

130 

120 

110 

100 

iTraxx MAIN 

EUROSTOXX 600 

90 

Start of the 

decoupling 

80 

Establishment of the 

110 resistance. 

70 

1/4 15/4 29/4 13/5 27/5 10/6 24/6 8/7 


Chart 2: MAIN vs. model (SXXP; V2X) 

155 

145 

135 

125 

115 

105 

95 

85 

75 

65 

15/4 29/4 13/5 27/5 10/6 24/6 8/7 


Diff. traded index - model 

Model (Eq + Vol) with static coefficients (3M) 

MAIN 

Over a longer timeframe, MAIN remains quite wide 

relative to both the EUROSTOXX 600 and VSTOXX 

indices. On a 3-months basis, it is 5bp wider than the 

level suggested by an equity + volatility model (chart 

2); on a 6-months basis, the cheapness of MAIN is of 

c.20bp. 

232 

237 

242 

247 

252 

257 

262 

267 

272 

20 

15 

10 

5 

- 

-5 

-10 

-15 

-20 

Pierre Yves Bretonniere 16 July 2010 


43 


The question is whether the 110 resistance can 

be broken on a sustainable basis; for us, it could 

only happen if a majority of bears throw the towel 

after a strong rally in equities. Can it happen in the 

current macro environment? We have some doubts 

and even if the tone of the earnings season 

remains on the positive side (so far, the three blue 

chips which reported, Alcoa, Intel and JPM, came 

above forecasts), the outlook can not be 

promising enough to trigger an equity rally that 

sends MAIN below 100. 

What’s the call? The only strategy which makes 

sense to us for the moment is to play the 110-120 

range. 

MAIN vs. FIN SEN 

The context remains favourable to FIN indices, SEN 

in particular, given the decrease in systemic risk and 

the progressive switch of the focus onto the earnings 

and the macro economic data. FIN SEN continues to 

outperform MAIN on a beta-adjusted basis as 

indicated on chart3. That being said, the newsflow on 

sovereigns –we had this week the downgrade by 

Moody’s of Portugal and of 8 Portuguese financials 

institutions – continues to have a bigger impact on 

FIN indices than on MAIN. 

What’s the call? 

Playing FIN SEN vs. MAIN remains for us throwing a 

coin in the air given the number of moving parts; in 

the very short term, we nonetheless feel two factors 

could play in favour of FIN SEN: 1/ upcoming results 

of the stress tests than could allow some further 

performance of Financials and 2/ stronger 

“psychological” support on MAIN at 110 than on FIN 

SEN at 130. 

In this backdrop, we would rather play a basket of the 

strongest banks that trade wide on a historical basis 

vs. MAIN. For example, the basket (2 x BACR SUB, 

1 x ACAFP SUB, 2.5 x RABO SUB and 1.5 x ISPIM 

SUB) vs. 10 x MAIN offers 1/ similar pick-up and 2/ 

more upside in a rally and 3/ less downside in the 

sell-off. 

Chart 3: FIN SEN vs. MAIN since 1/1/10 

FIN SEN 

230 

210 

190 

170 

150 

130 

110 

90 

70 

50 

FIN SEN Wide 


FIN SEN Tight 

y = 1.6645x - 42.21 

R 2 = 0.9541 

50 75 100 125 150 

MAIN 

Chart 4: Basket FIN vs. MAIN 

- 

40 

30 

20 

10 

-10 

-20 

-30 

7/09 8/09 9/09 10/09 11/09 12/09 1/10 2/10 3/10 4/10 5/10 6/10 7/10 


Chart 5: FIN SEN - MAIN 

- 

70 

60 

50 

40 

30 

20 

10 

-10 

-20 

07/09 08/09 09/09 10/09 11/09 12/09 01/10 02/10 03/10 04/10 05/10 06/10 


Last 



44 


SEN vs. SUB 

There has been no strong move in SUB/SEN ratio 

this week; at the time of writing FIN SEN and SUB 

indices are both tighter by 5bp w-o-w, signalling 

some decompression. In cash, the move is very 

similar with iBoxx Financials SEN and LT2 both 

tighter by 6bp. See chart 7 and 8. In financials, the 

major move has been the outperformance of T1 

(+1.9pt in price or 71bp of spread tightening) and to a 

lower extent UT2 (+0.7pt in price or 23bp in the 

spread). 


As already mentioned above, the potential for further 

tightening in FIN is probably fairly limited but it should 

benefit from the further decrease in systemic risk; we 

see the potential even more limited for the SUB 

index, less systemic, and still subject to the long 

position of dealers on callable LT2 and to the 

attractive level of basis on both bullet and callable 

bonds. 

For this reason, we think there is more 

decompression SUB/SEN to come should the market 

remain constructive (less systemic, more basis 

players). 

HVL vs. MAIN 

There has been no momentum at all in the HVL / 

MAIN relationship this week; the ratio between the 2 

indices stands at 1.49 for more than a week now. 

Our view remains that the different categories of 

names within HVL (consumer/retail, PIIGS-related 

and highly-cyclical credits) make the call on the index 

hazardous, unless being very bearish or very bullish 

on the market. 


Our medium-term view remains Constructive on HVL 

PIIGS-related names (which are Utilities and 

Telecoms) vs. market, Neutral on HVL 

consumer/retail vs. market and bearish on HVL 

highly-cyclical names vs. market; these 3 diverging 

views make us Neutral on HVL vs. MAIN. 

Chart 6: SUB/SEN ratio for iTraxx CDS indices 

2.00 

1.90 

1.80 

1.70 

1.60 

1.50 

iTraxx Sub / Sen (s13) 

Q1 (6m) 

Median (6m) 

Q3 (6m) 

1.40 

7/09 8/09 9/09 10/09 11/09 12/09 1/10 2/10 3/10 4/10 5/10 6/10 7/10 


Chart 7: SUB/SEN ratio for iBoxx Cash indices 

2.40 

2.30 

2.20 

2.10 

2.00 

1.90 

1.80 

1.70 

1.60 

1.50 

7/09 8/09 9/09 10/09 11/09 12/09 1/10 2/10 3/10 4/10 5/10 6/10 


Chart 8: HVL vs. MAIN history 

220 

200 

180 

160 

140 

120 

100 

80 

60 

iBoxx LT2/SEN ratio (OAS) 

1/09 3/09 5/09 7/09 9/09 11/09 1/10 3/10 5/10 7/10 


DJITX13 MST DISCONT 

DJITX13 HVL DISCONT 

490 

440 

390 

340 

290 

240 

190 

140 

90 

Note that our basket short Mittal / Lafarge / Holcim / 

Akzo / Schneider vs. NON-FIN has not lost a single 

bp this week despite the tightening of the market and 

is still a very good option for us. 



45 


XO vs. MAIN 

Last week, we were bullish MAIN and XO, although 

for different reasons (decrease in systemic risk / 

bullish market for MAIN and search for Yield / bullish 

market for XO) and the 2 indices performed roughly 

in line with their 1-month beta (4x)…marginal 

compression though. In cash, the compression trend 

is identical and the ratio between the spreads of the 

High-Yield cash index (OAS+724) and the High- 

Grade Non-financials one (OAS+143) has dropped to 

an historical low (5.1). Also, note that in terms of 

cash price, the High-Yield index gained 1.9pt this 

week while iBoxx Non-financials lost 0.1pt. 


Chart 9: XO / MAIN ratio history 

7.50 

XO / MAIN (DISCONT SERIES) 

7.00 

6.50 

6.00 

5.50 

5.00 

4.50 

4.00 

3.50 

7/09 8/09 9/09 10/09 11/09 12/09 1/10 2/10 3/10 4/10 5/10 6/10 7/10 


Chart 10: MAIN 5/10y bang in line with its 5y 

The XO/MAIN is likely to be very directional from 

here; MAIN could struggle to break 110 while XO has 

ample room to tighten further should 1/ the earnings 

continue to print above expectations, 2/ equities 

perform well and 3/ the new High-Yield new issue 

market stomach the pipeline. 

5/10y 

20 

10 

0 

-10 

60 

80 

100 

120 

140 

5y 

Bulls should play long risk XO / short risk MAIN with 

an aggressive ratio (2 or 3). 

Bears should stay away from this pair trade and buy 

protection on XO outright. 

Those who believe decompression is going to be the 

name of the game can also consider a 

decompression option strategy via receivers (page 

9). 

Update on Curves 

This week, all 5/10y curves massively steepened, 

sending all High-grade curves (MAIN, HVL, FIN SEN 

and SUB) in the positive territory; XO s13 and s12 

curves remain inverted (by 15bp and 10bp) but have 

well performed since the trough experienced 10 days 

ago (-50bp in s13). 

Most 5/10s look now fairly consistent with the level of 

the 5y; the only exception is FIN SEN which could 

trade 3bp steeper, i.e. at 7bp for an outright 5y at 

132. See charts 10 and 11. 

-20 

5/10Y MAIN (lhs) 

180 

5Y MAIN (rhs inverted) 

-30 

200 

3/09 5/09 7/09 9/09 11/09 1/10 3/10 5/10 7/10 


Chart 11: FIN SEN 5/10y too flat by c.3.5bp 

5/10y 

17 

60 

15 

80 

13 

11 

100 

9 

120 

7 

5 

140 

3 

160 

1 

180 

-1 

5/10Y FIN SEN (lhs) 

-3 

5Y FIN SEN (rhs inverted) 

200 

3/09 5/09 7/09 9/09 11/09 1/10 3/10 5/10 7/10 


160 

5y 


The positive momentum is unlikely to make curves 

diverge from their steepening trend; there are not any 

more screaming buys when compared to the outright 

(at the exception of FIN SEN) but remain good carry 

trades with limited downside. 

For references, the monthly carry (in breakeven) 

provide by MAIN, FIN SEN, SUB and XO is of 1.5bp, 

1.6bp, 2.3bp and 6.9bp. 

We keep all our steepeners open. 



46 


Technical Analysis – Interest Rates & Commodities 

Bond & Short-Term Contracts 

• Europe: Still a bottoming/up tone around key 2.559 (LT falling wedge sup) sustained by doji bottom reversal 

• US: Wide bottom H&S scenario remains possible from 2.90 area but needs to break above ST falling wedge 

• Short-term contracts u0: MT toppish tone on Euribor (Top H&S?) while ED is still above its ST 61.8% 

Equities & Commodities 

• WTI (Cl1): Stalling below 78.12/40 (LT rising channel support/ST 61.8%) & 79.38 top, keys to resume MT rise 

• Equity markets: Markets remain consolidative MT but with a ST up bias still developing improving MT picture 

US 10y: Down within ST falling wedge but bottoming on 2.90 support area MT Trend: Consolidative Range: 2.95/3.15 

Last correction since 4.01 April top sent it 2.458 3.311 

below 3.104 (Oct ’09 low) & 3.022 (LT 50%), 

opening the way for further weakness within 

the current ST falling wedge (2.774/3.049) 

towards the key 2.789 (LT 61.8%) level. 

However, if a ST rise now develops from the 

current 2.879 low, this could be analysed as 

the potential 2 nd shoulder’s low of a wide LT 

bottom Head & Shoulders with a potential 

neckline at 3.97. 

First negative step would be a break above 

3.049 (ST falling wedge res), with 

resistances then at 3.213 (61.8%), 3.311, 

3.444 & 3.578 (ST 38.2, 50 & 61.8%). 

Tech Snapshot 

- Within a ST falling wedge 

- Perhaps building LT Head & Shoulders 

Strategy: Aggressive could retry small 

short on 2.90 to play H&S. S/L 2.84. 

Aggressive will sell ST wedge resistance 

break 

UK/EUR 10y bond: Bias weak below 83.5/86.4 area for 63/66 MT Trend: Toppish/weak Range: 68.0/80.0 

Break above 81.4 (weekly LT triangle res) in 45.7 103.2 

February opened the way up for 115.8 (2005 

top) but it stalled on critical 103.2 (LT 

61.8%) and LT rising channel resistance 

(now 114.8) & bearish divergences printed 

on weekly RSI then favoured weakness. 

The risk still seems to extend current 

consolidation given 83.5/86.4 (2-dip neckline 

& ST rising channel support) break within a 

possible falling wave “4” for a move towards 

73.9 (weekly LT rising channel support) and 

perhaps then 59.3/63.0 (MT 38.2% & & 2- 

dip theoretical target). However, watch slight 

rising divergences appearing which could 

favour a ST rebound now. 

Tech Snapshot 

- Stalled on LT 61.8% 

- Back below LT triangle resistance 

- LT weekly rising channel support tested 

- Top 2-dip neckline at 83.5 broken 

STRATEGY: Bearish sold 83.5/85.3 with ½ 

covered 70 & ½ for 66 & S/L 77 now 

Christian Sené 16 July 2010 


47 


Germany 10y: Weekly/daily bottom doji reversals still favour upside MT Trend: Down/Bottoming Range: 2.60/2.80 

Decisive break below 2.849 (2009 low) in 2.389 3.00 

May allowed it to reach LT falling wedge 

support at 2.559 around which it has been 

bottoming for a few weeks. 

The bottom doji reversal drawn on weekly & 

daily charts still allows an attempt to develop 

a ST rising bias towards 2.95/2.977 (ST 

61.8% & MT 38.2%). First step would be a 

decisive break above 2.61 (ST falling wedge 

res) with intermediates then on 2.778/2.787 

(ST 38.2% & last top) & 2.864 (ST 50%). 

However, the MT bias will remain down 

oriented below 3.00 (LT falling wedge res). 

Tech Snapshot 

- Within MT & LT falling wedges 

- Daily/weekly doji bottom reversal printed 

Strategy: Retried small short on 2.55 area, 

S/L 2.495, for 2.80/90. Bearish could add 

short on 2.61 breakout 

UK 10y: Key MT 61.8% now broken slightly but has ST bottoming tone MT Trend: Down/bottoming Range: 3.35/3.55 

Market stalled in February below 4.38 (LT 

61.8%) and then fell sharply with a break 

seen first below the top Head & Shoulders 

neckline & then below the LT rising wedge. 

3.456 (LT 61.8% & H&S target) has now 

been broken slightly with 3.354 (October 

low) reached, around which it is trying to 

bottom with a doji bottom reversal drawn & a 

possible daily 2-bottom to be drawn with a 

neckline at 3.404. Rising divergences on 

2.933 3.805 

daily RSI still support such a ST 

bottoming/up scenario. A neckline break 

would call for 3.50 area initially. 

Tech Snapshot 

- Bottoming below LT 61.8% (3.465) 

- Doji bottom reversal & rising divergences 

Strategy: Bearish sold small 3.30/35, S/L 

3.26, for 3.50/60. Add above 3.404 

S&P: ST rebound to extend if ST falling wedge is now broken MT Trend: Consolidative Range: 1065/1140 

The S&P remains consolidative on a MT 1008/10

Trade Reviews 

Options, Money Market and Bond Trades – Tactical & Strategic Trades 

This page summarises our main tactical (T) and strategic (S) trades. The former focus on short-term horizons (a few weeks) 

allowing one to play any near-term corrections within a defined trend, while the latter rely on a medium-term assumed trend. 

For each trade we provide the expected target and the recommended stop loss. 

Current* Targets Stop Entry 

Closed Strategies 

USD Spread Fly Sell 3y ASW Buy 5y ASW Sell 10y ASW 

Trade closed (12/7). PnL: EUR +21k. 

28.0 6.0 13.1 

(06-Jul) 

Carry 

/ mth 

Risk** 

P/L 

(ccy/Bp) 

10k/01 USD +26k 

+2.6bp 

New Strategies 

USD Spread Fly Buy 3Y ASW Sell 5Y ASW Buy 7Y ASW 

Auction trends indicate that this spread fly has a strong downward bias in the days 

after the 3y auction. From an RV perspective, the fly is also at the high end of its 

recent range. 

10.5 

(T) 

7.0 13.0 10.125 

(13-Jul) 

10k/01 USD -4k 

-0.4bp 

Sell 30y UK Breakeven 

We expect a break below the 3.30-3.80% ‘normal’ range on 30y cash BE following 

the switch from RPI to CPI indexation for pension funds and ahead of 30y supply. 

We target 3.10%. 

OATEI Flattener Buy OATei 1.1% 2022 Sell OATei 2.25% 2020 

Spread is steep relative to OAT & OATei curves. We expect a correction in the 

coming two weeks. 

340.0 

(T) 

23.0 

(T) 

310.0 346.0 340.0 

(15-Jul) 

19.0 29.0 26.5 

(15-Jul) 

-0.6bp 

10k/01 GBP +0k, 

+0bp 

+0.2bp 20k/01 EUR +70k 

+3.5bp 

Existing Strategies 

Yield Curves 

EUR Flattener Receive EUR 1M-fwd 2s10s 

Asymmetric near-term response to "gradual" phasing out of unconventional 

policy/liquidity measures. 

150.8 

(T) 

115.0 200.0 184.8 

(04-Mar) 

-3bp 10k/01 EUR 

+340k 

+34bp 

Money Markets 

OIS Steepener Receive 9M3M OIS Pay 12M3M OIS 

Even though our macro call is not for rate hikes any time soon, we see this as a way 

to fade cycle-low yields in the front end, but with more limited downside and no 

negative carry/roll. In the event appetite recovers, this is a 'cheap short' with an 

option-like payout. 

13.6 

(T) 

28.0 8.0 14.1 

(02-Jul) 

25k/01 USD - 

12.5k 

-0.5bp 

Euribor Basis Buy ERU0 Basis 

Protection trade into the ECB. 

35.5 

(S) 

50.0 30.0 37.0 

(10-Jun) 

5k/01 EUR -7.5k 

-1.5bp 

Options 

Euribor Fly Buy ERU0 9862/75/87 P 

Cheap downside strategy, playing the normalisation of Eonia. The position 

complements with the upside fly (no-normalisation strategy). 

1.5 

(S) 

12.5 0.0 1.5 

(13-Jan) 

10k/01 EUR 0k 

0c 

Euribor Fly Buy ERU0 9912/25/37 C 

Upside protection in case of liquidity spillover post June. Rolldown trade. 

1.5 

(S) 

12.5 0.0 1.5 

(12-Jan) 

10k/01 EUR 0k 

0c 

Sterling Fly Buy L Z0 9900/25/50 C 

Rolldown strategy for unchanged MPC through 2010. 

12.5 

(S) 

25.0 0.0 3.5 

(05-Jan) 

5k/01 GBP +45k 

+9c 

*Tactical (T) and strategic (S) trades. **Risk: vega, gamma for options, or ΔDV01 for futures, bonds and swaps. 

Interest Rate Strategy 16 July 2010 


49 


Returning to EURAUD Bearish Strategies 

• Initial signs of a slowdown in the Chinese 

and US economies are being met by a 

commitment to maintain (or even extend) loose 

policy… 

• …suggesting that investor confidence will 

be maintained. Hence we maintain our positive 

view on commodity currencies. 

• We recommend taking advantage of the 

euro’s current recovery to establish short 

EURAUD positions once again. 

• Indeed, we believe that the euro’s recent 

recovery is coming to an end as optimism 

regarding European rescue packages and 

stress tests starts to fade. 

Percent 

Chart 1: Chinese Iron Ore Imports (% y/y) 

versus AUDUSD 

70 

60 

50 

40 

30 

20 

10 

0 

-10 

AUDUSD 

(RHS) 

Chinese Imports of Iron Ore 

05 06 07 08 09 10 

1.00 

0.95 

0.90 

0.85 

0.80 

0.75 

0.70 

0.65 

0.60 

Commodity currencies still favoured 

Equity markets rallied following the positive start to 

the earnings reporting season in the US, which has 

provide a broader boost to global investor optimism, 

allowing commodity currencies to resume gains. 

Indeed, is interesting to note that commodity-related 

currencies were the top performers over the past 

week among the major currencies and we expect this 

trend to continue in the near term, with long AUD 

positions still our favoured strategy for the medium 

term. 


Chart 2: Chinese IP Looks Vulnerable to 

De-Stocking 

The AUD is also benefiting from positive domestic 

conditions as was highlighted by the solid 

employment report. Although the RBA has signalled 

a pause in the tightening cycle, the strength of data 

anticipated in the coming months will probably 

prompt further rate hikes before the end of the year 

in our view. But, the real driving force for the AUD 

over the medium term will remain China and Chinese 

domestic demand in particular. 

Chinese data slow… 

The overall growth picture from China remains 

positive despite administrative tightening measures 

to cool overheating sectors of the economy (as China 

attempts to slow the economy to a more sustainable 

pace). However, some warning signs are developing, 

suggesting that a more cautious approach to the 

‘China proxy’ trade may be required in the future. 

One area that warrants close attention currently is 

Chinese demand for raw materials and commodities. 

While China’s trade surplus has continued to widen 

(the trade surplus widened to USD 20.02bn in June 

from USD 19.53bn in May), it is interesting to note 


that the main driver of this increase was a sharp 

slowdown of Chinese imports, which could be 

symptomatic of a broader slowing in Chinese 

domestic demand. At the headline level, the pace of 

growth in imports moderated to 34.1% y/y in June, 

from the 48.3% gain in May. 

However, of more significance is the fact that iron ore 

imports declined in both value and volume terms, as 

did coal and coal ore imports. This has also been 

reflected in the Australian trade data. Although the 

Australian trade data show exports increasing, this is 

a function of the rise in commodity prices, with 

exports in volume terms stagnating. The fact that 

there has been a decline in Chinese iron ore imports 

Ian Stannard 16 July 2010 


50 


should not come as a complete surprise given the 

attempts by the authorities to remove some of the tax 

incentives put in place for steel exporters since June 

of last year. 

…as administrative measures cool overheating… 

Effective from 15 July, the Chinese Ministry of 

Finance will abolish a 9% tax rebate on exports, such 

as hot and cold rolled coils, and long steel, which are 

primarily used in the construction sector. This could 

discourage Chinese makers from aggressively 

expanding steel production, which in turn would not 

bode well for Australia’s iron ore exports. If these 

developments start to be reflected in a slowdown of 

Australian exports, the AUD would become 

vulnerable to at least a corrective setback of recent 

gains. 

Our Asian economics team have lowered their 

Chinese growth forecast for 2010 to 9.8% from 

10.50% previously, and forecast a further growth 

slowdown in 2011 to 8.4%, anticipating further policy 

tightening via a mixture of quantitative credit controls 

and regulation of local government investment. 

Indeed, the authorities appear to be steadfast in their 

policies to tame speculative investments via curbs on 

loans to multi-home buyers in the property market, 

an area which has been a source of concern for 

some time. 

…but global policy will remain supportive 

Although the risk of a slowdown in China and the US 

has been clearly identified, it is encouraging that 

monetary authorities have responded. The latest 

FOMC minutes show a significant shift in tone, taking 

on a more dovish stance, suggesting that liquidity will 

be left in the system for longer than the market was 

initially anticipating. Some members of the FOMC 

have also put the case for further measures to be 

taken if the outlook deteriorates further. Furthermore, 

the Chinese authorities have reaffirmed their 

commitment to using an active fiscal policy together 

with a moderately accommodative monetary policy to 

maintain sustained growth. In an environment of 

continued ample global liquidity, we would expect 

asset markets to remain supported and investor 

confidence to be maintained, which will provide a 

favourable backdrop for the commodity and procyclical 

currencies. 

The risk of a sharper slowdown in Europe 

Along with many other central banks, Chinese 

officials have recently expressed concern over the 

external demand picture (namely Europe). As a 

producer of intermediate goods which are then 

finished and exported to the rest of the world, the 

largest destination being Europe, these concerns are 

not surprising. Chart 3 suggests that, in nominal 

60 

50 

40 

30 

20 

10 

0 

-10 

-20 

-30 

Chart 3: Chinese Exports (% y/y) 

00 01 02 03 04 05 06 07 08 09 


1.4 

1.5 

1.6 

1.7 

1.8 

1.9 

2.0 

EU 

annual terms, the growth of Chinese exports to 

Europe is peaking. So far, relative strength in core- 

European countries has, to some extent, provided a 

cushion to a significantly weaker growth profile in the 

peripheral eurozone countries. But that might be 

about to change. 

Both the survey and ‘hard’ activity data in Germany 

point to a noticeable acceleration in GDP growth over 

the second quarter, driven to a large extent by the 

export-sensitive manufacturing sector. But, looking 

forward, we anticipate that growth will slow in the 

second half of the year as tighter fiscal policy makes 

its presence felt. Indeed, leading growth indicators on 

the German front are already flagging such an 

outcome with the likes of the new-orders-to-inventory 

ratio in the manufacturing PMI survey turning sharply 

lower. We favour short EURAUD positions 

US 

Chart 4: EURAUD versus German Ifo 

Expectations. (Inversely) Hand in Hand? 

2.1 

94 96 98 00 02 04 06 08 10 


EURAUD (Inverted) 

German IFO Index 

115 

110 

105 

100 

95 

90 

85 

80 



51 


We continue to favour bullish AUD strategies as long 

as the overall growth picture in China is maintained 

and global liquidity remains ample, as currently looks 

to be the case. However, we would now favour short 

EURAUD positions to participate in anticipated 

further AUD gains as the EUR’s recent corrective 

rebound appears to be coming to an end. 

Chart 4 shows that, historically, there has been a 

close inverse correlation between the German Ifo 

expectations index and EURAUD. This can be 

explained by Australia’s status as a net exporter of 

commodities, and Europe’s as a net importer. 

Typically the Ifo index has been a timely indicator of 

turning points in EURAUD. However, we do not 

expect this simple historical correlation to continue to 

hold in the same way. The current environment is 

very different with the focus on fiscal consolidation. 

Hence, the current turn lower in the Ifo is unlikely to 

disrupt the longer-term down trend in EURAUD in our 

view. 

EURAUD rebound nearing completion 

We recently established a tactical long position to 

take advantage of a short-term corrective rebound in 

EURAUD as the unwinding of extreme euro short 

positions generated a recovery. Indeed, data from 

the last commitment of traders report (as of Tuesday 

6 July) showed a huge scaling back of short euro 

positions. The net euro short position declined to 

38,909, a hefty 34,761 drop in contracts on the week, 

which was the second-biggest short covering in EUR 

in recent years. This position adjustment is nearing 

completion, implying a return to strategic short euro 

positions is now possible. Hence, we would look to 

use any further EURAUD corrective gains over the 

coming week, which could see EURAUD rebound 

towards the 1.48 area, to establish renewed short 

positions targeting the 1.20 area by the end of the 

year. 

Chart 5: Australian Business and Consumer 

Confidence 

130 

Consumer Confidence 

125 

120 

115 

110 

105 

100 

(RHS) 

95 

90 

85 

Business Confidence 

(RHS) 

80 

75 

02 03 04 05 06 07 08 09 10 


Chart 6: EURAUD Risk Reversal 


50 

40 

30 

20 

10 

0 

-10 

-20 

-30 

-40 



52 

www.GlobalMarkets.bnpparibas.com 50

EUR/USD Rally Sets Sights on 1.3000 

• This week’s EUR/USD bullish trend reversal opens scope for a corrective rally toward 1.3125- 

1.3510 lasting until late-August to early-October. 

• However, extremely strong weekly momentum is fuelling the EUR/USD rise, potentially creating a 

larger rebound toward 1.37-1.39. 

• The EUR/USD advance has powerful allies in GBP/USD and AUD/USD with both currencies poised 

to extend gains during the next few weeks towards 1.55 and 0.9080, respectively. 

Tuesday’s EUR/USD breakout above the 

December downtrend near 1.27 triggered a 

bullish trend reversal. This indicated the Nov- 

June decline (1.5145-1.1875) is being unwound 

via a medium-term corrective rally toward at least 

1.3125-1.3510 representing the 38.2-50% 

retracement points of the Nov-June decline. 

Potentially a larger EUR/USD rise could occur 

toward 1.3895 – the common 61.8% retracement 

point -- given bullish momentum and pattern 

factors. 1) Momentum: Half way through July, the 

monthly chart shows this month’s rise is currently 

the largest since May’09: such a powerful surge 

is a propitious way to begin a sizable rally. The 

rally is fuelled by the strongest bout of weekly 

momentum since the explosive December’08 

jump. And weekly momentum is not overbought, 

suggesting more gains to follow. Although a 

somewhat arbitrary technical factor, the “slope” of 

the current June advance off 1.1875 is close to 

45-degrees on the daily chart – the most 

sustainable type of rally. 2) Pattern: Elliott wave 

analysis suggests “the logical point of return” for 

the correction is the 1.3692 April 12 high 

representing the last prominent high on the 

EUR/USD daily chart. 

The EUR/USD advance is also finding allies in 

GBP/USD and AUD/USD. GBP/USD broke out to a 

10-week high Wednesday and robust bullish weekly 

momentum favors now favor extending the gain 

toward 1.5490-1.5525 including a test of the April 

high. The AUD/USD rally, buoyed by accelerating 

bullish weekly momentum that is even stronger than 

at the start of the massive March-Nov’09 advance, 

next targets a break above 0.8885 retracement 

resistance with medium-term scope toward June up 

channel resistance near 0.9070/80. 

The bullish EUR/USD bias will get a boost if the S&P 

500 Index can confirm rising risk appetite by breaking 

above its April downtrend near 1093. A bullish trend 

reversal would open 1102-1106 resistance, with a 

break of 1106 opening scope for a bigger multi-week 

Wall Street rebound toward 1117-1131-1142. If the 

S&P 500 Index confirms this week’s bullish 

EUR/USD trend reversal, it would create a strong 

technical argument for “risk on” spanning several 

more weeks, as rising stock prices assist the 

EUR/USD rebound. 

Chart 1: EUR/USD – Bullish trend reversal 

The EUR/USD 

corrective rebound 

accelerated this week, 

decisively breaking 

the December 

downtrend at 1.2690. 

This confirms a bullish 

trend reversal next 

targeting the top of the 

June up channel near 

1.2980 and the 1.3000 

level, with scope to 

1.3125-1.3510 

Fibonacci retracement 

point resistance later 

this summer. 

1.48 

1.43 

1.38 

1.33 

1.28 

1.23 

1.18 

1.5060 

1.4630 

1.5140 

1.4582 

1.4219 

1.3815 

1.3690 

1.3455 

1.3270 

20-Nov-09 19-Jan-10 18-Mar-10 17-May-10 

1.1880 

1.2660 

14-Jul-10 


Andrew Chaveriat 16 July 2010 


53 


Chart 2: AUD/USD – Pausing before extending rally 

Aussie was a leader of 

the June “risk on” 

trade and once again 

is a key barometer for 

risk appetite. Currently 

0.95 

0.9405 

0.9320 

0.9390 

consolidating near 0.90 

0.9005 

0.8860 chart 

0.8910 

resistance and 0.8885 

Fibonacci resistance, 

0.8735 

the bullish mediumterm 

bias favors 

extension toward the 

top of the June up 

0.85 

0.8580 

channel near 

0.9070/80. 0.80 

0.8070 

20-Nov-09 19-Jan-10 18-Mar-10 17-May-10 

0.8860 

0.8315 

14-Jul-10 


USD/JPY is being 

dragged lower by 

bearish weekly and 

daily momentum. This 

risks a re-test of strong 

support from the 

recent twin-low near 

87.00 – with a 

downside break 

opening a deeper 

decline toward 86.50- 

85.60. 

97 

95 

93 

91 

89 

87 

Chart 3: USD/JPY – Rolling over 

97.78 

93.76 

92.32 

92.15 

94.95 

88.00 

86.95 

85 

27-Jul-09 

23-Sep-09 

84.81 

20-Nov-09 

19-Jan-10 

18-Mar-10 

17-May-10 

14-Jul-10 


Although weekly 

momentum remains 

bearish following the 

break of the March 

uptrend on July 1st, 

the recent $80 decline 

in spot gold is 

reminiscent of 

previous corrective 

declines seen this 

year. Any further 

corrective weakness 

should be limited to 

key $1166 support 

followed by resumption 

of the February 

advance. 


Chart 4: Gold – Correcting off the June peak 

1300.00 

1250.00 

1226 

1200.00 

1161 

1164 

1150.00 

1100.00 

1050.00 

1074 

1090 

1043 

1000.00 

20-Nov-09 19-Jan-10 18-Mar-10 

1264 

1248 

17-May-10 14-Jul-10 



54 


Currency Spot Trade Recommendations Date 

EUR/AUD 1.4675 Sell 1.4875, stop at 1.5075, target 1.3850 15 Jul 2010 

EUR/GBP 0.8380 Buy 0.8290, stop at 0.8210, target 0.85 08 Jul 2010 

USD/CHF 1.0430 Short from 1.0585, lower stop to 1.06, target 1.0150 08 Jul 2010 

USD/JPY 87.35 Short at 88.00, lower stop to 88.60, target 85.00 02 Jul 2010 

USD/KZT 147.50 Short at 147.00, stop at 149.50, target 135.00 28 May 2010 

EUR/AUD 1.4670 Long from 1.4700 stopped at 1.4340 07 Jul 2010 

GBP/USD 1.5365 Short from 1.5165 stopped at 1.53 08 Jul 2010 

TRY/CZK 12.95 Long from 13.20 stopped at 12.90 28 May 2010 




55 


Economic Calendar: 16 - 23 July 

GMT Local Previous Forecast Consensus 

Fri 16/07 23:50 08:50 Japan Tertiary Index (sa) m/m : May 2.1% -1.0% -0.7% 

(15/07) 

08:00 10:00 Italy EU Trade Balance : May EUR0.2bn EUR1.0bn n/a 

09:00 11:00 Eurozone Foreign Trade Balance (sa) : May EUR1.6bn EUR-0.5bn n/a 

09:00 11:00 ECB’s Honohan Speaks in Dublin 

12:30 08:30 US CPI m/m : Jun -0.2% -0.1% -0.1% 

12:30 08:30 CPI y/y : Jun 2.0% 1.2% 1.2% 

12:30 08:30 Core CPI m/m : Jun 0.1% 0.0% 0.1% 

12:30 08:30 Core CPI y/y : Jun 0.9% 0.9% 0.9% 

13:00 09:00 TICS Data : May USD15.0bn USD25.0bn n/a 

13:55 09:55 Michigan Sentiment (Prel) : Jul 76.0 74.0 74.0 

Mon 19/07 23:01 00:01 UK Rightmove House Price Index m/m : Jul 

(18/07) 

Japan Public Holiday 

08:00 10:00 Eurozone Current Account : May EUR-5.1bn EUR-3.0bn n/a 

14:00 10:00 US NAHB Housing Market Index : Jul 17 15 17 

Tue 20/07 01:30 11:30 Australia RBA MPC Minutes 

06:00 08:00 Germany PPI m/m : Jun 0.3% 0.2% 0.2% 

06:00 08:00 PPI y/y : Jun 0.4% 1.2% 1.2% 

07:30 09:30 Neths Consumer Confidence : Jul -18 -19 n/a 

08:00 10:00 Italy Industrial Orders y/y : May 20.6% 0.2% n/a 

09:00 11:00 Non-EU Trade Balance : Jun n/a 

08:30 09:30 UK PSNCR : Jun GBP12.0bn GBP20.0bn n/a 

08:30 09:30 PSNB : Jun GBP16.0bn GBP13.0bn n/a 

10:00 11:00 CBI Monthly Industrial Trends : Jul 

12:30 08:30 US Housing Starts : Jun 593k 580k 579k 

14:00 10:00 Fed’s Tarullo Testifies on Financial Regulation in Senate 

13:00 09:00 Canada BoC Rate Announcement 

Wed 21/07 Japan BoJ Minutes 

08:30 09:30 UK BoE MPC Minutes 

14:00 10:00 US Fed’s Bernanke Gives Monetary Policy Report to Senate Banking Panel 

14:30 10:30 EIA Oil Inventories 

Thu 22/07 06:45 08:45 France Business Confidence (sa) : July 95 94 n/a 

06:45 08:45 Consumer Confidence (sa) : July -39 -41 n/a 

07:00 09:00 Eurozone PMI Manufacturing (Flash) : Jul 55.6 55.4 55.1 

07:00 09:00 PMI Services (Flash) : Jul 55.5 54.5 55.0 

07:00 09:00 PMI Composite (Flash) : Jul 56.0 55.2 n/a 

09:00 11:00 Industrial Orders m/m : May 0.9% 0.0% n/a 

09:00 11:00 Industrial Orders y/y : May 22.1% 21.3% n/a 

ECB Governing Council Meeting (No Rate Announcement) 

07:30 09:30 Neths Unemployment Rate : Jun 5.6% 5.5% n/a 

08:30 09:30 UK Retail Sales inc Auto Fuel m/m : Jun 0.6% 0.3% 0.6% 

08:30 09:30 Retail Sales inc Auto Fuel y/y : Jun 2.2% 0.7% 1.1% 

12:30 08:30 US Initial Claims 429k 440k n/a 

14:00 10:00 FHFA HPI : May 

14:00 10:00 Existing Home Sales : Jun 5.66mn 5.00mn 5.20mn 

14:00 10:00 Leading Indicators m/m : Jun 0.4% -0.2% -0.3% 

14:30 10:30 Canada BoC Monetary Policy Report 

Market Economics 16 July 2010 


56 


Economic Calendar: 16 - 23 July (cont) 

GMT Local Previous Forecast Consensus 

Fri 23/07 06:45 08:45 France Household Consumption m/m : Jun 0.7% -0.6% n/a 

06:45 08:45 Quarterly Industry Survey : Q3 4 5 n/a 

07:00 09:00 Spain PPI m/m : Jun 0.2% 0.2% n/a 

07:00 09:00 PPI y/y : Jun 3.8% 3.3% n/a 

07:30 09:30 Italy ISAE Consumer Confidence : Jul 104.4 104.0 n/a 

08:00 10:00 Retail Sales y/y : May -0.5% 0.4% n/a 

08:00 10:00 Germany IFO Business Climate : Jul 101.8 102.1 101.5 

08:00 10:00 IFO Current Conditions : Jul 101.1 102.6 102.4 

08:00 10:00 IFO Expectations : Jul 102.4 101.4 101.3 

08:30 09:30 UK GDP (Prel) q/q : Q2 0.3% 0.6% 0.6% 

08:30 09:30 GDP (Prel) y/y : Q2 -0.2% 1.1% 1.0% 

11:00 07:00 Canada CPI m/m : Jun 0.3% 

13:00 15:00 Belgium Business Confidence : Jul -7.7 -10.0 n/a 

During 22-29/7 Germany Import Prices m/m : Jun 0.6% 0.5% n/a 

Week Import Prices y/y : Jun 8.5% 8.6% n/a 

Release dates and forecasts as at c.o.b. prior to the date of publication: See Daily Economic Spotlight for any revision 




57 


Key Data Preview 

Chart 1: US Total vs. Core CPI Inflation 


% m/m Jun (f) May Apr Mar 

CPI -0.1 -0.2 -0.1 0.1 

Core 0.0 0.1 0.0 0.0 

NSA (index) 218.26 218.18 218.01 217.63 

Key Point: 

Falling energy prices will offset higher food prices, 

bringing headline to zero. Core unchanged will bring 

y/y to its 1961 low. 

BNP Paribas Forecast: More Weakening 

US: Consumer Price Index (June) 

Release Date: Friday 16 July 

Headline CPI is expected to decline by 0.1% m/m in June, 

driven mainly by declining energy prices. Weekly EIA data 

indicate that pump prices declined throughout June, 

reflecting the decline in crude oil prices in May. As a result, 

we expect CPI energy prices after seasonal adjustment to 

fall by 1.4% m/m in June, approximately half the decline 

seen in May. Food prices are forecast to increase by 0.2% 

m/m in June. Food prices have followed a rollercoaster 

path of strongly up followed by negligible increases in 

alternate months. Excluding food and energy, core CPI is 

expected to remain unchanged after nudging higher (0.1%) 

in May. As a result, core yearly inflation should ease to 

0.85% y/y from 1.0% previously, pushing it closer to its 

1961 all-time low (0.7%). Weakness should be 

concentrated in core goods (no change), and shelter prices 

(-0.04%). Within shelter, only lodging away from home has 

any price buoyancy. There is a risk to the goods price 

forecast that state and local governments could raise taxes 

on tobacco and other goods to help redress massive 

budget deficits again, as they did in May. In non-seasonally 

adjusted terms, total CPI is expected to remain largely 

unchanged, inching up to 218.256 from 218.18 in May. 

This should drive total yearly inflation much lower, to 1.2% 

in June from 2% previously. 

Chart 2: US Present Conditions Compared 


July p (f) Jun 2H Jun p Jun May 

Michigan 

Sentiment 74.0 76.5 75.5 76.0 73.6 

BNP Paribas Forecast: Decline 

US: Michigan Consumer Sentiment (July, preliminary) 


The University of Michigan Survey of Consumer 

Confidence index rose in June to 76.0 from 73.6 in May. 

Recent developments in consumer confidence likely reflect 

weakness in gasoline prices. Nevertheless, the turmoil in 

financial markets and the risks to the economic recovery 

from the European sovereign crisis as well as private 

sector hiring losing steam should send consumer 

confidence lower in the first half of July. In addition, stocks 

have given up all of this year’s gains. Therefore, we expect 

a decline to 74.0 in July from 76.0 in June. On the other 

hand, as the recovery progresses, albeit at a moderate 

pace, consumer confidence should continue trending 

higher in the coming months. 

Key Point: 

Unfavourable news on the European sovereign risk 

crisis and private sector hiring losing momentum 

should depress consumers’ optimism early in July. 



58 



Chart 3: US Housing Starts & Building Permits 

2000 

1750 

1500 

1250 

1000 

750 

500 

Building Permits (lagged 1 month, k) 

Housing Starts (k) 

250 

May Aug Nov Feb May Aug Nov Feb May Aug Nov Feb May Aug Nov Feb May 

06 07 08 09 10 


Jun (f) May Apr Mar 

Housing Starts 

(000s, saar) 580 593 659 634 

Key Point: 

A 5.9% decline in building permits in May suggests 

housing starts will ease in June. 

BNP Paribas Forecast: Small Decline 

US: Housing Starts (June) 

Release Date: Tuesday 20 July 

Housing starts are expected to decline by 13k to 580k in 

June after plunging by 66k in the previous month. Indeed, 

building permits dropped sharply in April by 10.9% m/m, 

and in May they dropped by another 5.9%. Given that 

permits lead housing starts by one to two months, the May 

decline in permits points to more weakness in new 

construction over the near term. Also supporting our 

forecast, construction hours worked declined by 0.1% m/m 

in June following a 3.0% decline in May. In line with that, 

the NAHB index of homebuilders’ optimism dropped in 

June by 5 points after two month of somewhat stronger 

readings. It appears that much of the stabilisation in 

housing demand over the past year was a pulling forward 

of demand through the tax credit, leaving the outlook for 

housing highly uncertain. New lows in mortgage rates 

should provide some support to housing demand, although 

we look for only a modest improvement from these levels 

through the remainder of the year. 

1.2 

1.1 

0.9 

0.9 

0.8 

0.7 

0.6 

Chart 4: Eurozone Manufacturing PMI 

1.4 Manufacturing PMI: 

Ratio of New Orders to Stocks of Finished Goods 

1.3 

Manufacturing PMI: Headline (RHS) 

0.5 

30 

97 98 99 00 01 02 03 04 05 06 07 08 09 10 


Jul (f) Jun May Apr 

Manufacturing 55.4 55.6 55.8 57.6 

Services 54.5 55.5 56.2 55.6 

Composite 55.2 56.0 56.4 57.3 

Key Point: 

The more forward-looking elements of the PMIs point 

to a further moderation in activity. 

60 

55 

50 

45 

40 

35 

BNP Paribas Forecast: Past the Peak 

Eurozone: ‘Flash’ PMIs (July) 

Release Date: Thursday 22 June 

Following fourteen consecutive rises, taking the ‘headline’ 

index of the manufacturing PMI for the eurozone to its 

highest level since mid-2006, May and June figures saw a 

moderation in activity in the sector. 

The output and new orders indices of the manufacturing 

PMI have both declined by around four percentage points 

from their peaks though both remain consistent with robust 

levels of activity (at 57.2 and 55.9, respectively). 

The ratio of the sub-indices for new orders and stocks of 

finished goods, historically a good leading indicator of the 

future direction of the manufacturing PMI, is consistent with 

a further moderation in activity going forward (see chart). 

External economic conditions remain supportive of activity 

in the sector but developments within the eurozone are not 

so favourable. Domestic demand is already weak and will 

be undermined further by fiscal policy tightening. 

In line with the relative weakness of domestic demand, the 

PMI for the service sector has been less elevated than its 

manufacturing sibling. The services PMI weakened in June 

and, with the new business and future expectations indices 

both falling sharply, we look for a further fall in July. 

The employment indices of the manufacturing and services 

PMIs are barely above the 50 expansion level, indicative of 

high unemployment continuing. This in turn bears down on 

labour costs, keeping output price indices low. 



59 



Chart 5: UK Retail Sales vs RICS Sales to Stocks 

10 

9 

8 

7 

6 

5 

4 

3 

2 

1 

0 

-1 

-2 

-3 

RICS Sales to Stocks 

(3m-lag, RHS) 

Retail Sales (% y/y) 

00 01 02 03 04 05 06 07 08 09 10 



% m/m 0.3 0.6 0.0 0.7 

% y/y 0.7 2.2 1.3 1.5 

% 3m/3m 1.7 1.2 0.1 -2.4 

% 3m/yr 1.4 1.7 1.6 0.5 

Key Point: 

We expect a solid m/m expansion, though base 

effects will push y/y growth to a subdued level. 

0.7 

0.6 

0.5 

0.4 

0.3 

0.2 

0.1 

BNP Paribas Forecast: Solid 

UK: Retail Sales (June) 

Release Date: Thursday 22 July 

We expect a solid 0.3% m/m pace of expansion in UK retail 

sales during June. However, given the m/m surge a year 

earlier, the y/y pace of growth is likely to slump to below 

1% y/y. 

The joker in the pack this month is likely to be the effect of 

the football world cup. There have been mixed reports with 

regards to what impact this had on consumer spending. 

One retailer complained of poor sales of flatscreen TVs in 

comparison with the experience during past football 

competitions. This suggests that household goods probably 

didn’t take off in a big way. By contrast, food and 

beverages sales are likely to have been buoyed to some 

extent – reinforced by the particularly favourable weather 

during the month. 

Survey indicators have been mixed. The GfK measure of 

consumer confidence continued to trend lower and 

suggested that consumers’ appetite for major purchases 

continued to slide. By contrast the BRC retail sales monitor 

showed a modest acceleration in sales values (around 

3.4% y/y). However, since the latter is reported in nominal 

terms, subtracting inflation would leave sales volumes 

close to our estimate for the ONS equivalent. 

Chart 6: French Industry Surveys (Normalised) 

30 

20 

Own Production Outlook 

10 

0 

-10 

-20 

-30 

Composite Indicator (RHS) 

-40 

-50 

-60 

General Production Outlook 

-70 

-80 

01 02 03 04 05 06 07 08 09 10 


SA Jul (f) Jun May Jul 09 

Services 97 98 99 78 

Industry 94 95 97 80 

Overall Manuf. Outlook -8 -4 -3 -40 

Own Manuf. Outlook -5 -7 3 -18 

Key Point: 

Both services and industry should suffer a decline in 

confidence in July. Global uncertainties and fiscal 

tightening should weigh on growth momentum. 

115 

110 

105 

100 

95 

90 

85 

80 

75 

70 

BNP Paribas Forecast: Second Decline 

France: Monthly Industrial Survey (July) 


Industrial production has done remarkably well in the past 

few months: manufacturing output rose 2.3% in the three 

months to May. This should translate into strong GDP 

growth in Q2; we forecast 0.5% q/q. However, the 

momentum of the recovery seems to be fading. 

We expect the July confidence indices to confirm this 

concern. The INSEE survey may print a second 

consecutive decline for services, which has not occurred 

since the trough of the cycle in March 2009. 

Despite more favourable international conditions (with the 

weaker euro helping exports outside the eurozone and 

some improvement in GDP growth in most eurozone 

trading partners), industrial confidence is also likely to 

retrench. 

Own manufacturing output suffered a severe setback in 

June, and we may see a technical correction in July. 

However, other sub-indicators are likely to deteriorate 

further. In particular the overall manufacturing outlook 

should weaken again, and more significantly than the 

previous month. Overall, we forecast industrial confidence 

to decline for the second month in a row. 



60 



Chart 8: French Hh Confidence (key items) 

10 

0 

-10 

-20 

-30 

-40 

-50 

-60 

Future Finances - Personal 

Past Finances - Personal 

-70 Past Living Standard - National 

Future Living Standard - National 

-80 

04 05 06 07 08 09 10 


Diffusion Index, SA Jul (f) Jun May Jul 09 

INSEE indices: 

Overall -41 -39 -38 -37 

Buying opportunity -27 -24 -24 -28 

EU Commis. Index: 

Headline -24.0 -22.0 -21.3 -28.1 

BNP Paribas Forecast: Continued Decline 

France: Household Confidence (July) 


The economic news that usually drives household 

confidence has been mixed over the past few weeks. 

Unemployment data did not confirm in the past two months 

(+1.4% in April and May) the improvement seen earlier in 

the year. Conversely, inflation eased in June, especially 

energy prices. 

However, the main piece of news affecting household 

confidence recently is the announcement of the pension 

reform and the prospect of fiscal tightening, much needed 

in order to reduce the deficit to 3.0% in 2013. This is 

probably weighing on confidence, with the political 

scandals that affected various government members also 

likely to have taken their toll. 

The perceived national standards of living, both past and 

future, have deteriorated significantly since the start of the 

year. The personal financial situation, which usually moves 

in tandem with the standard of living, has held up better 

(see chart). These low levels probably explain the decline 

in the ability to save. 

Key Point: 

The prospect of fiscal tightening is probably the 

major reason for the continued decline in household 

confidence. 

Chart 9: US Existing & Pending Home Sales 

130 

125 

120 

115 

110 

105 

100 

95 

90 

85 

80 

75 

Existing Home Sales 

(mn, RHS) 

Pending Home Sales 

(2001=100, 1m lag) 

02 03 04 05 06 07 08 09 10 



New Home Sales 

(000s saar) 310 300 446 389 

Existing Home Sales 

(millions saar) 5.00 5.66 5.79 5.36 

Key Point: 

We expect existing home sales to decline by 12% 

m/m in June as pending home sales plummeted in 

May by 30%, while new home sales should remain 

weak, at 310k annualised units. 

7.2 

6.7 

6.2 

5.7 

5.2 

4.7 

4.2 

BNP Paribas Forecast: Weak 

US: Existing & New Home Sales (June) 

Release Date: Thursday 22 and Monday 26 July 

Existing home sales should drop sharply in June following 

a smaller decline the previous month. In May, existing 

home sales declined by 2.2% m/m and we expect they will 

drop by 12% in June as pending home sales plummeted 

30% in May. It appears that much of the stabilisation in 

housing demand over the past year stemmed from a pulling 

forward of demand through the tax credit. Indeed, 

mortgage applications to purchase a home declined by 

22% m/m in May, and by another 11.5% m/m in June, to 

their lowest level since 1996, suggesting prospective 

buyers are already pulling back sharply. 

New home sales plummeted by 32.7% m/m in May, adding 

to evidence that prospective home buyers withdrew from 

the market en masse in May after the government 

homebuyers’ tax credit expired in April. We expect new 

home sales to remain weak at 310k annualised units, up 

just 3.3% from their 30-year low. The end of the 

government tax credit at the end of April should cool sales 

in the summer months, with housing demand troughing in 

June or July, before the cyclical upward trend resumes in 

the second half of the year. 

In line with that, the NAHB index of prospective buyers’ 

traffic dropped back to 14 in June after blipping to 16 the 

previous month. 



61 



120 

115 

110 

105 

100 

95 

90 

85 

80 

Chart 9: German Ifo Business Climate 

Expectations (4-Mth Lag) 

Current Conditions 

75 

93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 


Jul (f) Jun May Apr 

Headline 102.1 101.8 101.5 101.7 

Expectations 101.4 102.4 103.7 104.0 

Current Conditions 102.6 101.1 99.4 99.3 

Key Point: 

Expectations have topped out but strength in the 

industrial sector is boosting current conditions. 

BNP Paribas Forecast: Mixed Picture 

Germany: Ifo Business Climate (July) 


Ifo’s ‘headline’ business climate index has gone sideways 

in the most recent couple of months, with declines in the 

expectations sub-index broadly offset by improvements in 

the current assessment of business conditions. 

We expect a similar outcome in July. The fall-out from the 

debt crisis in the eurozone and the German government’s 

decision to implement a fiscal austerity plan are again likely 

to weigh on expectations. 

There is a high correlation between Ifo’s expectations index 

and the ZEW survey’s equivalent. The latter declined by a 

larger than expected margin for the third straight month in 

July, with both factors above cited for the deterioration. 

In contrast, Ifo’s current assessment of business conditions 

should continue to improve, in line with buoyant activity in 

the export and manufacturing sectors in Germany. Output 

in the industrial sector is on track to increase at a record 

pace of around 5% q/q in Q2. 

The rate of increase in incoming orders, however, seems to 

be topping out, pointing to Ifo’s current assessment index 

probably following suit in the coming months. It is already 

close to its cycle peaks recording in previous upswings with 

the exception of 2006’s ‘pre-crisis boom’ (see chart). 

Chart 10: French Sales of Manuf. Goods (3m avg) 

20 

15 

10 

5 

0 

-5 

Total (% 3m/3m annualised) 

-10 

Total excl. autos (% 3m/3m annualised) 

-15 

Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr 

07 08 09 10 


Volume index Jun (f) May Apr Jun 09 

SA-WDA 

% m/m -0.6 0.7 -1.3 1.9 

% y/y -0.5 1.9 1.0 1.3 

Key Point: 

The seasonal sales only started on 30 June, so the 

impact will be smaller than usual during that month, 

temporarily pushing down overall sales. 

BNP Paribas Forecast: Distorted Again 

France: Hh Consumption of Manuf. Goods (June) 


The June retail sales data are of particular importance. 

Over the past few months, private consumption has been 

severely distorted by the car purchase incentives and their 

progressive phasing out. This is largely complete. 

Nevertheless, we do not necessarily have a clearer view of 

the underlying strength of PCE. 

May sales were bolstered by an increase of electronic 

goods sales, ahead of the World Cup. This helped to revive 

retail sales momentum. However, as this factor was most 

probably short-lived, it remains to be seen whether 

household consumption can remain the engine of French 

growth. 

The main uncertainty concerns sales of clothes and shoes 

(the second most volatile item after new cars); we expect a 

relatively solid trend although seasonal sales only started 

on the last day of the month so the bulk of sales may only 

show up in July. This item should thus drag on seasonally 

adjusted retail sales in June. 

The last concern with regard to PCE is the impact of the 

announcement of the pension reform and the prospect of 

fiscal tightening. We believe this has adversely affected 

household confidence but should not impact actual 

consumption. 



62 



Chart 11: UK GDP vs Composite CIPS 


Q2 (f) Q1 Q4 Q3 

% q/q 0.6 0.3 0.4 -0.3 

% y/y 1.1 -0.2 -2.9 -5.3 

Services % q/q 0.5 0.3 0.7 -0.2 

Ind Prod % q/q 1.5 1.0 0.5 -0.9 

Key Point: 

We expect a sharp acceleration in headline GDP 

growth, helped by strong industrial production. 

BNP Paribas Forecast: Improving. 

UK: GDP (Q2, preliminary) 


We expect a sharp, albeit short-lived, acceleration in GDP 

growth during Q2. Part of the improvement is likely to be 

technical. More specifically, widespread snow-related 

disruption held back growth during Q1. That should lead to 

a snapback during Q2 as output returned to normal. 

More generally, the reliable early warning indicators of 

growth point to at least double the pace of GDP growth 

during Q2. Both the CIPS surveys continued to rise until 

mid-Q2, which, given the usual lead times, points to a 

catch-up in GDP. Given the tendency for the initial estimate 

of GDP to surprise on the downside before being 

subsequently revised up, we have aimed low and expect a 

0.6% q/q pace of expansion. 

The breakdown by output is likely to show a rapid pace of 

expansion in industrial production given the recent monthly 

data. However, services output has been more subdued. 

Given the rolling over in the CIPS surveys in the last month 

or so, we suspect that this pace of headline GDP growth 

will be temporary and a more pedestrian pace of growth 

will resume during H2. 



63 


Economic Calendar: 26 July – 20 August 

26 July 27 July 28 July 29 July 30 July 

Australia: PPI Jun 

Japan: Trade Balance Jun 

US: New Home Sales Jun 

Eurozone: Monetary 

Developments Jun 

UK: CBI Distributive 

Trades Jul 

Germany: GfK Consumer 

Confidence Aug 

France: Housing Starts 

Jun, Job Seekers Jun 

Sweden: PPI Jun 

Neths: Producer 

Confidence Jul 

US: S&P CaseShiller 

Home Price Index May, 

Housing Vacancy Q2, 

Consumer Confidence Jul 

Australia: CPI Jun 

Germany: States’ CoL 

Jun, HICP (Prel) Jun 

Spain: Retail Sales Jun 

US: Durable Goods 

Orders Jun, Beige Book 

Japan: Retail Sales Jun 

Eurozone: Business & 

Consumer Survey Jul, 

Retail PMI Jul 

UK: Net Consumer Credit 

Jun, Mortgage Approvals 

Jun 

Germany: Labour Jun 

France: PPI Jun 

Italy: Wages Jun, ISAE 

Business Confidence Jul 

Spain: HICP (Flash) Jul 

Belgium: CPI Jun 

Sweden: Retail Sales 

Jun, Consumer 

Confidence Jul 

Norway: Labour Jul 

During Week: Germany Retail Sales May, UK Nationwide House Prices Jul 

2 August 3 August 4 August 5 August 6 August 

Eurozone: PMI 

Manufacturing (Final) Jul 

UK: CIPS Manufacturing 

(Final) Jul 

Switz: PMI Jul 

US: Construction Jun, ISM 

Manufacturing Jul, Help 

Wanted Jul 

Canada: Public Holiday 

Australia: RBA Rate 

Announcement, Retail 

Sales Jun 

Eurozone: PPI Jun 

Switz: CPI Jun 

US: Personal Income & 

Spending Jun, Factory 

Orders Jun, Pending 

Home Sales May 

Australia: Trade Balance 

Jun, House Price Index 

Q2 

Eurozone: Retail Sales 

Jun, PMI Services (Final) 

Jul 

UK: CIPS Services Jul 

US: ADP Labour Jul, ISM 

Services Jul, Challenger 

Layoffs Jul 

Eurozone: ECB Rate 

Announcement & Press 

Conference 

UK: BoE Rate 

Announcement 

Germany: Factory Orders 

Jun 

Spain: Industrial 

Production Jun 

Sweden: Labour Jun 

Norway: Labour May 

Neths: CPI Jul 

During Week: UK Halifax House Prices Jul 


Australia: NAB Business 

Survey Jul 

Japan: M2 Jul, Current 

Account Jun 

Germany: Trade Balance 

Jun 

Japan: BoJ Rate 

Announcement 

UK: BRC Retail Sales 

Monitor Jul, RICS House 

Price Balance Jun, Trade 

Balance Jun 

France: Industrial 

Production Jun 

Germany: CPI Jul 

Norway: CPI Jul, PPI Jul 

US: FOMC Rate 

Announcement, 

Productivity & Costs 

(Prel) Q2, Wholesale 

Trade Jun, NFIB Small 

Business Optimism Jul 

Australia: Westpac 

Consumer Confidence 

Aug 

Japan: CGPI Jul, 

Machinery Orders Jun 

UK: BoE Inflation Report, 

Labour Aug 

France: Current Account 

Jun 

Norway: Norges Bank 

Rate Announcement 

US: Trade Balance Jun, 

Treasury Statement Jul 

Australia: Labour Jul 

Eurozone: Industrial 

Production Jun, ECB 

Monthly Report 

Italy: CPI Jul, EU Trade 

Balance Jun 

Spain: CPI Jul 

Sweden: CPI Jul 

Norway: Retail Sales Jun 

US: Import Price Index 

Jul 

Japan: CPI Tokyo Jul, CPI 

National Jun, Labour Jun, 

Hh Consumption Jun, IP 

Jun, Housing Starts Jun 

Eurozone: Labour Jun, 

HICP (Flash) Jul, Eurocoin 

Jul 

UK: GfK Cons Conf Jul 

Germany: Wages Q2 

Italy: PPI Jun, CPI (Prel) 

Jul 

Spain: Labour Q2 

Belgium: GDP (Prel) Q2 

Sweden: GDP (Flash) Q2 

Switz: KoF Leading 

Indicator Aug 

Canada: GDP May 

US: GDP (Adv) Q2, ECI 

Q2, Chicago PMI Jul, UoM 

Sentiment (Final) Jul 

Japan: Leading Indicator 

June 

UK: IP Jun, PPI Jun 

Germany: IPJun 

France: Trade Balance Jun, 

Budget Balance Jun 

Italy: IP Jun, GDP (Prel) Q2 

Norway: IP Jun 

Neths: IP Jun 

US: Labour Jul, Consumer 

Credit Jun 

Canada: Labour Jul 

Japan: BoJ Monetary 

Policy Meeting Minutes 

Eurozone: Trade Balance 

Jun, GDP (Flash) Q2 

Germany: GDP (Prel) Q2 

France: CPI Jul, GDP 

(Prel) Q2, NF Payrolls 

(Prel) Q2, Wages (Prel) 

Q2 

Spain: GDP (Flash) Q2 

Neths: GDP Q2, Retail 

Sales Jun 

Sweden: IP Jun, AMV 

Labour Jul 

US: CPI Jul, Retail Sales, 

Jul, Business Inventories 

Jun, UoM Sentiment (Prel) 

Aug 

During Week: Germany WPI Jun 


Japan: GDP (Prel) Q2, 

Tertiary Index Jun 

Eurozone: HICP Jul 

US: Empire State Survey 

Aug, TICS Data Jun, 

NAHB Housing Index Aug 

UK: BoE MPC Minutes 

Germany: PPI Jul 

Canada: CPI Jul 

Australia: RBA MPC 

Minutes 

Eurozone: Current 

Account Jun 

UK: CPI Jul 

Germany: ZEW Survey 

Aug 

US: New Home Starts 

Jul, PPI Jul, Industrial 

Production Jul 

UK: PSNCR Jul, PSNB 

Jul, Retail Sales Jul 

Norway: GDP Q2 

Neths: Consumer 

Confidence Aug, Labour 

Jul 

US: Philly Fed Aug, 

Leading Indicators Jul 


Release dates as at c.o.b. prior to the date of this publication. See our Daily Spotlight for any revisions 



64 


Treasury and SAS Issuance Calendar 

Daily update onto https://globalmarkets.bnpparibas.com, Tools & Apps, Analytical Tools, Market Calendar, Government Flows 

In the pipeline - Treasuries: 

France: Cancels its 5 Aug OAT auction, issuance to resume in Sep 

Italy: To issue new BTP Mar-21 and new CTZ Aug-12 in Q3 

UK: To hold 2 more syndications: H2 Jul, IL gilt 0.625% Mar40 (tap); H2 Sep, long-dated conv. gilt or IL gilt (details c. 2wks in advance) 

Finland: To hold a second syndicated auction (new 5y) most likely in Sep/Oct; H2: to arrange one or two bond auctions 

Czech Rep.: Considers carrying out further EUR-denominated domestic auctions during 2010 

Denmark: H2 2010, to issue a 5y EUR loan (EUR 1-2bn); opening of a new 5y (Nov 2016) & a new 10y (Nov 2021) DGBs postponed to the 

beginning of 2011 

Slovak Rep.: Considering issuing new syndicated 15y benchmark bond (around EUR 1.5bn) in the autumn 

During the week: 

UK: (w/c 2 August mini-tender) choice of gilt on 23 July 

US: Announcement of 2-, 5- & 7y Notes (new) details on Thu 22 Jul 

FHLB: July Global Notes auction details to be announced on Tue 20 Jul 

Date Day Closing Country Issues Details BNPP forecasts 

Local GMT 

16/07 Fri 12:00 03:00 Japan JGBs 10y Auction for Enhanced-liquidity issue 274-305 

JGBs 20y Auction for Enhanced-liquidity issue 56-83 

JPY 0.3tn 

Italy 

Exchange Offer CCT 15 Dec 2015 (CCTeu) vs. BTPs 

Sep11 & Mar12 and CCTs Mar-Nov12 & Jul13 

20/07 Tue 10:00 09:00 Ireland Gilt 4.6% 18 Apr 2016 

Gilt 5% 18 Oct 2020 

16 Jul EUR 1-1.5bn 

10:30 09:30 UK Gilt 4% 7 Sep 2016 GBP 3.75bn 

12:00 16:00 Canada Repurchase of 7 Cash Mgt Bonds (Sep10 - Sep11) CAD 1bn 

21/07 Wed 11:00 09:00 Germany Bund 4 Jul 2042 (new) EUR 4bn 

22/07 Thu 12:00 03:00 Japan JGB 20 Jun 2030 JPY 1.1tn 

26/07 Mon 12:00 10:00 Belgium OLO 19 Jul 

27/07 Tue 12:00 03:00 Japan JGB 2-year 20 Jul JPY 2.6tn 

10:55 08:55 Italy CTZ 22 Jul 

Neths DSLs (Off-the-run facility) 21 Jul 

13:00 17:00 US Notes 2-year (new) 22 Jul USD 40bn 

28/07 Wed 10:55 08:55 Italy BTPeis 22 Jul EUR 1-1.5bn 

10:30 09:30 Portugal OTs (To be confirmed) 22 Jul 

Denmark DGB 4% 15 Nov 2010 (buy back) 

12:00 16:00 Canada CAN 2-year (Repurchase/Switch) 22 Jul 


29/07 Thu 10:55 08:55 Italy 3 & 10y BTPs and CCT 22 Jul 


03/08 Tue 12:00 03:00 Japan JGB 10-year 27 Jul JPY 2.2tn 

11:00 09:00 Austria RAGBs (Reserve date) 27 Jul 

10:30 09:30 UK Gilt 2.75% 22 Jan 2015 27 Jul 

04/08 Wed 12:00 16:00 Canada CAN 3-year 29 Jul 

05/08 Thu 12:00 03:00 Japan JGB 40-year 29 Jul JPY 0.3tn 

10:30 08:30 Spain Bono 2.5% 31 Oct 2013 2 Aug 

09/08 Mon 12:00 03:00 Japan Auction for Enhanced-liquidity 2 Aug JPY 0.3tn 

10/08 Tue 10:30 09:30 UK Gilt 4.5% 7 Sep 2034 3 Aug 

13:00 17:00 US Notes 3-year (new) 4 Aug USD 35bn 

11/08 Wed 12:00 03:00 Japan JGB 5-year 4 Aug JPY 2.4tn 

11:00 09:00 Germany Schatz 14 Sep 2012 (new) EUR 7bn 

10:30 09:30 Portugal OTs (To be confirmed) 5 Aug 

12:00 16:00 Canada CAN 2-year 5 Aug 

13:00 17:00 US Notes 10-year (new) 4 Aug USD 24bn 

12/08 Thu 10:30 09:30 UK Gilt 4% 7 Mar 2022 3 Aug 

13:00 17:00 US Bond 30-year (new) 4 Aug USD 16bn 

13/08 Fri 10:55 08:55 Italy 5-year BTP and possibly 15- or 30-year BTP 6 Aug 

16/08 Mon Slovak Rep. SLOVGB 3.5% 24 Feb 2016 (#213) 

17/08 Tue 10:00 09:00 Ireland Gilts 10 Aug EUR 1-1.5bn 

Denmark DGB 12 Aug 

18/08 Wed 11:00 09:00 Germany Bund 4 Sep 2020 (new) EUR 6bn 

11:00 09:00 Sweden T-bonds 11 Aug SEK 2.5bn 

12:00 16:00 Canada CAN 5-year 12 Aug 

19/08 Thu 12:00 03:00 Japan Auction for Enhanced-liquidity 12 Aug JPY 0.3tn 

10:30 09:30 UK Index-Linked Gilt 1.25% 22 Nov 2027 10 Aug GBP 1bn 

Sources: Treasuries, BNP Paribas 



65 


Next week's T-Bills Supply 

Date Country Issues Details 

16/07 UK T-Bills Aug 2010 GBP 1bn 

T-Bills Oct 2010 

GBP 1.5bn 

T-Bills Jan 2011 

GBP 1.5bn 

Canada T-Bill Aug10 (Cash Mgt) CAD 1.5bn 

19/07 France BTF Sep 2010 EUR 1.5bn 

BTF Oct 2010 

EUR 4.5bn 

BTF Jan 2011 

EUR 2.5bn 

Germany Bubills Apr 2011 EUR 2bn 

Neths DTC Oct 2010 EUR 1.5-3bn 

DTC Nov 2010 

EUR 1.5-3bn 

DTC Mar 2011 

EUR 1-2.5bn 

US T-Bills Oct 2010 USD 30bn 

T-Bills Jan 2011 (new) USD 30bn 

FHLMC Bills 3-month & 6-month 16 Jul 

20/07 Japan T-Bills Sep 2010 JPY 2.5tn 

Spain Letras Jul 2011 19 Jul 

Letras Dec 2011 

19 Jul 

Canada T-Bill Oct 2010 CAD 7.4bn 

T-Bill Jan 2011 

CAD 2.8bn 

T-Bill Jul 2011 

CAD 2.8bn 

US T-Bills 4-week 19 Jul 

FHLB Discount Notes 

21/07 Japan T-Bills Oct 2010 JPY 4.8tn 

Portugal BT Jul 2011 (new) EUR 1.25bn 

FNMA Bills 3-month & 6-month 19 Jul 

22/07 Ireland T-Bills 20 Jul 

FHLB Discount Notes 

23/07 UK T-Bills 16 Jul 

Sources: Treasuries, BNP Paribas 

Next week's Eurozone Redemptions 

Date Country Details Amount 

19/07 Austria ATB (EU20) EUR 0.2bn 

19/07 Austria ATB (EU16) EUR 0.1bn 

20/07 Austria ATB EUR 0.7bn 

21/07 Finland T-Bills EUR 0.7bn 

22/07 France BTF EUR 8.5bn 

23/07 Spain Letras EUR 7.6bn 

23/07 Greece GTB (13W) EUR 2.4bn 

23/07 Portugal BT EUR 4.5bn 

Total Eurozone Short-term Redemption EUR 24.7bn 

Next week's Eurozone Coupons 

Country 

Amount 

Greece 

EUR 2.4bn 

Total Long-term Coupon Payments 

EUR 2.4bn 



66 


Central Bank Watch 

Interest Rate 

EUROZONE 

Current 

Rate (%) 

Minimum Bid Rate 1.00 

US 

Fed Funds Rate 0 to 0.25 

Discount Rate 0.75 

JAPAN 

Call Rate 0.10 

Basic Loan Rate 0.30 

UK 

Bank Rate 0.5 

DENMARK 

Lending Rate 1.05 

SWEDEN 

Repo Rate 0.50 

NORWAY 

Sight Deposit Rate 2.00 

SWITZERLAND 

3 Mth LIBOR Target 

Range 

CANADA 

0.0-0.75 

Overnight Rate 0.50 

Bank Rate 0.75 

AUSTRALIA 

Cash Rate 4.50 

CHINA 

1Y Bank Lending 

Rate 

BRAZIL 

5.31% 

Selic Overnight Rate 10.25 

Date of Last 

Change 

-25bp 

(7/5/09) 

-75bp 

(16/12/08) 

+25bp 

(18/2/10) 

-20bp 

(19/12/08) 

-20bp 

(19/12/08) 

-50bp 

(5/3/09) 

-10bp 

(14/1/10) 

+25bp 

(1/7/10) 

+25bp 

(5/5/09) 

-25bp 

(12/3/09) 

+25bp 

(1/6/10) 

+25bp 

(1/6/10) 

+25bp 

(5/5/10) 

-27bp 

(22/12/08) 

+75bp 

(09/6/10) 


Next Change in 

Coming 6 Months 

No Change 

No Change 

No Change 

No Change 

No Change 

No Change 

No Change 

+25bp 

(2/9/10) 

+25bp 

(15/12/10) 

No Change 

+25bp 

(20/7/10) 

+25bp 

(20/7/10) 

+25bp 

(2/11/10) 

No Change 

+75bp 

(21/7/10) 

Comments 

The uneven, lacklustre recovery and low inflation pressures imply 

no rise in the refinancing rate for a considerable period of time. 

The FOMC should maintain the funds rate at 0 to 0.25% for an 

extended period and will probably keep the discount rate where 

it is for now. 

The BoJ could expand its liquidity provision further in order to 

cooperate with the government in countering deflation and the 

yen’s appreciation. 

We expect the MPC to reengage in asset purchases from 

August onwards. 

We expect the central bank to draw on its FX reserves to defend 

the currency, given the recent up-tick in EUR/DKK. If this proves 

unsuccessful, policy rates will likely be raised. 

Given strong domestic demand, increases in employment and 

re-accelaration in house prices, we expect the Riksbank to 

deliver its second rate hike in this cycle in September. 

Weaker-than-expected growth since the start of the year and 

uncertainty over Norway’s economic outlook due to 

developments elsewhere in Europe suggest further rate hikes 

will come gradually. We expect the next hike in December. 

Rates are looking inappropriate given the strength of the 

domestic economy. But we expect the first hike to be delayed to 

early 2011 by an intensification of the fiscal and financial stress 

in the markets over the coming months. 

Barring a re-intensification of global financial troubles, we expect 

the BoC to deliver an additional 0.75bp of tightening over H2 

2010. The BoC is then expected to pause at 1.25% to re-assess 

the situation. 

The RBA noted in its June statement that policy was appropriate 

for the “near term”. This appears to rule out any move in the 

coming months, especially in the context of volatility in global 

markets. However, likely strong Q2 growth should be enough to 

prompt a hike late in the year. 

Significant monetary tightening has slowed credit growth and 

boosted money market rates while both economic growth and 

inflation are decelerating; the eurozone sovereign crisis is 

further clouding the export outlook. As all these factors call for 

policy flexibility, we no longer expect further hikes in the RRR or 

any interest rate hikes in 2010. 

Given the robust recovery in domestic demand, the very low 

level of economic slack, still-elevated inflation expectations and 

relatively loose fiscal policy, the BCB should continue to tighten 

monetary conditions with bold hikes. 

Change since our last weekly in bold and italics 

For the full EMK Central Bank Watch please see our Local Markets Mover 



67 


Economic Forecasts 

GDP 

Year 2010 

2011 

(% y/y) ’09 ’10 (1) ’11 (1) Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1) 

US -2.4 2.9 2.8 2.4 3.4 3.4 2.6 2.6 2.7 2.9 3.1 

Eurozone -4.1 1.2 0.6 0.6 1.4 1.3 1.4 1.2 0.6 0.4 0.4 

Japan -5.2 3.6 2.3 4.6 3.0 3.7 3.2 2.4 2.5 2.2 2.1 

World (2) -0.6 4.5 3.8 4.7 4.8 4.5 4.2 3.9 3.8 3.8 3.9 

Industrial Production 

Year 

2010 

2011 

(% y/y) ’09 ’10 (1) ’11 (1) Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1) 

US -9.7 5.5 4.6 2.4 7.0 6.6 5.9 5.1 4.5 4.4 4.5 

Eurozone -14.6 8.1 0.8 4.2 10.1 9.9 8.0 3.4 0.4 -0.2 -0.3 

Japan -21.9 18.6 5.3 27.5 21.4 16.5 11.7 5.7 5.2 5.4 4.8 

Unemployment Rate 

Year 

2010 2011 

(%) ’09 ’10 (1) ’11 (1) Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1) 

US 9.3 9.6 8.5 9.7 9.8 9.6 9.5 9.2 8.7 8.2 8.0 

Eurozone 9.4 10.0 10.3 10.0 10.0 10.0 10.0 10.1 10.2 10.3 10.4 

Japan 5.1 4.8 4.2 4.9 5.1 4.8 4.6 4.4 4.3 4.1 4.0 

CPI 

Year 

2010 

2011 

(% y/y) ’09 ’10 (1) ’11 (1) Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1) 

US -0.4 1.7 1.0 2.4 1.8 1.4 1.2 1.0 1.3 1.0 0.7 

Eurozone 0.3 1.6 1.5 1.1 1.5 1.8 2.1 2.0 1.5 1.4 1.3 

Japan -1.4 -0.6 -0.2 -1.2 -0.9 -0.5 0.2 -0.3 -0.2 -0.1 -0.2 

Current Account 

(% GDP) ’09 

Year 

’10 (1) ’11 (1) General Government 

(% GDP) 

’09 

Year 

’10 (1) ’11 (1) 

US -2.7 -2.7 -2.7 US (4) -9.9 -10.0 -8.4 

Eurozone -0.6 -0.3 -0.1 Eurozone -6.3 -6.6 -5.3 

Japan 2.8 3.9 3.9 Japan -10.7 -9.4 -6.8 

Interest Rate Forecasts 

Interest Rate (3) 

Year 

2010 

2011 

(%) ’09 ’10 (1) ’11 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) 

US 

Fed Funds Rate 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 

3-month Rate 0.25 0.95 0.75 0.29 0.54 1.00 0.95 0.90 0.85 0.80 0.75 

2-year yield 1.14 0.75 2.00 1.02 0.68 0.75 0.75 0.85 1.00 1.25 2.00 

10-year yield 3.84 3.00 3.75 3.83 3.12 2.90 3.00 3.10 3.25 3.50 3.75 

2y/10y Spread (bp) 269 225 175 281 244 215 225 225 225 225 175 

Eurozone 

Refinancing Rate 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 


2-year yield 1.37 0.50 1.25 0.97 0.58 0.40 0.50 0.50 0.50 0.50 1.25 

10-year yield 3.40 2.00 3.00 3.10 2.65 2.20 2.00 2.10 2.25 2.60 3.00 

2y/10y Spread (bp) 203 150 175 212 207 180 150 160 175 210 175 

Japan 

O/N Call Rate 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 


2-year yield 0.15 0.25 0.75 0.18 0.16 0.20 0.25 0.30 0.35 0.55 0.75 

10-year yield 1.30 1.40 1.80 1.40 1.15 1.30 1.40 1.50 1.60 1.70 1.80 

2y/10y Spread (bp) 115 115 105 122 99 110 115 120 125 115 105 

Footnotes: (1) Forecast (2) Country weights used to construct world growth are those in the IMF World Economic Outlook Update 

April 2010 (3) End Period (4) Fiscal year Figures are y/y percentage change unless otherwise indicated 

Market Economics / Interest Rate Strategy 16 July 2010 


68 


FX Forecasts* 

USD Bloc Q3 '10 Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 

EUR/USD 1.16 1.08 1.00 0.98 0.97 1.00 1.05 1.08 1.12 1.15 1.17 

USD/JPY 85 88 94 101 106 114 118 121 124 126 123 

USD/CHF 1.12 1.18 1.29 1.33 1.35 1.33 1.29 1.26 1.23 1.22 1.40 

GBP/USD 1.43 1.35 1.28 1.26 1.21 1.27 1.24 1.24 1.26 1.28 1.31 

USD/CAD 1.02 0.98 0.95 0.90 0.87 0.90 0.95 1.00 1.02 1.09 1.11 

AUD/USD 0.86 0.90 0.94 0.97 0.97 0.95 0.92 0.93 0.92 0.90 0.87 

NZD/USD 0.71 0.74 0.78 0.78 0.75 0.73 0.72 0.69 0.67 0.66 0.64 

USD/SEK 8.02 8.43 9.20 9.29 9.59 9.30 8.76 8.70 8.57 8.43 8.12 

USD/NOK 6.81 7.13 7.35 7.55 7.84 7.50 7.05 6.94 6.79 6.52 6.24 

EUR Bloc Q3 '10 Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 

EUR/JPY 99 95 94 99 103 114 124 131 139 145 144 

EUR/GBP 0.81 0.80 0.78 0.78 0.80 0.79 0.85 0.87 0.89 0.90 0.89 

EUR/CHF 1.30 1.27 1.29 1.30 1.31 1.33 1.35 1.36 1.38 1.40 1.64 

EUR/SEK 9.30 9.10 9.20 9.10 9.30 9.30 9.20 9.40 9.60 9.70 9.50 

EUR/NOK 7.90 7.70 7.35 7.40 7.60 7.50 7.40 7.50 7.60 7.50 7.30 

EUR/DKK 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46 

Central Europe Q3 '10 Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 

USD/PLN 3.62 3.70 4.20 4.23 4.18 3.95 3.71 3.56 3.39 3.26 3.16 

EUR/CZK 26.5 26.0 25.8 25.5 25.0 24.7 24.3 24.0 23.9 23.8 24.0 

EUR/HUF 275 270 275 270 270 265 250 250 250 245 235 

USD/ZAR 7.80 8.00 7.90 8.20 8.00 8.00 7.80 7.80 7.50 7.70 7.00 

USD/TRY 1.56 1.59 1.60 1.60 1.61 1.62 1.60 1.58 1.56 1.54 1.45 

EUR/RON 4.50 4.40 4.35 4.25 4.20 4.05 4.00 3.95 3.90 3.80 3.90 

USD/RUB 30.78 31.37 32.25 32.29 32.24 31.50 30.32 29.68 28.94 28.29 29.73 

EUR/PLN 4.20 4.00 4.20 4.15 4.05 3.95 3.90 3.85 3.80 3.75 3.70 

USD/UAH 7.9 8.0 7.5 7.7 7.5 7.5 7.4 7.2 7.0 7.5 ----- 

EUR/RSD 110 110 105 115 105 100 90 86 87 85 86 

Asia Bloc Q3 '10 Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 

USD/SGD 1.36 1.34 1.33 1.32 1.31 1.30 1.30 1.30 1.30 1.30 ----- 

USD/MYR 3.15 3.10 3.07 3.05 3.03 3.00 3.00 3.00 3.00 3.00 ----- 

USD/IDR 8800 8600 8500 8400 8300 8200 8100 8000 8000 8000 ----- 

USD/THB 32.30 32.00 31.70 31.50 31.30 31.00 31.00 31.00 31.00 31.00 ----- 

USD/PHP 44.00 43.00 42.50 42.00 41.50 41.00 41.00 41.00 41.00 41.00 ----- 

USD/HKD 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80 ----- 

USD/RMB 6.70 6.80 6.75 6.70 6.64 6.60 6.54 6.49 6.45 6.41 ----- 

USD/TWD 31.00 30.00 29.70 29.50 29.30 29.00 29.00 29.00 29.00 29.00 ----- 

USD/KRW 1100 1050 1030 1020 1010 1000 1000 1000 1000 1000 ----- 

USD/INR 43.50 42.00 41.00 40.00 39.00 38.00 38.00 38.00 38.00 38.00 ----- 

USD/VND 20000 20500 20500 20500 20500 20500 20500 20500 20500 20500 ----- 

LATAM Bloc Q3 '10 Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 

USD/ARS 4.10 4.20 4.25 4.35 4.45 4.50 4.60 4.70 4.80 4.90 4.95 

USD/BRL 1.80 1.75 1.72 1.70 1.70 1.75 1.80 1.85 1.90 1.90 1.91 

USD/CLP 520 510 500 490 485 495 505 510 510 515 520 

USD/MXN 12.20 11.90 11.70 11.50 11.40 11.60 11.85 11.90 12.00 12.00 12.00 

USD/COP 1900 1875 1850 1825 1825 1875 1900 1925 1950 1950 1955 

USD/VEF (Priority) (1) 4.29 4.29 4.29 4.29 4.29 4.29 8.80 8.80 8.80 8.80 8.80 

USD/VEF (Oil) (1) 2.59 2.59 2.59 2.59 2.59 2.59 5.30 5.30 5.30 5.30 5.30 

Others Q3 '10 Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 

USD Index 88.61 93.44 99.58 101.62 103.22 102.03 100.08 99.11 97.26 96.30 95.20 

*End Quarter 

(1) Following the devaluation of the VEF, there is now an official ‘priority’ exchange rate and a so-called ‘oil’ exchange rate used for certain transactions 


Foreign Exchange Strategy 16 July 2010 


69 


Market Coverage 

Market Economics 

Paul Mortimer-Lee Global Head of Market Economics London 44 20 7595 8551 paul.mortimer-lee@uk.bnpparibas.com 

Ken Wattret Chief Eurozone Market Economist London 44 20 7595 8657 kenneth.wattret@uk.bnpparibas.com 

Luigi Speranza Head of Inflation Economics, Eurozone, Italy London 44 20 7595 8322 luigi.speranza@uk.bnpparibas.com 

Alan Clarke UK London 44 20 7595 8476 alan.clarke@uk.bnpparibas.com 

Eoin O’Callaghan Inflation, Eurozone, Switzerland, Ireland London 44 20 7595 8226 eoin.ocallaghan@uk.bnpparibas.com 

Gizem Kara Scandinavia London 44 20 7595 8783 gizem.kara@uk.bnpparibas.com 

Dominique Barbet Eurozone, France Paris 33 1 4298 1567 dominique.barbet@bnpparibas.com 

Brian Fabbri Chief Economist North America New York 1 212 841 3633 brian.fabbri@americas.bnpparibas.com 

Julia Coronado Senior US Economist New York 1 212 841 2281 julia.l.coronado@americas.bnpparibas.com 

Yelena Shulyatyeva US, Canada New York 1 212 841 2258 yelena.shulyatyeva @americas.bnpparibas.com 

Ryutaro Kono Chief Economist Japan Tokyo 81 3 6377 1601 ryutaro.kono@japan.bnpparibas.com 

Hiroshi Shiraishi Japan Tokyo 81 3 6377 1602 hiroshi.shiraishi@japan.bnpparibas.com 

Azusa Kato Japan Tokyo 81 3 6377 1603 azusa.kato@japan.bnpparibas.com 

Richard Iley Head of Asia Economics Hong Kong 852 2108 5104 richard.iley@asia.bnpparibas.com 

Dominic Bryant Asia, Australia Hong Kong 852 2108 5105 dominic.bryant@asia.bnpparibas.com 

Chan Kok Peng Chief Economist South East Asia Singapore 65 6210 1946 kokpeng.chan@asia.bnpparibas.com 

Michal Dybula Central & Eastern Europe Warsaw 48 22 697 2354 michal.dybula@pl.bnpparibas.com 

Julia Tsepliaeva Russia & CIS Moscow 74 95 785 6022 julia.tsepliaeva@ru.bnpparibas.com 

Italo Lombardi Latin America New York 1 212 841 6599 italo.lombardi@americas.bnpparibas.com 

Diego Donadio Latin America São Paulo 55 11 3841 3421 diego.donadio@@br.bnpparibas.com 

Interest Rate Strategy 

Cyril Beuzit Global Head of Interest Rate Strategy London 44 20 7595 8639 cyril.beuzit@uk.bnpparibas.com 

Patrick Jacq Europe Strategist Paris 33 1 4316 9718 patrick.jacq@bnpparibas.com 

Hervé Cros Chief Inflation Strategist London 44 20 7595 8419 herve.cros@uk.bnpparibas.com 

Shahid Ladha Inflation Strategist London 44 20 7 595 8573 shahid.ladha@uk.bnpparibas.com 

Alessandro Tentori Chief Alpha Strategy Europe London 44 20 7595 8238 alessandro.tentori@uk.bnpparibas.com 

Matteo Regesta Europe Alpha Strategist London 44 20 7595 8607 matteo.regesta@uk.bnpparibas.com 

Ioannis Sokos Europe Alpha Strategist London 44 20 7595 8671 ioannis.sokos@uk.bnpparibas.com 

Camille de Courcel Europe Alpha Strategist London 44 20 7595 8295 camille.decourcel@uk.bnpparibas.com 

Bülent Baygün Head of Interest Rate Strategy US New York 1 212 471 8043 bulent.baygun@americas.bnpparibas.com 

Mary-Beth Fisher US Senior Strategist New York 1 212 841 2912 mary-beth.fisher@us.bnpparibas.com 

Sergey Bondarchuk US Strategist New York 1 212 841 2026 sergey.bondarchuk@americas.bnpparibas.com 

Suvrat Prakash US Strategist New York 1 917 472 4374 suvrat.prakash@americas.bnpparibas.com 

Rohit Garg US Strategist New York 1212 841 3937 rohit.k.garg@americas.bnpparibas.com 

Anish Lohokare MBS Strategist New York 1 212 841 2867 anish.lohokare@americas.bnpparibas.com 

Olurotimi Ajibola MBS Strategist New York 1 212 8413831 olurotimi.ajibola@americas.bnpparibas.com 

Koji Shimamoto Head of Interest Rate Strategy Japan Tokyo 81 3 6377 1700 koji.shimamoto@japan.bnpparibas.com 

Tomohisa Fujiki Japan Strategist Tokyo 81 3 6377 1703 Tomohisa.fujiki@japan.bnpparibas.com 

Masahiro Kikuchi Japan Strategist Tokyo 81 3 6377 1703 masahiro.kikuchi@japan.bnpparibas.com 

Christian Séné Technical Analyst Paris 33 1 4316 9717 christian.séné@bnpparibas.com 

FX Strategy 

Hans Redeker Global Head of FX Strategy London 44 20 7595 8086 hans-guenter.redeker@uk.bnpparibas.com 

Ian Stannard FX Strategist London 44 20 7595 8086 ian.stannard@uk.bnpparibas.com 

James Hellawell Quantitative Strategist London 44 20 7595 8485 james.hellawell@uk.bnpparibas.com 

Sebastien Galy FX Strategist New York 1 212 841 2492 sebastien.galy@bnpparibas.com 

Andy Chaveriat Technical Analyst New York 1 212 841 2408 andrew.chaveriat@americas.bnpparibas.com 

Emerging Markets FX & Interest Rate Strategy 

Drew Brick Head of FX & IR Strategy Asia Singapore 65 6210 3262 Drew.brick@asia.bnpparibas.com 

Chin Loo Thio FX & IR Asia Strategist Singapore 65 6210 3263 chin.thio@asia.bnpparibas.com 

Robert Ryan FX & IR Asia Strategist Singapore 65 6210 3314 robert.ryan@asia.bnpparibas.com 

Gao Qi FX & IR Asia Strategist Singapore 65 6210 3264 gao.qi@asia.bnpparibas.com 

Shahin Vallée Head of FX & IR Strategy CEEMEA London 44 20 7595 8306 shahin.vallee@uk.bnpparibas.com 

Elisabeth Gruié FX & IR CEEMEA Strategist London 44 20 7595 8492 elisabeth.gruie@uk.bnpparibas.com 

Bartosz Pawlowski FX & IR CEEMEA Strategist London 44 20 7595 8195 Bartosz.pawlowski@uk.bnpparibas.com 

For Production and Distribution, please contact: 

Ann Aston, Market Economics, London. Tel: 44 20 7595 8503 Email: ann.aston@uk.bnpparibas.com 

Danielle Catananzi, Interest Rate Strategy, London. Tel: 44 20 7595 4418 Email: danielle.catananzi@uk.bnpparibas.com 

Derek Allassani, FX Strategy, London. Tel: 44 20 7595 8486 Email: derek.allassani@uk.bnpparibas.com 

Martine Borde, Market Economics/Interest Rate Strategy, Paris. Tel: 33 1 4298 4144 Email martine.borde@bnpparibas.com 

Editors 

Amanda Grantham-Hill, Interest Rate Strategy/Market Economics, London. Tel: 44 20 7595 4107 Email: amanda.grantham-hill@bnpparibas.com 

Nick Ashwell, FX/Market Economics, London. Tel: 44 20 7595 4120 Email: nick.ashwell@uk.bnpparibas.com 

BNP Paribas Global Fixed Income Website 

www.globalmarkets.bnpparibas.com 

Bloomberg 

Fixed Income Research BPCM Market Economics BPEC 

Interest Rate Strategy BPBS Forex Strategy BPFR 

70

RESEARCH DISCLAIMERS: 

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