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

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
Market Mover
3
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