Market Mover - BNP PARIBAS - Investment Services India

EUR/GBP 2s10s Carry Box Revisited
• Rolldown strategies continue to be pursued
in a still-low yield environment. We review the
EUR/GBP 2s10s swap carry box trade, which
proved to be popular last year.
• STRATEGY: Given the weaker correlation
structure, we would monitor the forward term
structure in order to lock in a higher profit of
carry than currently available. Enter the trade for
total carry ex-ante of around 50bp.
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Chart 1: EUR vs GBP Spot Curves
EUR 2s10s
GBP 2s10s
After having weakened somewhat in Q4 2009, the
correlation between the EUR and the GBP swap
curve has strengthened again. On 2s10s, the 6M
rolling correlation is currently around 0.61, having
fallen as low as 0.28 in mid December.
In previous research, we have discussed how to
capture the positive carry on the swap curve, while
limiting the curve/delta risk implied by curve
strategies: assuming a positive correlation structure
between the EUR and the GBP curve: paying GBP
1y fwd 2s10s vs receiving 1y fwd EUR 2s10s allows
the locking in of a positive total carry as a result of
the significantly wider spread between GBP 2s10s
spot and GBP 1y fwd 2s10s.
Chart 2 plots the evolution of the total one year carry
of the combined position which could be locked in by
entering the trade at different points in time. We can
see that it reached values above 50bp in Q3 2009.
Instead, if we were to pay the GBP 2s10s start Z10
vs EUR today, we could lock in 39bp profit of carry
until the end of 2010 (Table 1). Such number is still
attractive but we would caution against entering the
position at the current juncture.
On the one hand, we remain convinced that the GBP
curve will stay entrenched at steep levels in the
medium term on the back of the combined forces of a
dovish BoE and relentless supply. On the other hand,
correlation is positive but rather low with respect to
the trading range throughout the crisis.
Hence, the hedge against total curve risk looks poor
at present. In addition, we don’t expect the EUR
curve to flatten in the short term: excess liquidity in
the eurosystem is still elevated and bear flattening
pressures resulting from the ECB’s implementation of
exit strategies are not likely to develop before the
beginning of H2. In fact, in the short term, bear
steepening pressures might prevail on the EUR
curve as a result of still unabated concerns regarding
sovereign credit risk.
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2006 2007 2008 2009 2010
Source: BNP Paribas
Chart 2: Evolution of Ex-Ante Total Carry From
1y fwd EUR/GBP 2s10s Swap Box
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2006 2007 2008 2009 2010
Source: BNP Paribas
Chart 3: EUR/GBP 2s10s Swap Box Carry
Analysis
Ccy GBP Ccy EUR
IMM Swap Curve Rolldown IMM Swap Curve Rolldown Box Rolldown
0 2 0 2
0 10 232 6 0 10 182 3 50 2
H10 2 H10 2
H10 10 226 18 H10 10 179 11 48 7
M10 2 M10 2
M10 10 209 20 M10 10 168 11 41 9
U10 2 U10 2
U10 10 189 21 U10 10 157 10 32 10
Z10 2 Z10 2
Z10 10 168 20 Z10 10 147 10 21 10
H11 2 H11 2
H11 10 148 H11 10 137 11
Total Carry 84 45 39
In sum, given the weaker correlation structure, we
would monitor the forward term structure in order to
lock in a higher profit of carry than currently
available. Enter the trade for total carry ex-ante of
around 50bp.
Matteo Regesta 12 February 2010
Market Mover, Non-Objective Research Section
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