Market Mover - BNP PARIBAS - Investment Services India

Update on curves
5/10y indices’ curves have experienced a massive
flattening this week, in harmony with the widening of
the outright levels. Taking the MAIN and FIN SEN
and SUB as references – they are the only liquid
curves – the extent of the flattening is of 4bp for
MAIN and 6bp for both SEN and SUB financial
indices. From the tightest of the market (65bp for
MAIN 5y and 63bp for SEN 5y reached the 11-Jan),
which also corresponds to the steepest level of 5/10y
curves (20.5bp for MAIN and 17bp for SEN), the
retracements are quite impressive. They are of 9bp
in MAIN, 14bp in SEN and 13bp in SUB!
While 5/10y curves were perfectly correlated to the
outright level of the 5y before the last leg of volatility,
there has been some de-correlation recently. With
the market essentially focussed on the outright,
curves are becoming more illiquid, which has the
consequence of making their moves brutal and
excessive.
Note that the latest moves wider in MAIN have not
implied further flattening in 5/10y which seems to
indicate that MAIN 5/10y found a resistance at 10bp
(Chart1). It has not been the case in FIN SEN and
SUB curves given the higher stress on the banking
sector. This pattern is quite new and contrasts with
the past behaviour of financials single-names’ and
indices’ curves, consistently less volatile than nonfinancials
ones (Chart 2).
Last but not least, curves trade significantly flatter
than their intrinsic; the differences are of c.3bp in
MAIN, c.6bp in SEN and c.3bp in SUB.
What’s next?
At +12, we find the 5/10y steepener in MAIN
relatively attractive. Given the insignificant lack of
jump-to-default risk on all of its 125 constituents and
our perception that the street position is much less
crowed with the steepener, we see downside risks
relatively limited. The curve can possibly reach +5
but that would occur only if there is a massive selloff,
pushing MAIN in the [120-130] range. The key
points supporting the trade remain: (1) a good level
of carry thanks to the widening of the outright and the
flattening of the curve (about 1.2bp of performance
per month) and (2) the fact that the supply in nonfinancials,
which represent 80% of the index, is
skewed towards longer maturities.
Update on “MAIN vs. SEN”
The turnaround of the market has made all indices
gap tighter, the obvious outperformers being SOVX,
FIN SEN and finally MAIN. In the short-squeeze, the
spread differential MAIN – FIN SEN re-steepened but
by less than what was implied by the sharp drop in
Chart 1: 5/10y MAIN vs. Outright 5y in Series 12
5/10y
23
21
19
17
15
13
11
9
7
5/10Y MAIN 12 (lhs)
5Y MAIN 12 (rhs inverted)
60
65
70
75
80
85
90
95
100
5
105
09/09 10/09 10/09 11/09 11/09 11/09 12/09 12/09 01/10 01/10 02/10
Chart 2: 5/10y MAIN, SEN and SUB in Series 11
30
20
10
0
-10
-20
-30
3/09 4/09 5/09 6/09 7/09 8/09 9/09 10/09 11/09 12/09 1/10
MAIN _ FIN SEN
-
20
15
10
5
-5
-10
-15
-20
MAIN s11
FIN SEN s11
FIN SUB s11
Chart 3: MAIN – FIN SEN vs. SOVX
y = -0.3963x + 28.857
R 2 = 0.9411
40 50 60 70 80 90 100 110 120
Source: BNP Paribas
"Fair-vlaue" MAIN
- FIN SEN
SOVX
SOVX, which is evidenced on Chart4, where the last
point corresponds to 10-Feb closing levels. At the
time of writing, the spread MAIN - FIN-SEN stands at
-9bp, about 1.5bp above the spread implied by the
current level of SOVX (92). The “fair-value” spread is
-7.5bp.
What’s next?
It is extremely difficult to have a strong call on this
spread given its strong directionality. That being said,
investors with a constructive view on the market can
play further tightening given its relative
underperformance. We do not expect SOVX to break
mid-January level (85) which implies that the spread
MAIN – FIN SEN is likely to stay below -5bp. From
Last
5y
Since Sep-09
Pierre Yves Bretonniere 12 February 2010
Market Mover Non-Objective Research Section
33
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