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

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.
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Chart 1: Developments in 2/10s ASW
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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.
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Aug 09 Oct 09 Dec 09 Feb 10 Apr 10 Jun 10
KFW EIB CADES
Source: BNP Paribas
Chart 2: CADES Offer the Steepest Curve
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0y 2y 4y 6y 8y 10y 12y
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KFW
EIB
CADES
Source: BNP Paribas
Chart 3: CADES versus Govvies (asw Space)
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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
Source: BNP Paribas
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
Market Mover, Non-Objective Research Section
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