Market Mover - BNP PARIBAS - Investment Services India

TIPS: A Pause Before a New Jump?This section is classified as non-objective research• Heading into month-end, TIPS have thus farturned in a stellar performance, beatingmatched duration USTs by approximately 1.98%since 1 October. They are likely to pause atcurrent levels.• The European bailout’s initial details are in,but the market still faces choppiness in themonths ahead.• Energy markets have provided a bit ofturbulence lately, leaving gasoline, crude, andfront-end breakevens a bit fractured.• We look at the efficacy of our 10s-30sbreakeven steepener thus far and maintain it forthe time being.• The Fed’s schedule will be out near monthend,and we look at the sales as anotherliquidity generating event for the TIPS market.TIPS have had a stellar month, thus far, with the CitiInflation Linked Bonds Index beating durationequivalent Treasuries by nearly 1.98% through 25October (before the European news). Rounding outthe month should still leave TIPS ahead, but whatremains to be seen is whether such a margin willshrink in the coming days. We doubt it, as the lastday of the month is likely to bring in more extensionneeds with a very large duration extension of +0.18yrs according to BNP estimates.The big event in the week ahead is the FOMCmeeting, which has the potential to move the nominaland TIPS market materially. Our economists believethat the Fed will introduce expanded communicationlanguage at this event, which will potentially set themup for an eventual bout of further quantitative easing.Much will depend on whether and what levels theFed ends up targeting. A 3% headline inflation targetwould certainly be bullish, but a lesser level or arange may leave a more mixed reaction. We wouldlean bullish on TIPS on the introduction of anytargeting communication. The damage from recentEuropean uncertainty raises our conviction that theFed would like to head off any economic weaknessat the pass, all of which is positive for the TIPSmarket. The actual mention of employment as atarget should be accretive from a sentimentperspective, even if it does highlight a known Fedobjective.340330320310300290280270260Chart 1: 5yr forward 5yr Inflation Swap25001/11 02/1103/11 04/11 05/11 06/11 07/11 08/11 09/11 10/11Source: BNP ParibasChart 2: Front-end breakevens have been a bitsluggish in following WTI’s rally1.5%1.4%1.3%1.2%1.1%1.0%0.9%1YR BECrude0.8%10/1/11 10/8/11 10/15/11 10/22/11Source: BNP Paribas, BloombergChart 3: 10-30 Breakevens curve runs into someheadwinds45352515501/11 02/1103/11 04/11 05/11 06/11 07/11 08/11 09/11 10/11Source: BNP Paribas10s-30s BreakevensThe second element, unemployment targeting, mayhave a more negative impact on sentiment if it servesto codify a higher NAIRU. If participants, perceive anunemployment level that is too high, they may beginto suspect that the Fed has significantly revised up$93$91$89$87$85$83$81$79$77$75Aaron Kohli 27 October 2011Market Mover56www.GlobalMarkets.bnpparibas.com