Market Mover - BNP PARIBAS - Investment Services India

This section is classified as non-objective researchGBP: Long-End Linkers and Gilts in Demand• Huge demand for UKTi-62 syndication.• APF shows risk of 20y+ UKT gilt squeeze.• STRATEGY: Keep 10/30y real yield and giltflatteners, and long 10y gilts versus Bunds.Chart 1: Huge Demand for UKTi-62 SyndicationMassive demand for UKTi-62 launchThere was incredible demand for the GBP 4.5bnlaunch of the new 50y index-linked benchmark with“a very large book of high-quality demand ofGBP 10bn in 90 minutes and at a time of persistingglobal market volatility”, according to the UK DMOpress release. The UKTi 0.375% 22-March-62 cameat a real yield of 0.49% and a spread of +2bp versusUKTi-55, the tight (or rich) end of the range. Despiteoffering the lowest real yield for an ultra syndicationand the longest duration linker (or sovereign bond)around, the UKTi-62 saw the largest order book forany linker transaction ever! Both LDI and extensiondemand were significant, as we expected, and theconcession was enough.We like real yield flatteners via ultras, especiallyversus the 12-20y sector given Novembersyndication intentions. Long ultra breakevens (at 3%)and breakeven steepeners remain very attractive inboth a historical and risk premia context, butTuesday’s APF operation highlights the risk of asqueeze on long-end conventionals. It seemssensible to wait until after early December’s couponpayments (on conventionals) to re-consider beingshort 15y+ conventionals in any capacity. Thecoupons will see GBP 5bn of cash coming back intogilts (DMO and BoE adjusted) or close to GBP 9bn of10y equivalent. After the 0.50y duration extension ofthe 5y+ UKTi index extension on 26 October, the 1y+UKTi index will extend by +0.45y at the end of themonth. We prefer to express our bullish long-endbreakeven via swaps at this stage, despite relativelywide ASW discounts. At the front-end, we stay bullishon UKTi-13 breakevens, with UKTi breakevenshaving fallen too much versus EUR and USDbreakevens since the end of July. Remember, UKlinkers offer the best 3/6month carry.Focus back on APF and supplyWeek three of the Bank of England’s APF operationssuggests it is becoming increasingly difficult for theBank of England to source conventional gilts forreverse auctions. In Table 1, we show averageoffer/cover ratios, discounts and duration of APFoperations over the last three weeks. Discounts andSource: BNP Paribas12.0010.008.006.004.002.000.00Chart 2: UK Conventional Gilt Coupon Flows(BoE/DMO and duration adjusted)GBP bn1.490.23offer/coverage ratios are, on average, much lowerthan at the end of week one. Furthermore, discountsand cover ratios are lower for the higher maturitysectors. Indeed, last week’s 25y+ sector reverseauction saw a coverage ratio of only 1.06 andvirtually no discount. In fact, some stocks were9.097.437.436.65 6.654.91Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov DecSource: BNP ParibasCoupon FlowsBoE & DMO AdjustedTable 1: Summary Statistics of APF (3 weeks)SectorOffersReceivedOffersAcceptedOffer/CoverRatioDiscount1.490.237.374.919.09Availiable freefloafloatof RA£25bn RA / free-Duration(y)3-10y 19,620 5,101 3.85 1.1 142,268 18% 5.0010-25y 12,877 5,099 2.53 0.5 59,174 42% 11.6925y+ 7,515 5,100 1.47 0.4 82,360 30% 19.73Average 2.62 0.7 12.14Source: BNP ParibasShahid Ladha 27 October 2011Market Mover47www.GlobalMarkets.bnpparibas.com