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

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
Market Mover, Non-Objective Research Section
37
www.GlobalMarkets.bnpparibas.com