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

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.
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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
Source: BNP Paribas
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
Source: BNP Paribas
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
Source: BNP Paribas
ASW Diff (RHS)
Yield Spread
ASW Diff (RHS)
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
Market Mover, Non-Objective Research Section
22
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