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US: Setup for Auctions with Spread Curve Flatteners • In general, 2y Tsy tends to cheapen relative to the long end going into the auction and reverse direction post auction (2s10s, 2s30s flatteners followed by steepeners). • 5y and 7y notes have a tendency to move almost in line with the long end going into the auctions and to richen relative to the long end post auctions (5s10s, 5s30s steepeners). • There is a clear trend of belly spread widening relative to the front end and long end spreads throughout the auction. • STRATEGY: Consider paying 5y spreads vs 10y spreads. Also consider paying 5y spreads vs 2y and 10y spreads for a higher average move which comes with higher volatility. With 2y, 5y and 7y auctions taking place next week, we highlight auction-based systematic trades which we have been recommending in the past issues of our weekly publication. While doing this analysis, we look at auctions since Jan 2010 (total of 12 auctions) and keep the issues fixed through each auction (i.e. always use the current issue pre auction which becomes old post auction) so that there is no spurious roll effect. Outright treasury curve behaviour around auctions Chart 1 shows that, while the front end cheapens relative to the long end going into the auctions, the belly moves more or less along with the long end. Post auctions, while both the front end and belly richen relative to the long end, a more pronounced steepening effect is seen in 5s10s and 5s30s Tsy curve. Chart 1: Treasury Yield Trends Around 2y, 5y and 7y Auction days 8 7 6 5 4 3 2 1 0 (1) (2) (3) 2s10s 2s30s 5s10s 5s30s 7s10s 7s30s T-5 T-3 T-1 T T+1 T+3 T+5 Source: BNP Paribas Chart 2: Spread-of-Spreads Trends Around 2y, 5y and 7y Auction Days 2 1 0 (1) (2) (3) (4) T-5 T-3 T-1 T T+1 T+3 T+5 2s10s 2s30s 5s10s 5s30s 7s10s 7s30s Source: BNP Paribas Chart 3: Comparison of 5s10s Spread Flattener with 2s5s10s Spread Fly 10 8 5s10s 2s5s10s Table 1 (at the end of this article) helps us put some numbers in perspective for the above-mentioned curve trades. 5s10s Tsy curve steepener has turned in a profit 10 times in the past 12 auctions. The average movement in favour of this strategy has been about 5.2bp with a volatility of 3.8bp. 6 4 2 Sharpe Ratio for 5s10s: 1.82 Sharpe Ratio for 2s5s10s: 1.64 Disclosure: Given our existing structural Tsy 5s10s flattening view initiated at 138.5, now at 139.5, we will choose not to put on a tactical steepener but may use any potential steepening as an opportunity to increase our flattening position. 0 Jan Feb Mar Source: BNP Paribas Apr May June July Aug Sept Oct Nov Dec Rohit Garg 20 January 2011 Market Mover, Non-Objective Research Section 34 www.GlobalMarkets.bnpparibas.com
Trades with higher hit ratio and Sharpe ratio in swap spreads The swap spread curve witnesses a consistent flattening trend around these month-end auction cycles. Chart 2 shows a clear trend of spread curve flattening going into the auction across all maturities. This spread-flattening trend becomes more pronounced post auction, especially in 5s10s. Based on the rankings (in Table 1, which takes into account average move, volatility and hit ratio), 5s10s spread curve flattener post 5y auction emerges as a clear winner. However, another strategy with a higher average movement at the expense of higher volatility is the 2-5-10 spread fly (go long 5y spreads vs 2y and 10y spreads) which has also worked 12 times in last 12 auctions (see Chart 3). One other important take-away from this chart is that on occasions when the spread curve flattener hasn’t worked well, the spread fly has worked very well and vice versa. Hence, it might be beneficial to take positions in both these trades simultaneously to increase the chances of net profit margin in terms of risk taken. Table 1: Auction Trades with Hit Ratios Adjusted for Vol and Hit Ratio (T – respective auction day) Average Move (in bp) Overall Rating When did it not work Entry Exit Hit Ratio Vol (in bp) 2y Auction 2s3s Tsy Flattener T+1 T+5 9/12 2.47 3.07 0.60 March/May/Nov 2s5s Tsy Flattener T-1 T+5 9/12 4.70 7.14 0.49 March/May/Dec 2s10s Tsy Flattener T-5 T 10/12 5.47 9.3 0.49 July/Oct 2s30s Tsy Flattener T-5 T 9/12 7.03 8.74 0.60 Jan/July/Oct 2s5s10s Tsy Fly trading lower T+1 T+5 11/12 7.41 7.19 0.94 Nov 2s5s30s Tsy Fly trading lower T+1 T+5 11/12 7.77 10.5 0.68 Nov 2s3s Spd Flattener T-5 T+1 9/12 1.17 2.4 0.37 July/Oct/Dec 2s10s Spd Flattener T-3 T+5 10/12 3.66 5.4 0.56 Sept/Oct 2s30s Spd Flattener T-3 T+5 10/12 3.76 7.5 0.42 Oct 2s5s10s Spd Fly trading higher T+1 T+5 12/12 4.40 2.7 1.63 2s5s30s Spd fly trading higher T+1 T+5 11/12 3.95 3.4 1.06 Nov 5y Auction 5s10s Tsy Steepener T T+5 10/12 5.19 3.82 1.13 June/Nov 5s30s Tsy Steepener T T+5 11/12 6.99 8.3 0.77 Nov 3s5s7s Tsy Fly trading lower T-3 T+5 9/12 3.68 3.67 0.75 March/May/Nov 3s5s10s Tsy Fly trading lower T-3 T+5 11/12 6.87 6.12 1.03 Nov 3s5s30s Tsy Fly trading lower T-3 T+5 11/12 9.41 10 0.86 Nov 5s10s Spd Flattener T T+5 12/12 3.24 1.78 1.82 5s30s Spd Flattener T T+5 11/12 2.95 2.66 1.02 Dec 3s5s7s Spd Fly trading higher T-3 T+5 11/12 2.46 1.97 1.15 March 3s5s10s Spd Fly trading higher T-3 T+5 11/12 4.91 2.74 1.64 Nov 3s5s30s Spd Fly trading higher T-3 T+5 10/12 5.34 4.74 0.94 Nov/Dec 5s10s30s Spd Fly trading lower T T+5 11/12 3.04 2.53 1.10 Sept 7y Auction 2s7s Tsy Flattener T-3 T+5 7/12 3.70 11.64 0.19 March/May/Aug/Nov/Dec 7s10s Tsy Steepener T-3 T+5 10/12 2.39 3.25 0.61 June/Nov 7s30s Tsy Steepener T-3 T+5 8/12 4.65 11.53 0.27 March/April/June/Nov 3s7s10s Tsy Fly trading lower T-3 T+5 7/12 3.11 8.79 0.21 March/May/Aug/Nov/Dec 3s7s30s Tsy Fly trading lower T-3 T+5 7/12 5.38 16.12 0.19 March/April/May/Nov/Dec 7s10s Spd Flattener T-5 T+3 11/12 1.82 1.51 1.10 Nov 7s30s Spd Flattener T-5 T+3 9/12 1.94 4.76 0.31 Oct/Nov/Dec 3s7s10s Spd fly trading higher T-3 T 9/12 1.60 3.82 0.31 March/June/Nov 3s7s30s Spd fly trading higher T-3 T 9/12 2.14 4 0.40 March/June/Nov Source: BNP Paribas Rohit Garg 20 January 2011 Market Mover, Non-Objective Research Section 35 www.GlobalMarkets.bnpparibas.com
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Page 3 and 4: The obvious focal point is the Summ
Page 5 and 6: such shocks at the moment, such as
Page 7 and 8: US monetary conditions, because the
Page 9 and 10: Chart 9: Asia- Ifo Expected Inflati
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Page 13 and 14: Canada: Betting on Investment and E
Page 15 and 16: Eurozone Inflation: Forecast Revisi
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Page 21 and 22: The nominal policy rate and nominal
Page 23 and 24: households. Furthermore, the statis
Page 25 and 26: Norway: Norges Bank Preview • We
Page 27 and 28: Japan: New Cabinet and Policy Outlo
Page 29 and 30: Japan: Capex Outlook • Core machi
Page 31 and 32: US/EUR Spreads: Further Tightening
Page 33: US: Could the Short End Have a Puls
Page 37 and 38: ange bound, as we expect, given tha
Page 39 and 40: EUR: Liquidity is No Stress • The
Page 41 and 42: EMU Debt Monitor: Trade Ideas • K
Page 43 and 44: EMU Debt Monitor: CDS Analysis Char
Page 45 and 46: EMU Debt Monitor: Redemptions • O
Page 47 and 48: EUR: Buy 3m5y Straddle vs 3m10y Str
Page 49 and 50: Global Inflation Watch Eurozone HIC
Page 51 and 52: Table 2: BNP Paribas' Inflation For
Page 53 and 54: Inflation: With Supply Comes Opport
Page 55 and 56: Pricing Date Repo Rate Sett. Date T
Page 57 and 58: Germany 10y: MT 61.8% (3.12) break
Page 59 and 60: Travelling Asia • Inflation has e
Page 61 and 62: Capitalism requires business cycles
Page 63 and 64: EURUSD Rally Eyes 1.3750-1.3950 •
Page 65 and 66: Currency Spot Trade Recommendations
Page 67 and 68: than an unrelenting rise in prices
Page 69 and 70: Economic Calendar: 21 - 28 January
Page 71 and 72: Key Data Preview 120 115 110 105 10
Page 73 and 74: Key Data Preview Chart 5: French Sa
Page 75 and 76: Key Data Preview 10 5 0 -5 -10 -15
Page 77 and 78: Key Data Preview 3 2 1 0 -1 Chart 1
Page 79 and 80: Economic Calendar: 31 Jan - 25 Feb
Page 81 and 82: Next Week's T-Bills Supply Date Cou
Page 83 and 84: Economic Forecasts GDP Year 2010 20
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Market Coverage Market Economics Pa
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