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

also means that, the more peripherals suffer, the
more core will have to bear the burden.
Chart 4: Technicals Plead for Further ST
Tightening
What’s next?
While the long-term outlook is for higher yields and
wider US/EUR spreads, the near-term picture
remains supportive of tighter spreads, notably in the
10y area. Regarding short spreads, there is a risk of
re-widening / disinversion as Fed expectations have
barely moved while both EUR and GBP front-end
levels have significantly changed. Both the BoE and
ECB are expected to hike rates before the FOMC, a
situation that does not fit with previous cycles.
Overall, the front end of the euro curve now faces
asymmetric risks. While it may have been too quick
to discount more than one rate hike by the end of the
year, it makes sense for the front end to discount a
less favourable ECB scenario than previously. Any
further data – notably on the inflation front –
surprising on the upside will reinforce this new bias.
With regard to longer maturities, speculation about
an agreement on the EFSF will remain high going
into 4 February and the late-March EU summit,
maintaining pressures on core EGBs during a period
of high supply.
In other words, as long as Treasuries remain stuck in
the same narrow range, EMU/ECB news will set the
tone and on balance favour additional US/EUR
spread tightening. A more constructive tone in
Treasuries would obviously reinforce this bias.
Though govvies look heavy, the latest signals on
risky assets indicate a risk of a pause/setback which
would likely benefit the Treasury market – watch
carefully the earnings season and behaviour of the
S&P 500.
Technicals (Chart 4) as well as fundamentals (Charts
2 and 3) are also supportive of such a trend over the
coming weeks/months. The 10y T-Note/Bund spread
has broken below the 22.7/24.5bp area (61.8%),
opening the way for a move towards the 4.0/6.9bp
lows (“wave C”). The core inflation differential
between the US and the eurozone also supports a
further tightening in the short run. Further, our model
(3m Euro$/Euribor spreads, inflation differential,
business cycle expectations - ISM) also points to
tighter spreads over the months ahead.
The fundamental relationship (see inflation
differential forecasts, Chart 3), however, supports a
re-widening of US/EUR spreads later in the year.
This is in line with our bearish views on the market,
i.e. US yields resuming their rise in the spring. A
likely rise in volatility later in the year (the VIX is
currently on lows) would also support this mediumterm
call (Chart 6).
Source: BNP Paribas
Chart 5: Partly Driven by Risk Appetite…
Source: Reuters EcoWin
Source: Reuters EcoWin
Chart 6: …and Volatility
Cyril Beuzit 20 January 2011
Market Mover, Non-Objective Research Section
32
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