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

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Trade Reviews Options, Money Market and Bond Trades – Tactical & Strategic Trades This page summarises our main tactical (T) and strategic (S) trades. The former focus on short-term horizons (a few weeks), allowing one to play any near-term corrections within a defined trend, while the latter rely on a medium-term assumed trend. For each trade we provide the expected target and the recommended stop loss. Existing Strategies Yield Curves BTP Flattener Long BTP 5% Sep 40 Short BTP 4% Sep 20 We enter 2/3 now and the rest on any overshoot to 90bp. Tsy Flattener Sell UST 5Y Buy UST 10Y Structurally, we like the trade given QE2 purchases. PCA also shows that 10s look cheap while 5s look rich, which makes us comfortable with the timing of this trade. Also, there is a slight flattening bias beginning next week going into the following week's 5y auction. EUR Butterfly Receive EUR 2/5/10s M1 IMM Proxy for 2/10s flatteners with positive carry. Cross Markets USD Agency Callable Long FNMA 5nc6M 2.60 01/16 Short T 0.75 08/13 Short-vol bullish strategies in the short end are attractive given the Fed status. Callables outperform in a range-bound environment, but currently tolerate a larger rise in rates (+115 bps) than a rally (-20 bps) before breaking even over a 6m horizon. Money Markets U1U2 Euribor/Eurodollar box Long Eurodollar Short Euribor We entered 2/3 of the position and would add at 10bp. GBP OIS Swap Pay May11 MPC Media and economists are beating on the inflation drum. The front end has been listening: we tactically try to ride the bearish momentum in the market via OIS swap at small size. 78.5 (S) 138.5 (S) 15.5 (T) -4k (S) 17 (T) 0.71 (T) 70 94 85.5 (13-Jan) -1.5bp 10k EUR 70k 7bp 130 146 138.5 5k/01 USD 0k (13-Jan) 0bp 0.0 16.5 11.5 (05-Jan) 300k -150k 0k (06-Jan) 30/35 7 15 (14-Jan) 0.75 0.64 0.67 (11-Jan) Options Euribor Put Spread Buy ERU1 9862/50 P/S 5.5 12.0 0.0 3.0 Bearish long-term strategy, playing improved macro conditions, the ECB's exit strategy as well as the risk of a rate hike in Q2. Good entry level for shorts after aggressive rally at the end of 2010. (S) (04-Jan) *Tactical (T) and strategic (S) trades. **Risk: vega, gamma for options, or ΔDV01 for futures, bonds and swaps. +1.0bp 10k/01 EUR -40k -4bp 1k/01 USD -4k 10k EUR 20k +2bp 7.5k/01 GBP +30k +4bp 12.5k/01 EUR +32k +2.5bp Interest Rate Strategy 20 January 2011 Market Mover, Non-Objective Research Section 58 www.GlobalMarkets.bnpparibas.com
Travelling Asia • Inflation has emerged in Asia. Changes in relative competitiveness are in train, suggesting Asia’s surpluses will erode over time. • China’s booming economy will be most at risk should inflation accelerate further. But markets may have started with an inappropriate distribution of risk. • Asset-driven currencies such as the AUD are the most vulnerable. The EUR will benefit from the credibility of its central bank… • …but the ECB’s inflation-fighting credentials will be challenged by diverging monetary conditions. • Rising global inflation will put the JPY under selling pressure. The challenge of inflation: The example of India I am writing this document during a business trip to Asia. It has been fascinating talking to our clients and to policymakers. While Asia is clearly booming, the clouds of inflation are appearing in the blue sky; the outlook is no longer universally sunny. India, which had been hoping to become a second China because of its growth dynamics, is now hopelessly behind the curve in respect of tackling inflation. The RBI has allowed real rates to become negative, the current account deficit is taking off and the government is acting only slowly to reduce its fiscal deficit. Still, India is an agriculturally driven country, with the monsoon heavily influencing the state of the economic cycle. Last year’s good monsoon season helped push GDP growth up to 8% but industrial production growth has now declined to 2.7%. Rising inflation rates will undermine India’s competitiveness, not boding well for its already-weakening trade and current account deficits. Meanwhile, the RBI stands at a crossroads. Either it understands the inflation risks and acts accordingly, putting rates up aggressively or it remains behind the curve. In the first scenario, India would face a cyclical slowdown due to rising real rates. In the second case, India would be heading into troubled waters where rising inflation expectations kill off inward investment. Falling real rates would start undermining the INR. 9.5 9 8.5 8 7.5 7 6.5 6 5.5 5 Chart 1: India Behind the Curve 4.5 Dec-06 Jul-07 Feb-08 Sep-08 Apr-09 Nov-09 Jun-10 Source: Bloomberg, BNP Paribas 0.34 0.33 0.32 0.31 0.3 0.29 0.28 0.27 0.26 0.25 0.24 WPI (y/y, RHS) RBI CRR Chart 2: China Wages Relative to Output are Rising China Wages are a proportion of GDI China CPI (y/y, RHS) Mar-92 Sep-94 Mar-97 Sep-99 Mar-02 Sep-04 Mar-07 Sep-09 Source: Reuters Ecowin Pro, BNP Paribas We discussed this topic with a well-respected Asianbased hedge fund manager. The conclusion we reached was that either scenario would lead to lower share prices. Last week, the Indonesian equity market moved into a higher volatility regime. In 2009 and especially 2010, the Indonesian market saw a lot of inward investment and was one of the best performers globally. That might be changing now as inflation is on the rise. India is in the same boat as its equity market was the main destination for foreign inflows into the country. Since November, shares in Bombay have lost around 10% and we wonder when there will be a bigger correction in the FX market on the back of this development. China: domestically funded leverage The other big theme is China and its satellite economies. Looking out of the hotel room window, I 5 0 -5 12 10 8 6 4 2 0 30 25 20 15 10 -2 Hans Redeker 20 January 2011 Market Mover, Non-Objective Research Section 59 www.GlobalMarkets.bnpparibas.com
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Market Economics | Interest Rate St
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The obvious focal point is the Summ
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such shocks at the moment, such as
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Page 31 and 32: US/EUR Spreads: Further Tightening
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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: Germany 10y: MT 61.8% (3.12) break
Page 61 and 62: Capitalism requires business cycles
Page 63 and 64: EURUSD Rally Eyes 1.3750-1.3950 •
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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
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