Market Economics | Interest Rate Strategy - BNP PARIBAS ...
Market Economics | Interest Rate Strategy - BNP PARIBAS ...
Market Economics | Interest Rate Strategy - BNP PARIBAS ...
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EUR: Bund ASW Risk/Reward Analysis<br />
• We combine swap spreads’ single-factor<br />
sensitivity into a scenario matrix.<br />
• STRATEGY: Buy Bund 10Y ASW at 22bp,<br />
target 35bp, based on risk/reward analysis.<br />
0<br />
-5<br />
-10<br />
-15<br />
Chart 1: Impact of Fiscal Variables<br />
Germany federal govt budget (EUR bn)<br />
Bund 10Y swap spread (RHS)<br />
0.70<br />
0.60<br />
0.50<br />
We aggregate the single drivers of Bund swap<br />
spreads into a scenario matrix. The idea is to provide<br />
scenario projections and thus minimum/maximum<br />
boundaries for spreads. We can then derive a<br />
strategy based on risk/reward arguments.<br />
We look at the following factors:<br />
• Fiscal variables (German budget);<br />
• ECB expectations (Eonia forwards);<br />
• Yield curve (EUR 2/10s);<br />
• Liquidity (OIS/Bor spreads);<br />
• Credit variables (iTraxx and SovX); and<br />
• Global variables (Tsy swap spread and Vix).<br />
Estimating swap spread sensitivity is not a trivial<br />
exercise, especially during the transition from a precrisis<br />
to a crisis environment. Nonetheless, we report<br />
the aggregate impact of two distinct scenarios (“risk<br />
on” versus “risk off”) on the Bund swap spread in the<br />
table below. Note how the risk/reward is tilted<br />
towards a spread widening strategy.<br />
-20<br />
0.40<br />
-25<br />
-30<br />
0.30<br />
-35<br />
0.20<br />
-40<br />
<strong>BNP</strong><br />
-45<br />
Paribas 0.10<br />
f<br />
-50<br />
0.00<br />
1997 1999 2001 2003 2005 2007 2009 2011 2013 2015<br />
Source: <strong>BNP</strong> Paribas<br />
100<br />
90<br />
80<br />
70<br />
60<br />
50<br />
40<br />
30<br />
20<br />
10<br />
Chart 2: Impact of Liquidity<br />
OIS/BOR<br />
Bund 10Y z-spread (RHS)<br />
0<br />
10<br />
Jan-07 Aug-07 Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11<br />
Source: <strong>BNP</strong> Paribas<br />
-90<br />
-80<br />
-70<br />
-60<br />
-50<br />
-40<br />
-30<br />
-20<br />
-10<br />
0<br />
Trade: Buy Bund 10Y ASW at 22bp, target 35bp.<br />
Bund 10Y Swap Spread Scenario Analysis<br />
Bund 10Y ASW 22<br />
Protracted Risk Scenario Variable Current Level E2011 level Change Weight Impact on ASW<br />
Government Budget (%) -3.5 -5 -2 0.125 7<br />
<strong>Rate</strong> expectations (bp) 0.793 0.5 -0.3 0.125 16<br />
EUR 2/10s yield curve (bp) 153 200 47 0.125 10<br />
EUR OIS/BOR (bp) 34 50 16 0.125 38<br />
VIX (% pts) 17 30 13 0.125 38<br />
EUR iTraxx Master 10Y (bp) 120 150 30 0.125 44<br />
SovX 5Y 190 250 60 0.125 45<br />
US TSY 10Y ASW 7 30 23 0.125 36<br />
Bund 10Y ASW projection 29<br />
Risk Normalisation Scenario Current Level E2011 level Change Weight Impact on ASW<br />
Government Budget (%) -3.5 -1.5 2 0.125 42<br />
<strong>Rate</strong> expectations (bp) 0.793 1.1 0.307 0.125 28<br />
EUR 2/10s yield curve (bp) 153 100 -53 0.125 35<br />
EUR OIS/BOR (bp) 34 20 -14 0.125 8<br />
VIX (% pts) 17 10 -7 0.125 13<br />
EUR iTraxx Master 10Y (bp) 120 100 -20 0.125 6<br />
SovX 5Y 190 150 -40 0.125 5<br />
US TSY 10Y ASW 7 0 -7 0.125 18<br />
Bund 10Y ASW projection 19<br />
Alessandro Tentori 20 January 2011<br />
<strong>Market</strong> Mover, Non-Objective Research Section<br />
40<br />
www.Global<strong>Market</strong>s.bnpparibas.com