Market Mover - BNP PARIBAS - Investment Services India

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EUR: Receive OIS/BOR SpreadsThis section is classified as non-objective research• The 12mth tender conducted this weekattracted reasonable demand but it was not thatstrong. However, both the amount of liquidityand its duration have increased.• In addition, EU decisions on Greece, theEFSF and banks, are likely to improve the creditquality assessment on banks. CDS have roomto fall.• STRATEGY: receive OIS/BOR spreads. Onthe Mar12, target 45bp (versus 58.5 currently).Chart 1: Cost of Carry Weighed onDemand for 12mth (EUR bn)Reasonable demand, but not that strong, for12mthAt its LTRO, the ECB allotted EUR 56.9bn for12 months. The number of bidders (181) was lowerthan at previous 12mth tenders conducted in 2009(even if we exclude the spectacular demand at thefirst one). Demand for 12mth liquidity was very closeto the lower bound of the range of expectations(EUR 50-200bn). We were expecting strongerdemand accompanied by lower demand for 3mthliquidity. However, demand at the 3mth tenderremained high, at EUR 44.6bn, while EUR 85bn wasexpiring. To summarise, more than a half of positionsrolled for another 3mth period and the rest for 12mth,while an additional EUR 16.5bn jumped into the12mth tender.The cost of carry prevented demand from being verystrong, although there were advantages to shiftingmore significantly from the 3mth to 12mth. Indeed,the rate on the 12mth tender will benefit from theECB’s rate cuts if the central bank delivers. Going forthe 3mth to benefit from potential rate cuts thereforemakes little sense. In addition, rolling from 3mth to3mth for a year is exposed to the risk of aninterruption of non-standard procedures for tendersnext year, even though this risk is now very small.However, although demand was lower than expectedat the 12mth tender, both the amount and theduration of liquidity provided by the ECB increasedafter this week’s operations. Liquidity is now muchmore than EUR 200bn above needs, and theduration of liquidity increased from 30 to 71 days.This is significant enough to allow stress on liquidityto ease somewhat. Banks’ funding is improving andthere is more certainty thanks to the extension of theduration of liquidity. Thus OIS/BOR spreads haveroom to tighten.Source: BNP ParibasChart 2: OIS/BOR Spreads are TighteningSource: BNP ParibasRisk assessment on banks to improveDecisions taken at the EU summit have majorimplications for banks. As the situation looks, to alarge extent, addressed, and the implications forbanks are largely manageable, the creditassessment on banks is likely to improve in the nearterm. The early market reaction is clear in stocks andCDS. The decline in banks’ CDS will beaccompanied by tighter short-term credit spreads.OIS/BOR spreads therefore have room to narrowmore significantly.Strategy: receive OIS/BOR spreads. On the Mar12,target 45bp (versus 58.5 currently).Patrick Jacq 27 October 2011Market Mover38www.GlobalMarkets.bnpparibas.com
This section is classified as non-objective researchEUR: Update on the 50y Point• We review the decoupling between volatility,term premium and the 30/50s yield curve.• TRADE: Buy OAT55 versus OAT35 @11bppick-up, target flat, stop/loss 15bp.Valuation models continue to suggest that the levelof convexity implied by the ultra-long end of the yieldcurve is significant. For example, by decomposingthe reference OAT35/55 spread into its rateanticipation, term premium and convexity premium(Chart 1), we get about 10bp of convexity RV. Thisresults primarily from a dislocation between the bullflattening of 10/30s, the rally in 30Y volatility and thesteepening of the 30/50s segment.Anecdotal information suggests that significantpaying flows in the 40Y and 50Y buckets areresponsible for this decoupling. We suspect thatsome investors are trying to position themselvesahead of a rumoured change in the Dutch pensionregulation (nFTK). Nonetheless, the appetite forduration from investors in negative convexity shouldcontinue to prevail in the environment of low yieldsand dull equity performance.Interestingly, when we further analyse the ultra-longend of the OAT curve we note an outperformance ofOAT55 in ASW-terms relative to OAT35 (same foron-the-run OAT41 and OAT60). The ASW-box hascompressed by some 15bp after briefly scratchinglevels in excess of 30bp.We do not put too much weight on credit-relatedarguments when valuing 50Y bonds. In the currentregime, we still have a well-behaved curve anddefault probabilities are discounted so heavily atultra-long maturities that the impact of durationextension on credit premia is negligible. Given recentOAT price dynamics, we cannot fully dismiss thecredit argument either (Chart 3). As we have seen inprevious episodes (e.g. Italy and Spain), yield curvestend to flatten when spreads to Bunds enter a new‘high yield’ regime (investors start hedging notionalexposure rather than dv01). This is not yet the casefor France, though!TRADE: Buy OAT55 versus OAT35 @11bp pick-up,target flat, stop/loss 15bp.Chart 1: Modelling the OAT 30/50s40residuals (LHS)35OAT35/55 yield spread30model2520151050-5-102005 2006 2007 2008 2009 2010 2011Source: BNP Paribas50403020100-10Chart 2: OAT55 Outperforming in ASWSpread of z-spreads (LHS)OAT35 z-spreadOAT55 z-spread2005 2006 2007 2008 2009 2010 2011Source: BNP Paribas35030025020015010050Chart 3: Contagion Risk in AAA02007 2008 2009 2010 2011Source: BNP ParibasiTrax SenFin 10YOAT/Bund 10Y (RHS)0.150.100.050.00-0.05-0.10-0.15-0.20-0.25-0.301501301109070503010-10-30-50120100806040200Alessandro Tentori 27 October 2011Market Mover39www.GlobalMarkets.bnpparibas.com
Page 1 and 2: Market Economics | Interest Rate St
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Page 15 and 16: In September, we estimated 2012 Fre
Page 17 and 18: a fairly significant change in the
Page 19 and 20: Japan: Exports Slow on End of Catch
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Page 25 and 26: Australia: Not Yet• Having been f
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Page 42 and 43: EMU Debt Monitor: Trade IdeasThis s
Page 52 and 53: Table 1: BNP Paribas' Inflation For
Page 54 and 55: Table 3: BNP Paribas' Inflation For
Page 56 and 57: TIPS: A Pause Before a New Jump?Thi
Page 70 and 71: Economic Calendar: 28 Oct - 4 Nov (
Page 72 and 73: Key Data PreviewChart 3: Japanese P
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