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JPM_Global_Fixed_Income__2012-03-17_810381

JPM_Global_Fixed_Income__2012-03-17_810381

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Sections

  • Overview
  • Euro Cash
  • European Derivatives
  • United Kingdom
  • US Cross Sector
  • US Treasuries
  • US Interest Rate Derivatives
  • Japan
  • Australia & New Zealand
  • Interest rate forecasts
  • Recent curve movements
  • Recent sovereign cash spread movements
  • Recent sovereign CDS spread movements
  • Euro-area fact sheet / SMP purchases
  • Global Market Movers

European Rates Strategy

J.P. Morgan Securities Ltd. March 16, 2012

Global Fixed Income Markets Weekly
Overview Pavan Wadhwa, Kedran Panageas • We analyse two distinct strategies for investors wishing to hold out from the Greek foreign-law bond exchange. Although tendering is the best strategy in our view, holding out has reasonable chance of success for the handful of bonds that mature early, have small outstanding size, and carry strong creditor protections. Triggering cross-default clauses with railway and public transport bonds is more risky as it could create a political backlash and would likely produce an outright Greek default if bondholders accelerate en masse. New Greek bonds do not cross-default with old Greek bonds, limiting the fallout from a default on holdouts. Euro Pavan Wadhwa, Fabio Bassi, Gianluca Salford • Stay short duration, although yields are likely capped given sky-high liquidity and already short positions; we target 2.20% in 10Y Bunds. Stay positioned for tighter intra-EMU spreads, but favour Italy over Spain and Finland over the Netherlands. Hold 2Y Belgium longs and 4s/10s BTP flatteners. If other peripherals restructured debt along Greek lines, their debt/GDP ratio would also fail to decline appreciably. Initiate weighted reds/blues EONIA steepeners. Close Jun12/Jun13 Euribor bear flatteners since the curve is now positively directional. Buy Jun12 midcurve put spreads funded by selling call spreads as a short duration trade. Hold weighted greens/10s steepeners and initiate 5s/30s bear flatteners. Hold 2Y Schatz narrowers with a 75bp target on b/m spreads. Exit short 3Mx10Y gamma; instead sell proxy gamma by shorting 3Mx10Y vs. 3Mx5Y gamma. Sell Schatz vs. swaption gamma. UK Francis Diamond • Negative technicals and continued risk-on dynamic makes us bearish on gilts; sell 10Y duration with a tight stop loss. Take profit on 5s/10s steepener and enter 10s/30s gilt curve flattener. Stay long belly of 10s/30s/50s gilt fly. Initiate tactical 5Y swap spread narrower. We think investor demand for 100Y gilts will be limited. US Terry Belton, Srini Ramaswamy • Stay bearish on duration and neutral on yield curve. Turn neutral on intermediate swap spreads but hold 30Y swap spread widener. Stay short gamma in 10Y. Japan Takafumi Yamawaki, Yuya Yamashita • Stay neutral on duration. Unwind the 5s/8s JGB flattener while maintaining long 7Y via weighted 5s/7s/10s butterfly. We recommend selling 3Mx10Y payers swaption with the strike of ATMF + 20bp. Australia and New Zealand Sally Auld • Take profit on tactical shorts in AUD 3Y bonds and AUD 3M/12M OIS steepeners. Enter AUD 1Yx(2s/9s) swap curve steepener. Hold AUSUS 10Y bond spread contraction trades.
www.morganmarkets.com
Pavan WadhwaAC
(44-20) 7777-3370 pavan.wadhwa@jpmorgan.com

Fabio Bassi
(44-20) 7325-8615 fabio.bassi@jpmorgan.com

Contents
Overview Euro Cash European Derivatives United Kingdom US Cross Sector US Treasuries US Interest Rate Derivatives Japan 2 10 16 25 31 34 43 52

Australia & New Zealand 57 …………………………………………………. Interest rate forecasts Recent curve movements Recent sov cash spread movements Recent sov CDS spread movements Sov & bank redemptions Event risk calendar Euro-area fact sheet / SMP Purchases Global Market Movers 63 64 65 66 67 68 69 72

J.P. Morgan Securities Ltd.

See page 70 for analyst certification and important disclosures.

European Rates Strategy Global Fixed Income Markets Weekly March 16, 2012 Pavan WadhwaAC (44-20) 7777-3370 Kedran Panageas (44-20) 7777-0326 J.P. Morgan Securities Ltd.

Overview
• Stay positioned for risk-on: we see potential follow-through to this week’s sharp move higher in yields We analyse two distinct strategies for investors wishing to hold out from the Greek foreign-law bond exchange in late March Greece has limited ability and willingness to pay holdouts; the vast majority of foreign-law investors would be better served by tendering into the exchange,… …which should boost participation and potentially create opportunities for small investors The ‘quiet’ holdout strategy has the most chance of success. The handful of bonds which mature early, have small outstanding size, and carry strong creditor protections, may be able to slip through the cracks Indeed, we estimate that each 1-month reduction in maturity adds about €5-10, €2-3, and €1-2 to bond prices, respectively, for bonds maturing from 1-2, 3-5, and 6-12 months out,… …while each €1bn reduction in outstanding bond size boosts bond price by around €2 points, and… …each 10% increase in the CAC voting threshold boosts bond price by around €8 Some Greek foreign-law bonds may be able to accelerate principal payment based on crossdefault clauses with railway and public transport bonds… …however, this ‘loud’ holdout strategy is more risky as it could create a political backlash and would likely produce an outright Greek default if bondholders accelerate en masse Note that new Greek bonds do not cross-default with old Greek bonds, limiting the fallout from any default on holdouts We also review financial covenants in Portuguese foreign-law bonds; the 2016 Loan Stock has particularly strong covenants including a restructuring EOD

Stay positioned for risk-on
The main newsflow this week was the conclusion of the US bank stress tests on Tuesday, which led to a 2% rally in the S&P500 and a 4.5% boost to US bank stocks (up over 8% on the week). European yields reacted with a lag: the 10Y Bund and Gilt yield rose 14bp and 16bp on Wednesday, respectively. This move single-handedly retraced the last two weeks of yield compression and, along with some follow-through on Friday, brings yields to three-month highs. We hold short duration trades in Bunds, and enter short duration trades in Gilts, as we see the potential for further follow-through. However, we don’t necessarily expect a large or sustained move higher in yields given the implication of high excess liquidity for positive carry, long-duration trades, as well as the still-mixed economic backdrop and ongoing fiscal consolidation. We also hold risk-on peripheral spread trades (see Euro Cash). Below, we provide an update of the Greek PSI process as it relates to foreign-law bonds, review financial covenants in existing and new Greek bonds, and estimate how various foreign-law bond characteristics (maturity, size, and voting thresholds) affect bond price. The Greek domestic-law bond exchange settled on Monday but the foreign-law exchange extends through late March. Some creditors are reportedly seeking ways to hold out, and we review the potential avenues by which they could seek to accelerate Greek bonds. This could potentially force Greece into a hard default over the next few weeks although ultimately we think this is more a source of headline risk than actual market implications. Importantly, the new Greek bonds granted in the recent debt exchange do not cross-default with existing Greek bonds (Appendix-1). This means that Greece can default on existing Greek bonds without causing its newly-issued bonds to become immediately due and payable. We also review the financial covenants in Portuguese foreign-law bonds (Appendix-2).

• • •

The outlook for holdouts in Greek foreign-law bonds
The 2nd Greek bailout was formally approved by the EU and IMF on Monday 12 March and Thursday 15 March, respectively. The domestic-law exchange officially settled on Monday, but the foreign-law exchange extends through late March. The official deadline to send in participation instructions is Friday 23 March, but bondholders can also vote at their respective bondholders’ meetings which occur from Tuesday–

2

European Rates Strategy Global Fixed Income Markets Weekly March 16, 2012 Pavan WadhwaAC (44-20) 7777-3370 Kedran Panageas (44-20) 7777-0326 J.P. Morgan Securities Ltd.

Exhibit 1: Maturity is by far the most important variable in Greek foreign-law bond pricing;…
Greek foreign-law bond prices* regressed against months to maturity; €

potentially seeking ways to hold out. Broadly speaking, we see two possible ways for foreign-law bonds to hold out: 1) The “quiet” way: that is, accumulating a blocking stake in a particular issue, holding out of the exchange, and hoping that Greece continues to pay interest and principal up to the point at which one’s bond comes due; or 2) The “loud” way: attempting to accelerate payments on bonds which have experienced events-of-default, and hoping that Greece chooses to pay principal (or some fraction thereof) rather than default outright.

100 80 60 40 20 0 0 50 100 150 200 months to mat

y = -8.9Ln(x ) + 67.3 R 2 = 44.6%

250

300

* Includes Hellenic Railways and Athens Urban Transport bonds. We caveat that available bond pricing for existing Greek foreign-law bonds is extremely unreliable. We clean the data to some extent as follows. First, we use Bloomberg pricing if it appears reasonable. If not, we take the average of the best bid and offer prices from actual (and reasonable) screen quotes. If no reasonable quotes are available, we discard the bond. Source: Bloomberg, J.P.Morgan

Exhibit 2: …indeed, we estimate that each 1M reduction in maturity adds about €5-10, €2-3, and €1-2 to bond prices, respectively, for bonds maturing from 1-2, 3-5, and 6-12 months out
Price beta* to a 1M reduction in maturity for Greek foreign-law bonds**; €

10 8 6 4 2 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 months to maturity
* Beta defined as 9.2/maturity, where 9.2 is the partial regression beta shown in Exhibit 3 below. ** See footnote in Exhibit 1. Source: Bloomberg, J.P.Morgan

Below we review the best bonds for each type of holdouts, and their likelihood of success. Overall we think the outlook for holdouts is poor given Greece’s motivations to default. First, Greece has limited ability to pay holdouts given the severity of its financial challenges. This primarily impacts large bond issues (or a large acceleration effort). Any principal that comes due in size is likely to be defaulted on or settled on worse terms than offered now. Second, Greece has limited willingness to pay: EU politicians will support Greece in not paying holdouts, especially as policymakers can argue that doing so would be unfair to voluntary participants. Third, Greece has already triggered CDS, so has little to lose on that front. Fourth, the new Greek bonds granted in the exchange do not cross-default with old Greek bonds, limiting the fallout of a default on holdouts (see Appendix-1). Fifth, rewarding holdouts sets a bad precedent in case the EU ever proceeds with PSI in Portugal or Ireland. In short, neither the economics nor the politics support the holdout trade, and we think the vast majority of foreign-law investors would be better served by tendering. However, there may be some opportunities for small investors to slip through the cracks, which we discuss below.

1) The best foreign-law bonds for (quiet) holdouts
Bonds with the best chance of getting out whole are those that a) mature as soon as possible, b) have small outstanding face value, and c) have strong minority protections. For instance, the smaller the face value, the more likely that Greece can afford to close its eyes and pay out par. Similarly, the higher the voting threshold required to employ collective action clauses (CACs), the less likely that minority holdouts will be roped into the exchange. Based on current foreign-law bond pricing
3

Thursday 27-29 March (see Overview, Global Fixed Income Markets Weekly, 9 Mar 2012). According to the Greek Finance Ministry, 61% of foreign-law bondholders had already sent in positive participation instructions as of 8 March (the original deadline). The remainder are either abstaining (roughly 90% of bondholders responded to the domestic-law exchange), or are still evaluating their strategy and

The price/maturity curve starts to kink at around the 9 month maturity. each 10% increase in CAC voting threshold boosts bond price by around €8 Regression statistics* for Greek foreign-law bonds**. (admittedly an illiquid and low visibility market)1. which is small enough that Greece can likely Exhibit 4: Only a handful of Greek bonds are potentially attractive to holdouts on multiple fronts Greek foreign-law bonds that meet multiple holdout criteria*. however it matures a year from now which is longer than ideal. in price terms (€) Beta T-stat Intercept LN(months to maturity ) Face v alue (€bn) Voting threshold (%)*** 10. Morgan Securities Ltd. respectively (Exhibit 2).3 -1. we use Bloomberg pricing if it appears reasonable.2 -2. STRONG MINORITY RIGHTS €240mn OASA Mar 2013 (100%) €450mn Greece May 2012 (75%) EARLY MATURITY €190mn OSE Sep 2012 (66%) €250mn OSE Dec 2012 (66%) €413mn OSE Apr 2013 (66%) SMALL SIZE * Defined as having 12M or less to maturity and either 1) less than €500mn outstanding face value.1 -9. number in parentheses is the voting threshold required to employ CACs**. J.5bn in notional terms. *** We use the percentage of principal required to invoke collective action clauses assuming a 100% response rate. 3-5.9 • • * Cross-sectional regression on current bond prices. and Each 10% increase in the CAC voting threshold2 boosts bond price by around €8 (Exhibit 3). we discard the price. 1 We caveat that available bond pricing for existing Greek foreign-law bonds is extremely unreliable. we take the average of the best bid and offer prices from actual (and reasonable) screen quotes. ** See footnote in Exhibit 1. SE = €10. 4 . The OASA Mar2013 has extremely strong minority protections.1 81. 2 We use the percentage of principal required to invoke collective action clauses assuming a 100% response rate. If not. with a 100% approval threshold for changing bond terms. assuming a 100% response rate to any bondholder proposals.European Rates Strategy Global Fixed Income Markets Weekly March 16.Morgan Overall. Adj R-squared = 57%. We clean the data to some extent as follows. each 1M reduction in maturity adds about €5-10.P. 2012 Pavan WadhwaAC (44-20) 7777-3370 Kedran Panageas (44-20) 7777-0326 J. Exhibit 4 illustrates bonds that have less than 12 months to maturity and either 1) small size (defined as less than €500mn outstanding). Source: Bloomberg. Each €1bn reduction in outstanding bond size boosts bond price by around €2 points. based on a cross-sectional regression we estimate that: • For 1-2.P. and €1-2 points to bond price. or December 2012 (Exhibit 1). or 2) strong creditor rights (defined as requiring at least 75% of principal to change bond terms via CACs). For instance. The highlighted bonds tally about €1. or 2) a 75% voting threshold for CACs** ** CAC voting threshold as a % of principal. Size and minority protections have a more modest but still intuitive impact. and 6-12 months to maturity.2 2. bond prospecti.7 0. First.5 -5. If no reasonable quotes are available. Exhibit 3: Size and minority protections have more modest but still intuitive impact. there are just a handful of bonds that meet multiple criteria. €2-3. we find that maturity is by far the most important variable. Source: Bloomberg.

If exchange participation is high. albeit less so. there is a reasonable chance that Greece is willing and able to pay out on this small group of bonds. regulated investors who are susceptible to moral suasion should look to sell bonds with attractive holdout features to less regulated investors who are more able to take advantage of such features. the majority do have cross-default clauses. regardless of maturity. Exhibit 5: …we believe the vast majority of Greek foreign-law investors would be better served by tendering into the exchange Bond characteristics Exchange High (>80%) Low (<80%) Acceleration Limited Limited Large Matures early Small size Hold out Hold out or Tender Tender Large size Tender Tender Tender Matures medium/late Small size Accelerate Tender or Accelerate Tender Large size Tender Tender Tender participation tactics JPMorgan estimate of optimal exchange strategy for Greek foreign-law bondholders in various exchange scenarios.4 Following an EOD. This is also true. and it can be demonstrated that this foreign-law bond was placed initially with a non- • 2) The (mostly empty) threat of acceleration There’s also an avenue by which creditors could attempt to force the issue by accelerating Greek foreign-law debt. but also don’t force the issue by attempting to accelerate in large size. are summarized in Exhibit 5. or can cross-default with each other. we think the optimal strategy for other bondholders would be to participate voluntarily.P. The chain is as follows: • A number of government-guaranteed state agency bonds (OSE. Cross-default means that when Bond A is not paid its interest or principal. On the other hand. o Foreign-law debt issued to foreign holders (FL/FH). 2012 Pavan WadhwaAC (44-20) 7777-3370 Kedran Panageas (44-20) 7777-0326 J. In this eventuality. the Greek cross-default clauses are all defined with respect to “External Debt”. Then Bond B principal can also be accelerated. if other bonds don’t participate. or 3 For example. As far as we can tell by looking at available bond prospecti. see Hedge funds find loophole to trigger Greek default. as we estimate them. due to the domestic-law PSI exercise which just went through (Exhibit 6). This means that principal becomes immediately due and payable. However. 8 March 2012. it means that around €3bn of debt has the ability to accelerate already. Finally. if a large group of bonds attempt to accelerate their payment. and o Guarantees of other issuers’ debt that meet either of the above conditions5. as discussed above. • Greek government foreign-law bonds do not include this restructuring language. most likely outcome highlighted in blue afford to pay out. If each such bond has this clause. but Greece is likely to default if too many pursue this strategy). For instance. Morgan Securities Ltd. any bondholder can choose to accelerate the bond. from the OSE Oct2015 list of EODs: “A general moratorium is declared by the Guarantor in respect of its External Indebtedness or the Guarantor announces its inability to pay its External Indebtedness as it matures or the Guarantor otherwise commences negotiations with one or more of its respective creditors with a view to a general readjustment or rescheduling of its respective indebtedness. and OASA. depending on maturity. We would ballpark the probability at somewhere between 1/3 and 1/2." 5 OSE and OASA bonds are €-denominated. • Thus.3 This is most attractive to small issues which mature late (it moves them up in the queue. These optimal strategies for different bondholders. Bloomberg 4 For example.European Rates Strategy Global Fixed Income Markets Weekly March 16. The bet is that Greece would choose to settle on more favorable terms rather than default outright. we think that voluntary participation is the optimal strategy for all medium to large bond issues. so do not meet the foreigncurrency criterium. This category of debt is defined in various ways. 5 . Office of Athens Urban Transport) include a restructuring of the guarantor’s debt as an event-ofdefault (EOD). it will likely lead Greece to default or pursue a more severe restructuring which involves all holdouts (discussed below). Whether Greece chooses to do so depends in part on other creditor strategies. Bond B also suffers an EOD. but most commonly includes the following: o Foreign-currency (FX) debt. if a government-guaranteed state agency bond gets accelerated. or Hellenic Railways.

should cause exchange participation to be high. We sample around 85% of Greek international bonds. which should limit the amount of headline risk posed over the near term. First. in this strategy “two’s company. In particular. i. government bonds are more difficult to accelerate than state agency bonds. Exhibit 6: Some Greek international bonds may be able to accelerate principal payment based on cross-default clauses with railway and public transport bonds. This. which should reduce the outstanding principal considerably. as well as for need to control 25% of the outstanding principal. which in turn might allow some small bonds which mature early to hold out. it is probably better to wait until after the 11 April foreign-law exchange settlement. the euro. This ‘loud’ holdout strategy is more risky as it could create a political backlash and would likely produce an outright Greek default if bondholders accelerate en masse Estimated terms of financial covenants in existing Greek foreign-law bonds. The acceleration strategy is more risky than the quiet holdout strategy. weighted by principal amount outstanding*. This is not a trivial hurdle to meet given that 61% of principal is already reported to have been tendered into the exchange. three’s a crowd”: one acceleration is likely to encourage others to accelerate as well (for defensive reasons). so that one may own a higher proportion of existing debt. (Delaying has the risk of getting roped into CACs however). and 33% of public transport bonds by principal amount. then other foreign-law bonds can potentially accelerate as well. requiring 25% of principal rather than a single holder. ** Only shown for bonds which have cross-default clauses. 60% of Greek railway bonds. Both categories include guarantees of another issuer’s debt which meet the applicable criteria. Overall we ballpark the odds of an acceleration strategy working at something like 1/5. or participation looks to be on the low side. which if it snowballs is likely to lead Greece to default outright. Morgan Securities Ltd. 2012 Pavan WadhwaAC (44-20) 7777-3370 Kedran Panageas (44-20) 7777-0326 J. when the foreign-law exchange settles. it is probably preferable to wait until after 11 April.European Rates Strategy Global Fixed Income Markets Weekly March 16. We use cross-default criteria for debt issued from early2000’s onwards since the relevant railway and public transport bonds were all issued post-2002. the optimal strategy for investors in medium to large bond issues (which we define as anything over €500mn) is to tender into the exchange.***: FX and FL/FH 7% 0% 0% 6% FX or FL/FH 85% 100% 100% 87% * Based on sampling of available prospectus. In fact. plus moral suasion applied to highly regulated investors. we think that the vast majority of Greek foreign-law bondholders would be better served by tendering. This implies that holdout attempts are likely to be fairly small in size.e. or some small bonds which mature late to accelerate. For this reason. • As discussed above.EOD: includes pledge 93% 100% 100% 94% Def 93% 100% 100% 94% Greek Restruc? Any Holder No Yes Yes 15% 7% 100% 100% 21% >25% of Prin 86% 0% 0% 73% Neg Pledge / Cross-Default pertains to: Ex ternal Indebtedness Relev ant Debt for issuer / Ex ternal Indebtedness for guarantor Relev ant Debt for issuer / Ex ternal Indebtedness for guarantor -FX 1% 0% 0% 1% Ex ternal debt defined as**. If many investors attempt to accelerate. it is more aggressive and as such is more likely to prompt a political backlash. Source: Bloomberg. Note: The above summary is based on our reading of available bond documents and is not intended to represent legal advice.6 €20.4 €0. Greek investor. bond prospecti. it becomes more preferential to tender in order to avoid potentially more severe treatment (Exhibit 5).4 €2.4 w / Neg w / Cross. Second. • We reckon about 85% of Greek government foreignlaw bonds have the most relaxed version of crossdefault clauses which would allow them to pursue this strategy (Exhibit 6). Investors should consult their own counsel. 6 . which increases the odds that Greece chooses to default rather than pay out. However.P. FL/FH generally means foreign-law bonds initially issued to foreign holders. Acceleratable in an EOD by ** Amt Ty pe Greek International Hellenic Railw ay s Urban Transport Total (€bn) €17. *** FX (foreign-currency) generally means any currency other than that of the Greek Republic.

France Sell protection in 3Y Spain CDS Short 2Y Italy CDS-cash basis Neutral Vega Inflation Neutral Long ILG16 b/e Bearish Bullish bias Neutral Neutral Cross-market 7 . − In UK. 10Y French CPI vs. Morgan Securities Ltd. 3Mx5Y straddle Short Schatz vs. turn bearish on duration and sell 10Y Gilts. Euro HICP swaps Long BTANi16. OBLi13 & OATei15 b/e Long 9Y Finland vs.P. 2012 Pavan WadhwaAC (44-20) 7777-3370 Kedran Panageas (44-20) 7777-0326 J. take profits on 5s/10s gilt steepeners and enter 10s/30s flatteners.European Rates Strategy Global Fixed Income Markets Weekly March 16. have a steepening bias on curve. • Curve − In Euro. fixed) Rec. Trade recommendations • Duration − In Euro. Exhibit 7: Bird’s eye view of our major trade recommendations by currency Duration Curve Euro area Short 10Y Steepening bias Weighted greens/10s steepener 5s/30s bear flattener Jun12 Schatz narrower UK Short 10Y Pay 12Mx6M in swaps Reds/greens steepener 10s/30s flattener Long 10s/30s/50s gilts fly 5Y narrowers US Bearish bias Neutral Japan Neutral 8s/30s steepener Long 7Y JGB in 5s/7s/10s wtd. hold short duration in 10Y Bunds. maturity matched swaption gamma Neutral Pay 5Yx10Y HICP (rec. steepener Sell 3Mx10Y Sell OTM 3Mx10Y payers Swap spreads 30Y widener Jun12 Schatz narrower hedged with Jun12 FRA/OIS widener Swap spread curve Neutral Neutral Gamma Short Schatz unhedged strangle Short 3Mx10Y vs. Germany Long 5Y Italy vs. fly Pay 10Y in 5s/10s/20s swap wtd fly 1s/5s FX basis steepener 20s/30s wtd. Germany 4s/10s Italy flattener Long 2Y Belgium vs. − In UK.

This makes private creditors closer to pari passu with the official sector. Fourth. Third.P. Most are issued out of a common MTN platform and have one overarching bond prospectus. which includes all Greek debt or guarantees issued on or after 12 March 2012 (the exchange date). so terms cannot be changed by Greece at will. is paid to a "common paying agent" each payment period --. The voting thresholds are somewhat lower than in existing Greek foreign-law bonds and have shorter notice periods (effectively. the new Greek bonds can be characterized as offering more protection to bondholders than Greece’s prior bonds did (whether domestic or foreign-law).Non-payment or acceleration of principal on any Greek debt that is issued on or after 12 March 2012 (the exchange date). they carry both individual and aggregate CACs. either can be pursued --. The former operate across the series of 20 new Greek bonds whilst the latter can include other Greek debt series as well.Principal and interest on 1) the New Greek Bonds* and 2) the EFSF loan which covers the €30bn PSI sweeteners. one day). Bond terms are summarized in the gray box at right (Exhibit A1). the new Greek bonds are foreign-law. subject to meeting proper quorums at the separate meetings --. These bonds have the following characteristics: • Negative pledge clauses with respect to External Debt.Paying agent = Bank of Greece --. First. taken across all affected series. Second.This paying agent pays each class of creditors pro-rata.Any other covenant failure on the New Greek bonds*. Based on our reading.Acceleration of the 1Y/2Y EFSF sweeteners --.Aggregate CAC: operates across the New Greek bonds* + any other series of Greek debt securities --. Morgan Securities Ltd.Repudiation/expropriation of the New Greek bonds* or of the co-financing agreement --. Portugal has the 2nd highest proportion of foreign-law bonds (Greece has the 1st. but less minority bondholder rights. military assets. J. the new bonds cross-default with all Greek debt issued after the exchange date (not just external debt). or could elect to pursue a bond modification across its entire stock of debt securities. Appendix 1: Financial covenants in new Greek bonds Here we summarize the financial covenants in the new Greek bonds granted in the exchange. as a % of those voting --.Bonds controlled by Greece or Greek state agencies cannot vote --. individual threshold = 50% of total principal amount of each affected series --. with a 30D grace period --.Individual threshold = 67% of those voting.Individual CAC: operates across the New Greek bonds* --. Investors should consult their own counsel.Non-payment of interest on the new Greek bonds* or GDP warrants. subject to a €250mn minimum. 2012 Pavan WadhwaAC (44-20) 7777-3370 Kedran Panageas (44-20) 7777-0326 J. subject to meeting proper quorums at the separate meetings --. both must be met --.For written resolutions. but less minority bondholder rights Summary of financial covenants in New Greek bonds* (1) Governing Law = ENGLISH --. Note that these cross-default clauses do not trigger for payment disruptions to old Greek bonds. noncommercial properties. but not with respect any other debt securities • 8 . for each affected series separately.Any creditor who recovers any past due amounts must turn funds over for pro-rata distribution to all creditors --.Two voting thresholds. and all assets residing in Greece are not liable for attachment.Quorum = 2/3 for Reserved Matters and 1/2 for other matters --.Pertains to all Relevant Indebtedness. (2) Negative pledge clauses: YES --. Exhibit A1: Financial covenants in Greece’s new bonds offer more protection to bondholders than Greece’s prior bonds did (whether domestic or foreign-law). without curing of the EOD (5) CACs: both individual and aggregate CACs. diplomatic properties. they contain a co-financing arrangement between payments due to the EFSF and to the new Greek bonds: Greece pays interest and principal into a common vehicle. investors should consult their own counsel.Notice period = 1D (day of first publication in major Greek & Englishlanguage newspapers) (6) Co-financing arrangement --. and these funds are distributed pro-rata to the EFSF and to new Greek bonds. cultural heritage assets.European Rates Strategy Global Fixed Income Markets Weekly March 16.Morgan Appendix 2: Financial covenants in Portuguese foreign-law bonds Amongst the peripherals. by principal.P. Source: Greek Finance Ministry. including shortfalls --. and subject to applicable grace periods --. The above summary is based on our reading of available bond documents and is not intended to represent legal advice. with a 30D grace period --. 3 Feb 2012).Voting threshold = 75% for Reserved Matters and 50% for other matters. central bank assets.Legal decree prevents Greece from fulfilling its obligations to the New Greek bonds* or to the co-financing agreement (4) Acceleration by 25% of principal --. (3) Events of Default: cross-default does NOT extend to existing Greek bonds --. by principal.Moratorium declared w/respect to the New Greek bonds* --. which is defined as debt placed with investors outside the Republic of Portugal Cross-default clauses with respect to notes issued out of the MTN platform.Governed by laws of England *Note: The New Greek bonds are the 20 new bonds granted on 12 March 2012 in the debt exchange.Can be rescinded by holders of 50% of principal. but nevertheless. aggregate threshold = 67% of total principal amount taken across all affected series.Aggregate threshold = 75% of those voting. This means that Greece can pursue a bond modification to the new Greek bonds alone. see Overview. Global Fixed Income Markets Weekly.Modifications can also be passed by written resolution with signatures from 67% of total principal --. We caveat that the following is not intended to represent legal advice.Sovereign immunity is waived. which is a material advantage.

except for in the 2016 Loan Stock Summary of financial covenants in Portuguese MTN program* (1) Governing Law = ENGLISH --. or b) 75% of those voting at a bondholders’ meeting.Morgan • Another bond.Any event that could lead to acceleration of any External Debt (including loans).Any holder of Bearer or Registered notes can accelerate --.Sovereign immunity is waived.Notice period = 1D (day of first publication in major newspaper) or 7D if the entirety of notes are held by Euroclear/Clearstream and notice is disseminated via Euroclear/Clearstream Summary of financial covenants in 2016 Portuguese Loan Stock* (1) Governing Law = ENGLISH --.Any other covenant failure. (2) Negative pledge clauses: YES --.Non-payment of interest or principal on any External Debt (including loans). It also has a restructuring EOD (albeit somewhat ambiguously written).Portugal enters into debt restructuring with or for the benefit of any creditor (4) Acceleration by any holder (5) CACs exist.Pertains to all External Debt --. that are either 1) not in escudo currency or 2) placed with investors outside the Republic of Portugal (3) Events of Default: Includes Cross-default and Restructuring --.Sovereign immunity is waived.External Debt is defined as debt or debt guarantees. where External Debt is defined as above --. with a 30D grace period --.P. The voting threshold to implement a bond modification is not clear.Voting threshold not clear --. with a 30D grace period --. but public property used for public purposes or assets in the public domain are not liable for attachment. It has negative pledge and crossdefault clauses which apply to External Debt. Source: Bloomberg. with a 30D grace period. with a 30D grace period (4) Acceleration by any holder --. is a small issue that has relatively strong investor protections. Exhibit A2 summarizes these bond terms. We caveat that the above is based on our interpretation of available bond documents and is not intended to represent legal advice. investors should consult their own counsel.Non-payment of principal on any MTN note.6 Exhibit A2: Financial covenants in most of Portugal’s foreign-law bonds are fairly limited. Investors should consult their own counsel.European Rates Strategy Global Fixed Income Markets Weekly March 16. 9 6 . terms NA *The above summary is based on our reading of available bond documents and is not intended to represent legal advice.Moratorium --.Pertains to all External debt or debt guarantees.P. 2012 Pavan WadhwaAC (44-20) 7777-3370 Kedran Panageas (44-20) 7777-0326 J.Collective action clause operates across the MTN platform --. with a 30D grace period --. the definition of External Debt is somewhat antiquated: it includes any debt not denominated in Portuguese escudos (meaning that even €-denominated domestic-law bonds would apply). the Portuguese Loan Stock maturing in 2016.Non-payment of interest on any MTN note.Any other covenant failure on any MTN note. with a 30D grace period --. but is likely to be either a) 75% of total principal outstanding. even if the EOD is not acted upon (but remains uncured). • Fairly circumscribed EODs: only failure to pay principal/interest and failure to meet other MTN conditions (all with a 30-day grace period) CACs which operate across the MTN platform: at least 2 noteholders holding >75% of the principal are necessary to form a quorum to modify key bond terms. (2) Negative pledge clauses: YES --.Quorum = at least 2 holders holding >75% of total principal --. Morgan Securities Ltd. J.Non-payment of interest.Interbolsa notes (a small Portuguese-law subset of the MTN platform) may require 20% of principal to accelerate if a common representative has been appointed (5) CACs: aggregate across the MTN platform --. but public property used for public purposes or assets in the public domain are not liable for attachment. External Debt is defined as above --. and because the bond was issued in 1986. which is defined as debt placed with investors outside the Republic of Portugal (3) Events of Default: cross-default ONLY with other MTNs --.

How far can the sell-off go? Our fair value target is 2. we remain sceptical about the possibility of a meaningful sell-off beyond the 2. 2 March 2012) and a round of convexity hedging in the US might also help (see US sections for details). has arsenal of 15-Mar Now otny options. We believe recent market moves have corrected many of the RV themes we have been highlighting since the beginning of the year. with only Germany and Italy tapping the market Special focus: De facto subordination of peripheral bond holders in peripheral bond markets Exhibit 1: The shift in tone by ECB members has hurt safe assets… Recent comments from ECB members discussing the ECB’s exit strategies from crisis mode Date Speaker Comment "It is too early to decide on ex it strategy …We hav e to prepare for future ex it.80 52 50 Global PMI 2. The ECB chatter about the need to be ready to exit non-standard measures increased in volume (Exhibit 1). albeit with limited risk. hurting the short end of the curve.40 Pressure for higher yields. In GFIMs. as 2s/5s steepened 13bp and 5s/10s flattened 4bp. As discussed at length in the past. as the conditions for a more restrictive monetary policy are not in place. We 10 48 Jan-10 May -10 Sep-10 Jan-11 May -11 Sep-11 Jan-12 2.00 argue against extrapolating too much into the future the recent strength in the data.European Rates Strategy Global Fixed Income Markets Weekly March 16. timely ex it from recent 15-Mar Liikanen central bank steps.20% level Global composite PMI vs. In addition. pose no threat to price stability . 2012 Gianluca SalfordAC (44-20) 7325-4334 Aditya Chordia (44-20) 7777-9841 J. but I w ould say that time is not ripe now . We put a stop at 1. consensus on 1Y forward growth has lagged the message of contemporaneous activity indicators (Exhibit 2). therefore we do not expect the 10Y Bund yields to sell-off beyond the 2. targeting 2. and we believe the current adjustment should not be faded. 4s/10s BTP flatteners. we see little room for a sharp move beyond that level as excess liquidity is exceptionally high and positions are already skewed towards the short side Most RV opportunities on the German curve have corrected.95%. Ex it w ill depend on price stability . finally hurting AAA fixed income markets across the globe. we believe most investors are already positioned on the short side. Morgan Securities Ltd." "ECB discussing strategy to ex it crisis mode.20% in 10Y Bunds. how w e w ill limit the risks that w e hav e taken during the crisis. efficient functioning of capital and money markets. Long term refinancing ops had "decisiv e impact on market"." "It is v ery important on the one hand that gov ernments commit 16-Mar Liikanen and implement policies w hich consolidate their public finances and create a basis for grow th and on the other hand w e must also decide how and w hen w e ex it in a controlled and timely matter. given the newsflow We still recommend 2Y Belgium duration longs.60 • • 3. Euro Cash • • German yields finally caught up with the risk-on mood resulting in a significant sell-off Mentions of ECB exit from non-standard measures and a spillover from the US may explain part of the move We remain short duration." "Euro crisis solution requires controlled. but favour Italy over Spain and Finland over the Netherlands." "We as central banks must dev elop an idea of how w e w ill 13-Mar Weidmann organize and ex ecute an ex it from the special measures.20% (see GFIMs. with the exception of 2019 expensiveness We remain positioned for tighter intra-EMU spreads.20 2. consensus on 1Y ahead global real GDP growth index % • 58 56 54 Global consensus 3. the 5Y part of the curve suffered the most. process w ill be gradual. The 5Y underperformance looks excessive and now leaves 5Y around 3bp cheap on the . as for the past two years. but not the beginning of a bear market The risk-on trade gained traction on the week." 11-Mar Benoît Cœuré • • Source: Media articles • Exhibit 2: … but we would be cautious about extrapolating too much from current conditions.P. and selling protection in short-dated peripheral CDS Light bond supply over the next two weeks.20% level. In the sell-off. adding a domestic component to the US-driven sell-off. we have been highlighting for a while that valuations for Bunds and US Treasuries were stretched.

we focus on valuations and newsflow. 30 20 10 0 -10 -20 -30 Mar11 May 11 Jul11 Sep11 Nov 11 Jan12 Mar12 5Y 10Y Intra-EMU Despite higher yields in many countries.06*2s/10s -0.58*1s/2s OIS + 0. around 20bp cheap (Exhibit 4). The Sep21 remains the most expensive bond. Exhibit 3: After the recent sell-off. any tightening will be driven by Italy’s performance and find better value in BTPs at around 300bp over Bunds than OATs at around 100bp over. bp 300 350 ITL ESP FRF y = 0. respectively. 2018 and 2019 RAGBs remain stubbornly cheap on the Austrian curve and vs.P. most of the cheapness of the 10Y sector has been eroded. We believe the best value can be found at the short end of the curve. * 50:50 2s/5s/10s = 0.13*5Y – 0. we do not find any domestic reasons to change our cautious stance on French bonds: in our view. given attractive valuations. past 1Y. 20Y has outperformed 10Y and 30Y after we highlighted its cheapness a week ago. Germany 2Y spread to Germany as % of 10Y spread to Germany regressed against 10Y spread to Germany.0.20. we believe spreads can tighten further from here. In our country selection. R-squared: 87%. given the market segmentation accentuated by the 3Y LTROs. index 120 110 100 90 80 70 60 Jan-12 FIM-DEM KFW-DEM FRF-DEM Feb-12 Mar-12 11 . Austria We continue to believe that Austria’s fundamentals did not warrant S&P’s downgrade and the risk of banking sector exposure to Eastern Europe is overblown. and we continue to highlight the cheapness of the short end of Belgium. Germany since the beginning of the year despite the risk-on mood RFGB Apr21-Bund Jan21. However. We favour countries like Italy and Finland against Spain and the Netherlands. Belgium warrants an honourable mention: OLOs were the best performers despite the pricing of €4bn of a new 20Y bond.European Rates Strategy Global Fixed Income Markets Weekly March 16. Morgan Securities Ltd. OAT Apr21-Bund Jan21 and KFW Jan21-Bund Jan21 yield spread evolution since 1 January 2012. * 50:50 2s/10s/30s = 0. we are neutral on the rest of the curve. whereas at these levels. 1 January 2012 level indexed at 100. intra-EMU spreads were generally tighter. Selling protection in short-dated CDS remains another very interesting theme. As discussed above. Exhibit 4: We find value in the short end of the Belgian curve. We provide a country-by-country update on our favourite themes for the most liquid markets. the 5Y is no longer dear and the 10Y is no longer cheap on the German curve Residual from regressing 50:50 2s/5s/10s against curve and level and 50:50 2s/10s/30s against 1s/2s OIS and 2s/30s*. Belgium Belgium’s recent outperformance was concentrated in the 5-10Y part of the curve.11 R 2 = 63% ATS Exhibit 5: The 8-10Y sector of the Finnish curve has failed to tighten vs. given attractive valuations: stay long 2Y Belgium vs. 2012 Gianluca SalfordAC (44-20) 7325-4334 Aditya Chordia (44-20) 7777-9841 J.43*2s/30s -0. Italy was a relative outperformer and Spain a relative underperformer.14*Ln(x ) . At the same time. after months of expensiveness (Exhibit 3).58. In addition. France. In line with the theme of the past few weeks. bp curve. Increased risk appetite has prompted some investors to reconsider their consensus on France underweight. R-squared: 69%. The only remaining theme is the 3bp expensiveness of 2019 Bunds. % 80% BEF 60% NLG 40% FIM 20% 0 50 100 150 200 250 10Y spread to Germany .

J. Germany also plans to issue around €2bn of a new 10Y linker maturing in April 2023 (on Wednesday). but the election risk is well flagged. Our favourite play on the Spanish curve is to sell the high price Bono 2032 vs.0 Medium Long Ultralong 21-Mar Germany 29-Mar Italy Exhibit 8: 1Q12 supply came in marginally higher than expected. Also. Bund Jan21. recent data was not favourable: the January budget balance number was -€9. we believe Spain’s underperformance vs. Spain As discussed last week. On the T-bill side. The Netherlands A combination of poor growth prospects. realised* forecast Germany France Italy Spain Netherlands Belgium Austria Greece Finland Portugal Ireland Total 43 52 40 38 22 12 8 0 3 0 0 219 43 55 45 27 23 9 7 0 1 0 0 209 0 -3 -5 11 0 3 1 0 2 0 0 10 Issuance/News Next week will be very light in terms of supply. €bn Date Issuer Short Mar14 5. which looks cheap vs.P.0 3. Morgan forecast. We stick to 4s/10s flatteners and plan to reopen 10s/15s steepeners after the month-end 10Y auction. Indeed. Exhibit 6: 10Y part of the BTP curve looks cheap vs. ISDA will hold an auction in respect of outstanding Greek sovereign CDS transactions. . Italy We are positive on a continuation of spread compression in BTPs. We also find 5Y fairly cheap after the auction-induced cheapening. -€4. the Apr21 and the Apr22. Finland. (on Wednesday). whereas in longer maturities. We find the best value in the 3Y part of the curve. We therefore recommend investors to open longs in RFGBs Apr21 vs.P. France We recommend a token underweight in France: we believe fundamentals require wider spreads than Austria’s.European Rates Strategy Global Fixed Income Markets Weekly March 16.5bp expensive vs. with only Germany tapping the conventional market for €5bn (Exhibit 7). Morgan Q1 supply forecast made at the starting of the year. Germany since the beginning of the year despite the risk-on mood (Exhibit 5). but it has been trading special in repo. the Oct21 is around 3. 2012 Gianluca SalfordAC (44-20) 7325-4334 Aditya Chordia (44-20) 7777-9841 J. and 2) 2020 and 2021 RFGBs have failed to tighten vs.3bn (vs. official announcements and J. so we do not recommend short-selling. peripheral supply will come from Spain and Greece (on Tuesday) and Portugal 12 * We assume that Germany will issue €5bn at the 21 March auction and Italy will issue €6. both 4-5Y and 15Y (Exhibit 6). Exhibit 7: Euro area conventional bond issuance calendar for the next two weeks Euro area conventional bond issuance calendar.7bn in 2011) and house prices declined by a record amount in 4Q11 (-11% on the year). especially in 2020 and 2021 maturities as 1) the country’s fundamentals remain very solid. mainly due to aggressive front-loading by Spain Gross conventional bond issuance in 1Q12* vs. the low price 2037. Italy can continue in the short term. peripheral supply highlighted in grey. Our favourite sectors are 3Y as it is not pricing any LTRO premium (in contrast with the Spanish curve) and 10Y. Finland We recommend overweight in Finnish bonds.0 3. both 4-5Y and 15Y 5Y par Italian government rates. % 12 5Y spot 5Y 5Y fw d 5Y 10Y fw d 9 6 3 SMP2 3Y LTRO Jul11 Aug11 Sep11 Oct11 Nov 11 Dec11 Jan12 Feb12 Mar12 Note: SMP2 started on 8 Aug 2011 and first 3Y LTRO took place on 21 Dec 2011.P. on Monday. We recommend underweight. and France underweight remains fairly consensus. higher-thanexpected deficit and political noise do not justify relative valuations vs.0bn at the 29 March auction. Morgan Securities Ltd. €bn 1Q12 JPM 1Q12 Country Diff.

Exhibit 10: … and our calculations suggest that debt/GDP relief would be even more modest for other peripheral countries Estimate of the impact of a Greek-style debt restructuring* for Greece. estimates of current values based on publicly available sources. issuing around €38bn of conventional bonds (the highest ever in one quarter) vs.911 175 736 280 80 1. 3) Recapitalisation needs for the domestic banking sector equivalent to 80% of the NPV loss. govt consolidation Total debt reduction after Greek-style PSI Total reduction as % of GDP Greece Ireland Italy Portugal Spain 355 169 1. % of GDP General govt debt (Maastricth def. the total supply by Euro area countries will be around €219bn. Italy. Morgan projections of the sizes of the upcoming auctions. Germany announced an upward revision to net new borrowing in 2012 from €26bn to €35bn (due to early ESM payments). 2) to safeguard official bond holdings.P. Italy started the year on a cautious note and issued in small sizes. which engaged in aggressive issuance frontloading. Italy has set a 2. in a theoretical simulation.) Bonds Eurosystem bond holdings Bank bond holdings General govt consolidation Debt reduction due to haircut on all debt 1) Impact of haircut on bonds only 2) Impact of central bank seniority 3) Impact of fin. as it took advantage of the improved market sentiment and launched two syndicated deals in 1Q12 (in the 10Y and 20Y sectors). 9 March 2012) discussed how the Greek PSI provided more disadvantages than advantages for the stability of the region. reinforces private investors’ fears that in case a Greek-style PSI were decided. Morgan Securities Ltd. On Wednesday. sector recapitalisation 4) Impact of gen. 2) A 75% NPV reduction in the value of government bonds. Based on the supply so far and official announcements/J. … Estimate of the impact of a Greek-style debt restructuring* for Greece. but a downward revision to borrowing needs in the following years. but the supply has gained momentum since the second 3Y LTRO at the end of February. We will publish a new quarterly update on supply in the coming days. As 1Q12 comes close to an end. Belgium also issued more than expected. and 4) technical issues linked to general government consolidation. we take the opportunity to review the issuance dynamics of the Euro area countries during the quarter. 112% 77% 14% 15% 4% 37% 60% -9% -19% -3% -7% -10% -9% -3% -2% 11% 23% Special focus: De facto subordination of private bond holders in peripheral bond markets Our sister publication (Flows and Liquidity. our forecast of €45bn. Portugal and Spain.) Bonds Eurosystem bond holdings Bank bond holdings General govt consolidation Debt reduction due to haircut on all debt 1) Impact of haircut on bonds only 2) Impact of central bank seniority 3) Impact of fin. Germany will tap the 2Y benchmark Schatz Mar14 for €5bn. Italy. 3) to recapitalise the domestic banking sector. The conclusions of our analysis are two-fold: on the one hand it suggests that the balance between the pros and cons of applying a PSI-style medicine to other countries is even more skewed towards cons. our forecast of €27bn. €bn General govt debt (Maastricth def.European Rates Strategy Global Fixed Income Markets Weekly March 16. Ireland. Portugal and Spain. that applying the same debt restructuring format to other peripheral countries would achieve even more limited improvement in the debt/GDP ratio.5% reduction in principal to the stock of government bonds. sector recapitalisation 4) Impact of gen. with the least impact in Ireland and Spain. Ireland. but on the other hand.5% reduction in principal to the stock of government bonds.023 -247 -99 -144 -4 528 33% 93 -36 -9 -10 0 39 23% 394 -100 -35 -105 -33 121 11% * Assumptions: 1) A 53. The bond is the dominant CTD for the June Schatz future contract. * Assumptions: 1) A 53. govt consolidation Total debt reduction after Greek-style PSI Greece Ireland Italy Portugal Spain 163% 108% 121% 102% 69% 129% 51% 91% 63% 51% 28% 12% 12% 10% 6% 23% 9% 15% 9% 16% 11% 1% 1% 0% 6% 87% -18% -15% -14% -6% 34% 58% -30% -6% -5% 0% 15% 64% -16% -6% -9% 0% 33% 54% -21% -5% -6% 0% 23% Avg. 2012 Gianluca SalfordAC (44-20) 7325-4334 Aditya Chordia (44-20) 7777-9841 J. On the other hand. The bond will be tapped again in April. We show.P. estimates of current values based on publicly available sources. Greece’s debt restructuring provided only limited relief to the country (around 30% of GDP) and highlighted the issue of de facto private bond investor subordination. Greece’s limited reduction in debt/GDP after the debt restructuring is attributable to four factors: 13 . very harsh haircuts would be needed even for countries with a much lower debt/GDP ratio than Greece.450 108 550 62 19 186 17 66 50 14 240 16 175 25 1 8 0 62 190 -40 -33 -30 -13 73 34% 90 -47 -10 -9 0 24 15% 1. Italy has been lagging in terms of issuance. Exhibit 9: A Greek-style debt restructuring provided little relief to Greece’s debt to GDP ratio due to: 1) the decision to restrict haircuts to bonds. bringing the total outstanding size to €10bn.25% coupon for its retail BTPi Mar16 bond that will be sold next week. The upside surprise came mainly from Spain. 2) A 75% NPV reduction in the value of government bonds. issuing only €40bn over the quarter vs. marginally higher than our start-of-the-year forecast of €209bn (Exhibit 8). 3) Recapitalisation needs for the domestic banking sector equivalent to 80% of the NPV loss.

SMP purchases or official lending. recapitalisation needs might be necessary for other financial institutions like insurance companies. the problem of de facto subordination of private bond holders will grow with time. but much less in Ireland.5bp. Exhibits 9 and 10 show our estimates based on various public sources. European public institutions such as the ECB. the reduction in the debt/GDP ratio drops dramatically to 34% of GDP. Morgan Securities Ltd. a reduction in international investor support will continue to be offset by domestic bank purchases. the decision to focus only on bonds meant that the decline was reduced by 18% of GDP. . 3) Recapitalisation needs for the domestic banking sector equivalent to 80% of the NPV loss. 2) Among bond holders. 4) Finally. but we do not want to further complicate the analysis.P. a 53. reducing the decline by a further 15%. Arguably. and the EIB were spared from the PSI. • Keep Bono Jul32-Jan37 flattener − Keep long €25mn of Bono Jan37 and short €23.5% notional reduction on all debt would have reduced the debt/GDP ratio by almost 90%. If. national central banks. 2) A 75% NPV reduction in the value of government bonds. P&L since inception (9 March): 7bp. we assume: 1) A 53. 3M carry and slide: 14bp. as has been the case recently. private and official loans were spared a notional reduction (keeping in mind that official loans have seen maturity extension and interest-rate reductions). P&L since inception (2 March): -0bp. short €25. P&L since inception (24 February): 16bp. Germany − Open long €25mn RFGB Apr21 vs. 3M carry and slide: -6bp. The need to recapitalise the domestic banking sector subtracted another 14%. short €26mn Schatz Mar14 @ 95bp. Therefore. • Keep long 5Y Italy vs. the eventual decision to target only government bonds would be the most important factor reducing the effectiveness of a Greek-style debt restructuring. France − Keep long €25mn BTP May17 vs. 3M carry and slide: 0bp. • Keep long 2Y Belgium vs. 3) Part of the savings from the debt restructuring was offset by the need to recapitalise the domestic banking sector. 2012 Gianluca SalfordAC (44-20) 7325-4334 Aditya Chordia (44-20) 7777-9841 J. Germany − Keep long €25mn OLO Mar14 vs. and especially so in Spain.8mn OAT Oct17 @ 188bp. however. a restructuring of securities held by the public social security fund has no impact on the debt/GDP ratio. the more they tend to create effective subordination for the remaining investors. at 6%. in line with Greece.European Rates Strategy Global Fixed Income Markets Weekly March 16. Trade recommendations • Open long 9Y Finland vs.5% reduction in principal to the stock of government bonds. • Keep short 10Y Bund − Keep short €100mn of Bund Jan22 @ 2. Once the four factors are taken into account. 3M carry and slide: -2bp. more than 20% in Portugal. the role of international investors is therefore key: the more they disengage from peripheral countries. To gauge the relative importance of these factors for Greece and other peripheral countries. the general government debt/GDP ratio consolidates between different sectors of the public administration. P&L since inception (24 February): 62bp.5mn Bund Jan21 @ 57bp. short €19. A Greek-style debt restructuring would have an impact on the debt/GDP ratio of around 30% in Italy. The impact of preserving Euro system bond holdings and the required 14 recapitalisation of the banking system would be similar in most cases.5mn of Bono Jul32 @ 1. 3M carry and slide: -10bp. with the exception of Spain. 3M carry and slide: 21bp. For Greece. Spain is also peculiar in its significant bond holdings by the social security fund.05%. For the other countries. We make a final additional observation. 1) Only one type of debt was involved – bonds – whereas T-bills. In conclusion. whereas the impact of the consolidation of the social security fund’s holdings was lower. further reducing the improvement in the debt/GDP ratio. P&L since inception (2 March): 19bp. SMP purchases and previous bonds held by the Euro system in investment portfolios were not subject to the haircut. • Keep 4s/10s BTP flattener − Keep long €25mn of BTP Sep22 vs short €50mn of BTP Aug16 @ 158bp. where central bank holdings are considerably less important than domestic bank holdings.

European Rates Strategy Global Fixed Income Markets Weekly March 16. selling maturity-matched CDS protection − Keep short €25mn of BTP Dec13 @ 2. 2012 Gianluca SalfordAC (44-20) 7325-4334 Aditya Chordia (44-20) 7777-9841 J. P&L since inception (3 February): -36bp. Aug23 Long 10Y Spain v s. RFGB Apr21 Long BTP Nov 23 v s.P. Germany Italy 5s/10s flattener Long Bund Jan21 v s. Spain Long 8Y Austria v s. Germany and Spain Short 3Y Spain v s.10% and short $32mn of Dec13 CDS protection on Italy @ 300bp. 3M carry and slide: 30bp. Italy Short BTP May 31 v s/ BTP Aug23 and Sep40 Bono Jul19-Jul26 flattener Long Italy 5Yx 5Y 10s/15s Italy steepener CDS Sell protection on 2Y Italy CDS Spain 5s/10s CDS flattener 20-Jan-12 03-Feb-12 105 10-Feb-12 24-Feb-12 0 11-Nov -11 06-Jan-12 06-Jan-12 20-Jan-12 21 9 09-Dec-11 20-Jan-12 03-Feb-12 10-Feb-12 3 -2 27-Jan-12 10-Feb-12 6 ENTRY EXIT P&L 09-Dec-11 20-Jan-12 -132 06-Jan-12 03-Feb-12 -56 06-Jan-12 03-Feb-12 03-Feb-12 10-Feb-12 10-Feb-12 24-Feb-12 03-Feb-12 02-Mar-12 27-Jan-12 02-Mar-12 02-Mar-12 09-Mar-12 02-Mar-12 09-Mar-12 -5 14 11 7 20 27 5 15 . P&L since inception (20 January): -49bp. Morgan Securities Ltd. • Keep BTP Dec13 vs. 3M carry and slide: +5bp. Trades closed in 2012 TRADE DURATION Short 10Y Bund Jan22 CURVE 5s/10s flattener v s. beta adj. 2s/30s steepener 3s/10s flattener COUNTRY SELECTION/RELATIVE VALUE Short 25Y Italy v s. • Keep short protection on 3Y Spain CDS − Keep short protection on $25mn Spain 3Y CDS protection @ 371bp.

making the Euribor curve positively directional in yield… …and we recommend closing Jun12/Jun13 Euribor bear flattener We refrain from recommending conditional bear steepeners on the Euribor curve as implied directionality is rich to delivered directionality.… …however. … …instead. European Derivatives • The EONIA curve bear steepened. taking late 2012/early 2013 ECB OIS rates to their highest level since the beginning of the year ECB OIS rate. the improvement occurred only in • • • • • • 16 . sell 3Mx10Y gamma vs. Dec12 EONIA sold off 10bp from its lows and is currently trading around 0. Morgan Securities Ltd. investors sharing our bearish view should consider buying Jun12 mid-curve put spreads funded by selling call spreads Hold weighted greens/10s steepeners 5s/30s is trading too steep vs. investors may be tempted to fade the recent sell-off and implement longs on the EONIA curve to earn carry.50 Change 16-Mar-12 12 10 0. we do not recommend this and instead. turn mildly bearish on the EONIA curve with a steepening bias. the level of yields. buying maturity matched swaption gamma • • • • • Swap Curve Since our last publication. 2012 Pavan WadhwaAC (44-20) 7777-3370 Fabio Bassi (44-20) 7325-8615 Khagendra Gupta (44-20) 7777-1980 J. With the refi rate likely to remain on hold for the rest of 2012 and excess liquidity expected to stay sky high for at least 1 year. % Change since 9 March 2012. However.45 8 6 • • 0. buying 3Mx5Y gamma Sell Schatz gamma vs. taking late 2012/early 2013 ECB OIS rates to their highest level since the beginning of the year (Exhibit 1). the EONIA curve bear steepened. Exit short 3Mx10Y gamma at a loss.43%. on a risk-adjusted basis. turn mildly bearish on the EONIA curve with a steepening bias The risk-adjusted carry on long EONIA positions has improved for fronts and reds EONIA The reds/blues EONIA curve appears too flat vs. with our bearish duration view and ECB members discussing an early exit strategy from emergency liquidity measures (see Euro Cash). we recommend weighted steepeners as relative-value trade The volatility of the EONIA curve has increased relative to the volatility to the FRA/OIS curve. bp 0. however. taking late 2012/early 2013 ECB OIS rates to their highest level since the beginning of the year. risk-on sentiment and higher yields will continue to put narrowing pressure on front-end swap spreads… …and we recommend holding 2Y Schatz narrowers – both outright and hedged with FRA/OIS wideners – with a target of 75bp on b/m spreads Seasonally adjusted swapped issuance is running close to its lifetime high… …and we retain our bias for narrower 10Y swap spreads in the near term… …while expecting them to trade in a 20-40bp range in the intermediate term Exhibit 1: The EONIA curve bear steepened.35 Apr12 Jun12 Aug12 Oct12 Dec12 Feb13 0 • • • We reduce our conviction on outright short gamma positions and recommend low-risk alternatives to short gamma positions.40 4 2 • 0. but hold 2s/5s/10s bull-belly richeners Excess liquidity. implement 5s/30s bear flatteners Close longs in 5Y in the 1s/5s/12s level-neutral fly.P.European Rates Strategy Global Fixed Income Markets Weekly March 16. The recent bear steepening of the EONIA curve has clearly increased the carry of long positions. the level of 5Y and is expected to remain directional.

% 0. the implied directionality on the money-market curve is expensive relative to the delivered directionality (Exhibit 5).2 -0. as we see limited upside in Jun13 Euribor.6 4. since 1 December 2011.7 0.00 2.2 0. we recommend weighted steepeners as relative-value trade Reds/blues EONIA curve regressed against blues EONIA.52. Thus. for example.1 0.65 y = 77.9 4. FRA/OIS is no longer a significant driver of the Euribor curve.20 y = 67. We favour bearish positions on the Euribor curve. making the Euribor curve positively directional.8 4. bp 25 20 15 10 5 0 0.1 -0.Change in Change in 6M Change in (bp) 6M 6Mx 6M 1Yx 6M 1Y6Mx 6M 2Yx 6M 2Y6Mx 6M 3Yx 6M 3Y6Mx 6M 4Yx 6M 4Y6Mx 6M 5Yx 6M 36 41 56 77 100 125 151 176 201 223 242 (bp) 0 4 12 18 21 23 28 26 25 22 19 (bp) 0.7 0.6 0.20 Exhibit 4: Given that risks have dissipated.3 * Risk is defined as 1M standard deviation of daily changes of the underlying EONIA rate. limiting the attractiveness of these conditional structures. This clearly challenges our long-standing Euribor bear flatteners.1 R 2 = 95% 0.8 0.7 4. Investors wishing to position for a continuation of the positive directionality of the Euribor curve may consider conditional bear steepeners.7 0. therefore.85 6th Euribor futures y ield. Lev el 6M Carry Risk* Annualized risk.1 adjusted carry -0.2 -0.4 4.4 0. we recommend buying Jun12 mid-curve put spreads (on Jun13 Euribor) funded by selling call spreads.60 1. % 2.75 0. fronts and reds EONIA due to the large increase in volatility further out the curve (Exhibit 2). expressed via option structures. However.2 2. Our recommendation is to Exhibit 3: Reds/blues EONIA curve is too flat adjusted for the level of yields. we do not expect Jun13 Euribor to rally above 99.1 -0.95 17 . which we recommended in December 2011 as a hedge for a flare-up in the peripheral crisis.6 3.4 R 2 = 92% 16-Mar-12 1. bp 140 130 120 110 100 90 80 1.2 -0. we therefore recommend weighted reds/blues EONIA curve steepeners. making the Euribor curve positively directional. the FRA/OIS is no longer a significant driver of the Euribor curve.5 1.3 2.4 0. the level of yields since the announcement of the 3Y LTRO in December 2011 (Exhibit 3).7 0. Morgan Securities Ltd.90 0.4 0. which offer about 12bp of upside.5x .7 0.6 lev el (bp) 2 7 15 25 31 32 30 29 29 26 21 carry (bp) 2 5 5 7 4 0 -1 -1 0 -2 -5 risk-adj. On RV.70 0. 2012 Pavan WadhwaAC (44-20) 7777-3370 Fabio Bassi (44-20) 7325-8615 Khagendra Gupta (44-20) 7777-1980 J.80 Blues EONIA.9x .1. past 2W. carry 0. With EONIA likely to stabilise in the 35-40bp range for the first year of the EONIA curve. close Jun12/Jun13 Euribor bear flatteners 2nd/6th Euribor curve regressed against 6th Euribor contract. The reds/blues EONIA curve appears too flat vs.80 0. we close Jun12/Jun13 Euribor bear-flatteners.P.9 3. Given that tail risks have dissipated.40 1.European Rates Strategy Global Fixed Income Markets Weekly March 16.25. steepening in a sell-off and flattening in a rally (Exhibit 4).1 -0.2 -0. Exhibit 2: The steepening of the EONIA curve has increased the risk-adjusted carry in fronts and reds EONIA 6M carry (bp) and annualised risk*-adjusted carry across the EONIA curve (unitless) and changes since 9 March 2012. we expect some term premium to remain in the Euribor strip.8 0.

we refrain from recommending bear steepeners. we find it attractive to implement 5s/30s bear flatteners (Exhibit 8). with significant underperformance of the 5Y sector.75 put spread vs.00/98. given the risk of further intermediates under-performance. Going forward. A historical analysis shows that 5s/30s is trading too steep vs. the level of 5Y yields and has a decent negative directionality.875 -10 -20 buy the 99.75 Jun12 mid-curve put spread funded by selling the 99. with both 5s/10s and 5s/30s flattening about 2bp. Going forward. we believe the intermediates will drive the sell-off.375 99. we highlighted the cheapness of 5Y on the curve and recommended structures such as long 5Y in the 1s/5s/12s level-neutral fly to exploit the relative value.750 99.6 R 2 = 55% 18 * Isopremium indicates the breakeven level for entering conditional fly trades at zero cost. 2012 Pavan WadhwaAC (44-20) 7777-3370 Fabio Bassi (44-20) 7325-8615 Khagendra Gupta (44-20) 7777-1980 J.500 98. Morgan Securities Ltd.European Rates Strategy Global Fixed Income Markets Weekly March 16. bp 130 120 2s/10s 110 100 90 Sep 11 Oct 11 Nov 11 Jan 12 Feb 12 Wtd Greens/10s Mar 12 Exhibit 8: 5s/30s is trading too steep vs.500 99. % Exhibit 6: …however.50 call spread on Jun12 Euribor mid-curve options. Over the past week.000 155 150 145 140 135 130 125 . the swap curve bear steepened.25/99. 100. we have less conviction that relative value will be a driver of curve moves.25/99. compelling us to stop out of 1s/5s/12s level-neutral fly. which are likely to expire worthless if the sell-off continues. 98.125 98. We still find steepeners attractive and hold weighted greens/10s steepeners.125 99. hold weighted greens/10s steepeners.50 call spread (Exhibit 6).0x + 155.250 99.25/99.750 98.… Current implied* and delivered** directionality for various Euribor curve trades. However.000 99. investors sharing our bearish view should consider option structures on Jun13 Euribor via Jun12 mid-curve options such as buying 99.625 99. This is based on COB 15/3/2012. implement 5s/30s bear flatteners 5s/30s EUR swap curve regressed against 5Y EUR swap yield and isopremium* line.375 98. while the weighted greens/Bunds performed better and benefited from a narrowing of the swap spread.75 put spread funded via selling 99. Exhibit 5: Although the Euribor curve is positively directional in yield.000 98.20 y = -39. we hold 2s/5s10s bull-belly richeners.00/98. as implied directionality is rich to delivered directionality. ** Delivered directionality for the swap curve calculated as 1 . bp 110 Spot 100 3M Forw ard 90 80 70 60 1. the level of 5Y and is expected to remain directional. With options on 30Y tails trading more expensive than option on 5Y tails. % 2.50 call spread Projected P&L profile at expiry on long 99. Since last Friday. The weighted greens/10s steepeners have underperformed 2s/10s steepeners over the past week (Exhibit 7).875 99. which can be initiated at zero cost via 3M payers at a level close to spot (see Trade Recommendations).P.3M beta of daily changes in front contract regressed against daily changes in 1Y forward Euribor contract.250 98.625 98. Last week. short 99.80 2.00 5Y EUR sw ap y ield. which remain attractive on RV Weighted greens/10s curve and 2s/10s EUR swap curve. We also hold -30 Exhibit 7: Weighted greens/10s curve has lagged the 2s/10s steepening. cents Euribor curv e 2nd/6th 3rd/7th 4th/8th Implied directionality 59% 61% 61% Deliv ered directionality 49% 42% 36% Implied Deliv ered 10% 19% 25% 30 20 10 0 * Implied directionality for the Euribor curve calculated as a ratio of implied volatility of mid-curve/front option-1. exerting flattening pressure on 5s/30s. 2s/5s steepened about 10bp.00/98.40 1.60 1. past 6M.

30 10 Mar 07 Mar 08 Mar 09 Ex cess liquidity Mar 10 Mar 11 0 -100 Mar 12 bearish conditional structures such as 3s/7s/15s conditional belly cheapeners. 19 . We recommend investors hold 2Y swap spread narrowers on both an outright basis and on a hedged-against-FRA/OISwidening basis. 2Y. both on an outright basis and on an adjusted-for-the-FRA/OIS basis. Morgan Securities Ltd. respectively. bp Exhibit 10: In the past. Exhibit 11: Seasonally adjusted swapped issuance is running at very high levels as corporations and financial institutions take advantage of the reopening of debt capital markets… J. significant widening of front-end swap spreads has been followed by dramatic increase in liquidity provision by the ECB.0x + 28. 2Y swap spreads continue to appear too wide. 21-day MA of NSA excess liquidity. 9bp and 7bp. Morgan estimate of seasonally adjusted swapped issuance*. as an estimate of swapped issuance unprecedented amount of excess liquidity that exists in the banking system. In fact. front-end swap spreads appear too wide. hold 2Y Schatz swap spread narrowers – both outright and hedged with FRA/OIS basis wideners Rolling front* 2Y Schatz swap spread regressed against back Euribor FRA/OIS basis.P. past 5Y. the ECB has introduced considerable liquidity into the banking system. bp * Contract rolled 20D before option expiry. This time around. 10Y and 30Y German b/m swap spreads narrowed 7bp. 2Y swap spreads have narrowed around 30bp from their peak of 115bp. €-denominated issuance by financial institutions (including covered bonds) and supras/agencies.European Rates Strategy Global Fixed Income Markets Weekly March 16. Subsequent improvement in risk sentiment allowed 2Y swap spreads to narrow almost 100bp over the next 6-9 months. before narrowing 20bp as liquidity improved. Exhibit 9: Despite recent narrowing. past 1Y.4 R 2 = 86% 09-Mar-12 16-Mar-12 2Y benchmark b/m sw ap spread 110 90 70 50 700 600 500 400 300 200 100 30 10 20 30 40 50 60 70 80 90 Back FRA/OIS basis. €bn/day Swap Spreads The sharp sell-off in fixed income markets left its mark on swap spreads. On the week. we believe 2Y swap spreads can narrow significantly more. plus one half of corporate bond issuance. and retain our 75bp near-term target on 2Y b/m swap spreads. which has put narrowing pressure on 2Y swap spreads. 2012 Pavan WadhwaAC (44-20) 7777-3370 Fabio Bassi (44-20) 7325-8615 Khagendra Gupta (44-20) 7777-1980 J.8bn/day 1 0 -1 Mar 07 Mar 08 Mar 09 Mar 10 Mar 11 Mar 12 * We use the 60-day MA of swapped issuance and seasonally adjust the data by subtracting the 60-day MA of swapped issuance averaged over the past 5 years on a rolling basis. Despite the recent narrowing. regressing the front 2Y Schatz swap spread against the back Euribor FRA/OIS basis suggests that spreads are trading about 10bp too wide (Exhibit 9). bp €bn 110 90 70 50 y = 1.P. which narrowed across the curve. full-allotment tenders were introduced in October 2008 when 2Y swap spreads peaked at 120bp due to the Lehman crisis. We use fixed-rate. 2Y swap spreads peaked again in mid-2010 at 85bp in response to the Greek crisis. In past crises when 2Y swap spreads have widened dramatically. we retain our near-term target of 75bp for 2Y b/m swap spreads 2Y German b/m swap spreads vs. leading to narrowing pressure on front-end spreads (Exhibit 10). For example. Given the 3 2 Av g: €0.

Morgan estimate of seasonally adjusted swapped issuance.5 1050 y = 0. bp 140 y = 8. thereby putting narrowing pressure on swap spreads. we use the 60-day MA of swapped issuance and seasonally adjust it by subtracting the 60-day MA of swapped issuance averaged over the past 5 years on a rolling basis.0 -0.2-0. For example. 2012 Pavan WadhwaAC (44-20) 7777-3370 Fabio Bassi (44-20) 7325-8615 Khagendra Gupta (44-20) 7777-1980 J.P. Net. €bn/day 2. We expect markets to remain in risk-on mode and therefore expect swapped issuance to stay high. In the intermediate term. Morgan Securities Ltd. especially in the belly of the curve. we expect markets to remain in risk-on mode and therefore expect swapped issuance to stay high. implieds on shortdated options are up between 0.7bp/day on the back of the jump in yields on Wednesday.0 -0.2 1Y 2Y 3M 2Y 5Y 20 5Y Tails 10Y 30Y Note: Implieds on 1Y tails are based on the 3s curve. we continue to expect 10Y spreads to trade in a 2040bp range.93 R 2 = 89% 16-Mar-12 1150 1250 S&P500 index . Exhibit 11 shows the J.5bp/day over the week (Exhibit 14). Indeed.P.7*(10Y Yld) + 63. Despite the recent narrowing.12x + 68. bp/day 8 9 Euro Volatility Implieds had a roller-coaster week.0.4 0.2bn (Exhibit 12). After having dropped to the lows since the start of the Greek crisis in May 2010 during the early part of the week. Additionally. . bp/day 0.7*(3Mx 10Y Vol) .2bp/day and 0.7bn/day.6 0. Schatz implieds Exhibit 14: Shorter-dated implied volatility increased over the past week as yields shot higher Change since 9 March 2012 in implied volatility on EUR swaptions. 10Y swap spreads appear to be trading a tad wide (Exhibit 13).34. we continue to expect 10Y swap spreads to trade in a 2040bp range in the intermediate term 10Y German b/m swap spreads regressed against 10Y German b/m yield and 3Mx10Y swaption implieds. 2Y and 5Y expiries. We believe they can narrow further in the short term and retain our narrowing bias. 3M.European Rates Strategy Global Fixed Income Markets Weekly March 16. each 10-pt increase in the S&P500 index has resulted in seasonally adjusted swapped issuance increasing by around €0. thereby putting a narrowing pressure on swap spreads… J. they rebounded over the following three days.85bn/day. the 20-day MA of swapped issuance is currently at €5. the risk-on sentiment that has prevailed over the past 3 months has resulted in increased appetite for spread products. This reversal was driven by the increase in delivered volatility with rates selling off 10+bp across the curve on increased positive sentiment after the results of the US stress tests were announced on Tuesday. 1M delivered volatility also increased between 0.5 0. We note.2 0. Swapped issuance continues to run at very high levels. One could argue that this may merely be a reflection of the fact that January and February are good months for swapped issuance since debt capital markets take a hiatus in December. Implieds on govie options also followed a similar pattern.00001x 2 . The chart suggests that seasonally adjusted swapped issuance is running close to its lifetime high as corporations and financial institutions take advantage of the reopening of debt capital markets after a long hiatus in 2H11. which is exactly twice the 5Y average of €2.P. Exhibit 13: …especially in the belly of the curve where spreads are trading a tad wide and are most susceptible to swapping activity. points 1350 1450 * See Exhibit 11 for definition of swapped issuance.5 1. Exhibit 12: …and the risk-on sentiment that has prevailed over the past 3 months. Morgan estimate of seasonally adjusted swapped issuance* regressed against S&P500 index. To smoothen the data series.0 1.5 2.0 0.2 R 2 = 87% 130 120 16-Mar-12 110 100 4 5 6 7 3Mx 10Y implied v ol. that swapped issuance is running at high levels even after adjusting for this seasonality. however. past 6M. past 6M.

implieds now appear cheap 7 We use current implied volatility and 3M delivered volatility on the underlying swap to calculate carry.European Rates Strategy Global Fixed Income Markets Weekly March 16. returns from this gamma-neutral switch have exhibited a convex relationship to that of an outright short gamma position (Exhibit 17). Instead. bp/day 40 20 0 -20 -40 -100 y = 0.35 2. a short gamma position in 3Mx10Y would have lost around 9 days of gamma carry. when 10Y swap yield increased 10+bp.45 3Mx 10Y EUR sw ap y ield.8. We had argued that implieds were likely to stay low and delivered volatility to tread below implieds. Second.7 Exhibit 15 shows the estimated number of days of carry lost to various yield moves if we initiate short gamma positions at current levels.55 14 15 increased 1bp/day.5 7. Additionally. while Bobl and Bund implieds increased 0. a 10bp jump in 10Y swap yields would cost 9 days of carry to short gamma positions. Morgan Securities Ltd.5 5.882 R 2 = 52% -50 0 50 2W return from selling 3Mx 10Y gamma. we recommend exiting short 3Mx10Y gamma positions at a small loss (see Trade Recommendations). We estimate that on Wednesday.50 2.0 4. we do not discount the possibility of further jumps in yield. compared to the level of rates (Exhibit 16).78x . Exit short 3Mx10Y gamma as jump risk is high… 3Mx10Y implied volatility regressed against 3Mx10Y swap yield.0 6. bp 1 3 5 9 7 15 12 18 21 24 16-Mar-12 2. This mainly reflects the emerging and asymmetric risk of convexity-hedging flows (mortgage related paying) in the US mortgage markets if yields continue to risk. Options are re-struck at the beginning of each month. # days Exhibit 15: Short gamma positions are susceptible to jump risk. we reduce our conviction on outright short gamma positions (see below).40 2.0 5.5 6. the 10+bp move on Wednesday highlighted the risks of selling gamma at the current low levels of implied volatility (3Mx10Y is currently priced at 5.25 y = 5. buying a gamma equivalent amount of 3Mx5Y straddles regressed against rolling 2W returns from selling 3Mx10Y straddles outright. To be sure.35 R 2 = 51% 25 20 15 10 5 0 6 7 8 9 10 11 12 13 1D mov e in 10Y sw ap y ield. 2012 Pavan WadhwaAC (44-20) 7777-3370 Fabio Bassi (44-20) 7325-8615 Khagendra Gupta (44-20) 7777-1980 J.0 2. we are wary of the jump risk. Going forward.30 2. we have recommended outright short gamma positions on 3Mx10Y. This duration-extension-led increase in rates could potentially feed through to the EUR markets and could thus be detrimental for short volatility positions. Over the past few weeks. Therefore. which assume daily delta hedging and zero transaction cost.P.4bp/day. However. However. % 2. Morgan volatility indices.002x 2 + 0. past 2Y. At current levels. we recommend low-risk short gamma proxies such as selling 3Mx10Y swaption straddles vs.0.340x . bp/day Exhibit 16: …and implieds are trading cheap relative to yield levels 7. buying a gamma-equivalent amount of 3Mx5Y swaption straddles for several reasons. past 3M.P. we continue to favour short gamma positions as delivered volatility in yields is likely to stay below implieds over a long term (say 3M). Exhibit 17: Instead. the implied volatility spread is currently trading close to its multi-year highs (Exhibit 21 . Returns from this switch have exhibited a positively convex relationship to outright short gamma positions Rolling 2W returns* from selling 3Mx10Y straddles vs. initiate short gamma position via low-risk proxy such as selling 3Mx10Y vs. Number of days of carry lost from selling 3Mx10Y gamma for various one-day jump in 10Y swap rate. buying 3Mx5Y gamma.5 4. bp of notional 100 * Returns calculated using J.0bp/day). Thus. First.

18). however.7bp/day above the 1M delivered volatility spread (Exhibit 20). bp/day Exhibit 18: Additionally. during periods of high excess liquidity. While we do not expect that level of normalisation to occur over the trade horizon. Historically. 8 Implieds on Schatz options increased 1bp/day whereas implieds on maturity matched swaptions increased only 0.European Rates Strategy Global Fixed Income Markets Weekly March 16. Finally. bp/day Exhibit 19: …and has historically been profitable when initiated at current level of implied volatility spread (0. 2012 Pavan WadhwaAC (44-20) 7777-3370 Fabio Bassi (44-20) 7325-8615 Khagendra Gupta (44-20) 7777-1980 J.0 0. On a relative basis.5bp/day. Indeed. we do not expect the implied volatility spread to increase significantly higher even if Schatz yields continue to grind higher. These tail switches have.4bp/day below the implied volatility spread). low central bank activity and low volatility. the delivered volatility spread has. Furthermore. buying 3Mx5Y. buying a gamma equivalent amount of 3Mx5Y straddles regressed against 3M prior implied volatility spread (3Mx10Y – 3Mx5Y).3bp/day 150 100 50 0 -50 -100 -0. The highlighted areas indicate prior episodes of either low volatility and/or high excess liquidity during which 10Y implied was at par or below 5Y volatility.8bp/day). 10Y volatility trades at par or below 5Y (see highlighted section in Exhibit 18). bp/day 2.05 R 2 = 54% * Delivered volatility spread is defined as 3M delivered volatility on 3Mx10Y swaps – 3M delivered volatility on 3Mx5Y swaps. we recommend selling Schatz volatility vs.6bp/day is close to the highs of the past 3 months and is about 1.0 1. as Exhibit 21 illustrates. 0. we do believe that 10Y volatility is likely to decline relative to 5Y volatility as the volatility surface normalises.72x + 9. maturity-matched swaption volatility as this switch offers positive gamma carry Schatz/Swaption implied volatility spread* versus 1M delivered volatility spread**. this switch offers positive gamma carry (the 3M delivered volatility spread is 0. buying maturity-matched swaption volatility.5 1. Thus. the implied volatility spread (defined as Schatz volatility – maturity matched swaption volatility) exhibits a convex relationship to Schatz yield (with implieds spread declining rapidly when yields decline but 22 . Note: Futures are rolled 10D before option expiry. Schatz yields are likely to continue to under-deliver their swaption counterparts as they remain in a tight range. Morgan Securities Ltd. Exhibit 20: At the front end. bp/day 2 1 0 -1 -2 -3 16-Dec 03-Jan 21-Jan 08-Feb 26-Feb 16-Mar 1M deliv ered v ol spread Imp v ol spread * Schatz implied volatility minus maturity matched swaption implied volatility.5 3M prior imp v ol spread. Implied volatility spread (3Mx10Y – 3Mx5Y) versus 3M delivered volatility spread*.5 y = 55.8 This implied volatility spread of 0. remained below the current level of implied volatility spread. past 10Y. With excess liquidity at extremely high levels and the ECB temporarily on hold. lost money if initiated at < 0. Third. a trend we expect to continue over the next few weeks. past 3Y. ** 1M delivered volatility of Schatz futures – 1M delivered volatility of maturity matched swaps. in general.8bp/day Rolling 3M returns* from selling 3Mx10Y straddles vs. this switch has generally been profitable when initiated at current levels (Exhibit 19). we like selling Schatz volatility vs. Additionally. this switch offers positive gamma carry… 2 1 0 -1 -2 -3 2002 2004 2006 2008 2010 2012 Current imp spread: 0. past 3M.P. The recent increase in Schatz implied volatility compared to maturity-matched swaption volatility provides an attractive entry point. The one exception to this was during year-end 2008 when technical flows were dominant. we recommend selling 3Mx10Y gamma vs.0 * See Exhibit 17 for definition of returns.

European Rates Strategy Global Fixed Income Markets Weekly March 16, 2012 Pavan WadhwaAC (44-20) 7777-3370 Fabio Bassi (44-20) 7325-8615 Khagendra Gupta (44-20) 7777-1980 J.P. Morgan Securities Ltd.

are capped when yields increase). Thus, we recommend selling Schatz volatility vs. buying maturity-matched swaption volatility (see Trade Recommendations).9

Trade Recommendations
• Curve: Implement reds/blues weighted EONIA curve steepener. Buy Jun12 mid-curve put spread funded by selling call spread. Initiate 5s/30s bear flatteners. Close 1s/3s bull flatteners and Jun12/Jun13 Euribor bear flatteners. Exit receiving 5Y in 1s/5s/12s level-neutral fly. Hold greens/10s weighted steepeners. Hold 2s/5s/10s bull belly richeners and 3s/7s/15s OTM bear-bellycheapeners − Receive €500mm 1Yx1Y EONIA swap (start date 20 Mar 2013) vs. paying €168.5mm 3Yx1Y EONIA swap (start date 20 Mar 2015) to enter into a weighted reds/blues EONIA curve steepeners at -11bp (defined as 0.33* 3Yx1Y EONIA - 1Yx1Y EONIA); − Buy the 99.00/98.75 Jun12 mid-curve put spread funded by selling the 99.25/99.50 Jun12 mid-curve call spread at 3 cents with Jun13 Euribor at 99.075; − Buy €100mm 3Mx5Y 1.82% payers (notification date 16 Jun 2012) vs. selling €23mm 3Mx30Y 2.82% payers (notification date 16 Jun 2012) at close to flat net premium to enter into a 5s/30s conditional bear flatteners at 100bp vs. spot level of 99.4bp and 3M forward level of 93.4bp; − Exit at a loss longs in €100mn 1.33% 3Mx3Y receivers vs. short €297.7mn 1.25% 3Mx1Y receivers to exit a conditional bull flattener at 8.0bp vs. spot level of 21.6bp and forward level of 24.5bp (Global Fixed Income Markets Weekly, 6 January 2012); P/L since inception: -34bp of notional; − Exit at a loss longs in 1000 98.875 Jun12 Euribor puts vs. shorts in 1000 98.75 Jun12 Euribor mid-curve puts to remain into a Jun12/Jun13 Euribor bear-flattener at 12.5bp vs. forward levels of 23bp (Global Fixed Income Markets Weekly, 15 December 2011); P/L since inception: -3cents; − Close at a loss receiving €75mm 3Mx5Y vs. paying €245.0mm 3Mx1Y and €22.6mm 3Mx12Y to exit a level neutral fly (defined as 75% * Yield 5Y - 50% * Yield 1Y - 50% * Yield 12Y) at -50.5bp vs. an entry level of -55.5bp (Global Fixed Income Markets Weekly, 9 March 2012); P/L since inception: -5bp of yield;
9 We like to remind our readers that we currently have an outright short volatility in Schatz in our portfolio. We have expressed this view via selling 109.90/110.50 (or 13/44bp of yield) Jun12 Schatz unhedged strangles. We recommend holding on to that trade.

Front Schatz* implied volatility – maturity matched swaption volatility regressed against 2Y German b/m yield; past 6M; bp/day

Exhibit 21: Also, we do not expect the implied volatility spread (Schatz – swaption) to continue rising even if yields increase as super-high excess liquidity will potentially keep yields rangebound

2.5 2.0 1.5 1.0 0.5 0.0 -0.5 0.10

y = -3.7x 2 + 5.1x - 0.3 R 2 = 46%

16-Mar-12

0.20

0.30

0.40

0.50

0.60

0.70

2Y German b/m y ield; %
* Futures are rolled 10D before option expiry.

− Stay short 100% risk (€50mn) in 2.345% 3Mx10Y swaps vs. long 66% risk in 27Mx1Y (€311mn) 1.495% swaps to remain in a weighted steepener at 134.5bp vs. entry level of 135.8bp (weighted spread defined as 3Mx10Y – 0.66*27Mx1Y) as a carryefficient proxy to 2s/10s curve steepener (Global Fixed Income Markets Weekly, 24 February 2012); P/L since inception: -1.3bp of yield; − Stay long €100mm 1Mx7Y 2.02% payers vs. selling €113.3mm 1Mx3Y 1.26% payers and €25.8mm 1Mx15Y 2.68% payers to remain into a conditional bear belly cheapeners at 5bp vs. spot level of 2.8bp and 1M forward level of 3.4bp (Global Fixed Income Markets Weekly, 9 March 2012); P/L since inception: -2.8 bp of notional; − Hold longs in €100mn 1.67% 3Mx5Y receivers (notification date 27 April 2012) vs. shorts in 1.135% €122.6mn 3Mx2Y receivers and 2.39% 3Mx10Y €26.4mn receivers to remain in a conditional bullbelly richener in the 2s/5s/10s 50:50 weighted fly at -9.25bp vs. forward level of -8.8bp and spot level of -10.3bp (Global Fixed Income Markets Weekly, 27 January 2012); P/L since inception: -1.0bp of notional. • Swap spreads: Hold Jun12 Schatz ASW narrowers outright and hedged with Jun12 FRA/OIS wideners − Continue to receive €100mn Schatz CTD expirymatched swaps and sell 910 110.20 Jun12 Schatz futures to remain in Jun12 Schatz swap-spread narrower at 75.1bp vs. an entry level of 76.3bp
23

European Rates Strategy Global Fixed Income Markets Weekly March 16, 2012 Pavan WadhwaAC (44-20) 7777-3370 Fabio Bassi (44-20) 7325-8615 Khagendra Gupta (44-20) 7777-1980 J.P. Morgan Securities Ltd.

(Global Fixed Income Markets Weekly, 24 February 2012). P/L since inception: +1.2bp of yield; − Continue to receive €100mn Schatz CTD expirymatched swaps, sell 911 Jun12 Schatz futures, sell 704 Jun12 Euribor futures and receive €698mn Jun12 IMM EONIA swaps to remain in Jun12 Schatz swapspread narrower hedged for FRA/OIS widener at 38.9bp vs. an entry level of 40bp (Global Fixed Income Markets Weekly, 2 March 2012); P/L since inception: +1.1bp of yield. • Volatility: Sell 3Mx10Y vs. buying 3Mx5Y EUR swaption straddles. Sell Jun12 Schatz gamma vs. maturity matched swaption gamma. Take small profit in short 3Mx10Y EUR swaption straddles. Stay short 109.90/110.50 Jun12 Schatz unhedged strangles. Stay long GBP 2Yx1Y vol vs. GBP 1Yx1Y vol − Sell €100mn 2.49% 3Mx10Y EUR swaption straddles (notification date 16 June 2012, maturity date 20 June 2022) vs. buying €157mn 1.79% 3Mx5Y EUR swaption straddles (notification date 16 June 2012, maturity date 20 June 2017) at an implied volatility spread of 0.75bp/day. This trade requires active delta hedging; − Sell 1145 110 Jun12 Schatz straddles vs. buying €100mn 1.15% maturity matched swaptions (notification date 25 May 2012, maturity date 14 Mar 2014) at an implied vol spread of 0.55bp/day. This trade is structured to be gamma neutral at inception and requires active delta hedging; − Exit at a loss short €100mn 2.34% 3Mx10Y EUR swaption straddles at 5bp/day vs. an entry level of 5.1bp/day. This trade required infrequent delta hedging (once every two weeks) (Global Fixed Income Markets Weekly, 24 February 2012); P/L since inception: -12bp of notional; − Continue to sell 1000 109.90/110.50 Jun12 Schatz unhedged strangle for 14.5cents vs. entry level of 17cents (Global Fixed Income Markets Weekly, 24 February 2012); P/L since inception: +2.5cents; − Stay long £100mn 1.40% GBP 2Yx1Y straddles (notification date 20 January 2014, maturity date 20 January 2015) vs. short £112mn 1.21% GBP 1Yx1Y straddles (notification date 20 January 2013, maturity date 21 January 2014) at an implied spread of 1.1bp/day (defined as 2Yx1Y – 0.8*1Yx1Y) vs. an entry level of 1.55bp/day (Global Fixed Income Markets Weekly, 20 January 2012); P/L since inception: -5bp of notional.

Closed Trades in 2012
Trade Duration Long 6Mx6M EONIA Long 2Y6Mx6M EONIA Long Dec12 EONIA Curve Greens/10s weighted steepeners Receive 5Y in 1s/5s/12s level-neutral fly Conditional curve and flies 1s/5s bull flatteners Mar12 Schatz/Bund bear steepener 1s/3s bull flatteners Jun12/Jun13 Euribor bear flatteners Swap Spreads Mar12 Schatz ASW wideners Mar12 Bund bull wideners Options (outright) Short Mar12 Schatz straddles Buy 3Mx5Y EUR gamma Short Mar12 Schatz straddles Sell 3Mx10Y gamma Options (relative) Sell Mar12 Schatz vs. mat matched swaption 20 Jan 12 Sell 3Mx10Y EUR vs. 3Mx5Y Buy Mar12 Bund vs. mat matched swaption Buy Jun12 Bund vs. mat matched swaption 03 Feb 12 20 Jan 12 27 Jan 12 10 Feb 12 10 Feb 12 8.0 -4.0 18.0 8.0 15 Dec 11 06 Jan 12 04 Nov 11 20 Jan 12 24 Feb 12 20 Jan 12 10 Feb 12 16 Mar 12 10.0 -58.0 7.0 -12.0 15 Dec 11 20 Jan 12 20 Feb 12 24 Feb 12 -11.0 0.0 09 Dec 11 06 Jan 12 20 Jan 12 06 Jan 12 15 Dec 11 24 Feb 12 16 Mar 12 16 Mar 12 8.5 0.0 -11.5 -3.0 03 Feb 12 10 Feb 12 09 Mar 12 16 Mar 12 0.0 -5.0 09 Dec 11 06 Jan 12 03 Feb 12 24 Feb 12 20 Jan 12 02 Mar 12 10.0 5.0 1.0 Entry Exit P&L

10 Feb 12 02 Mar 12

Trade P&L is shown in bp for all trades except option trades, which are shown in bp of notional. Conditional trades are normalised by the PVBP of the underlying * Option Expiry; ** Annualised bp

* P/L for open trades calculated using Thursday’s closes.

24

European Rates Strategy Global Fixed Income Markets Weekly March 16, 2012 Francis DiamondAC (44-20) 7325-3541 francis.diamond@jpmorgan.com J.P. Morgan Securities Ltd.

United Kingdom
• • 10Y gilt yields rose sharply over the past week, driven by technicals and US yields 10Y gilts have broken out of the range that has been in place since December and we think yields can move higher still driven, by negative technicals and a continued risk-on dynamic We go short 10Y duration but with a tight stop loss Take profit on 5s/10s steepener We expect the 10s/30s curve to become directional as 10Y yields rise further – enter 10s/30s gilt curve flattener… …and we note that entering 10s/30s bear flatteners via 3M payers looks attractive Stay long the belly of 10s/30s/50s gilt fly, as we expect ultra-long gilt issuance in the coming months Gilt RV: The belly of the 3T19/4T20/4s22 fly is rich, take profit on selling the belly of the 3T21/5s25/4T30 fly, take profit on selling 4s60 vs. 4Q55 on a cash-for-cash basis Swap RV: We recommend paying the belly of the level-adjusted 3s/7s/15 swap fly We expect £167bn of gilt issuance in FY12/13, but given the uncertainty around several components of the remit, issuance could be in the £150-190bn range The idea of 100Y gilts was mooted by the government - we think investor demand would be limited Enter tactical 5Y swap spread narrowers given 1) our bearish view, 2) attractive valuations; 3) our view of increased short nominal gilt issuance for FY 12/13

Exhibit 1: The increase in 10Y gilt yields over the past week was the largest in the past three years
Weekly change in 10Y par gilt yield; bp

40 30 20 10 0 -10 -20 -30 -40 Mar 09 Sep 09

29bp

• • •

Mar 10

Sep 10

Mar 11

Sep 11

Mar 12

• •

Exhibit 2: 10Y gilts have broken out of the trading range that has been in place since early December 2011…
Gilt 4s22 yield; %

2.8 2.6 2.4 2.2 2.0 Sep 11 Nov 11 Jan 12 Mar 12

• •

Break-out! We turn bearish, enter 10s/30s flatteners
The past week has seen a sharp up-move in government bond yields globally, with 10Y par gilt yields posting their largest weekly rise of the past three years (Exhibit 1).

In our view the move feels very technical in nature as both 10Y US Treasuries and 10Y gilts have broken out of their yield ranges that has been in place since December (Exhibit 2). We think that the drivers for the move are more US specific, as the macro backdrop in the UK has not changed over the past week yet the beta between gilts and USTs has increased sharply (Exhibit 3). The move by Fitch to put the UK on negative outlook is not based on new information but did result in some underperformance of gilts vs. bunds after the announcement. The speed of the rise in gilt yields has surprised us and we had thought that gilts would struggle to break-out of the well-established trading range until the fundamentals began to improve. Now that this range-break has
25

16 Mar 12 2Y 19 3 1 8 3 10Y 23 24 29 25 31 2s/5s 1 21 15 12 20 2s/10s 5s/10s 10s/30s 4 20 29 18 28 3 -1 14 5 7 -9 -13 -15 -12 -3 * defined as periods of more than 20bp increase in 10Y gilt yields in the period from Feb11 – Mar 12 Exhibit 5: We expect the 10s/30s gilt curve to start trading directionally if 10Y yields continue to rise 10s/30s par gilt curve regressed against 10Y par yields. However.0 1. we think 10s/30s bear flatteners are attractive.0 -0. although there have been with sporadic instances of directionality.P.45%.5 4. the 10s/30s curve has generally been non-directional with 10Y yields. Morgan Securities Ltd. bp 140 120 100 80 60 40 2. as 10Y par yields rise above the 2. we recognize that unless the market begins to price base rate tightening that the rise in 10Y gilt yields and steepening in the 2s/10s curve is limited. bp unless stated Change Period 16 Mar 11 .5 1. 2) technicals are supportive with our technical analysts targeting the 2. We go short 10Y duration but look to trade this with a tight stop loss (current 4s22 yield @ 2.0 Gilt and swap RV In the 8-10Y sector of the curve we note that the belly of the 3T19/4T20/4s22 fly is close to its richest level since last August in yield space.diamond@jpmorgan.37%) We take profit on our tactical 5s/10s steepener. A similar dynamic is also observed in swap space where the directionality of 10s/30s swaps increases substantially with 10Y swap yields above 2.17 R 2 = 82% y = -0.60%.42x + 2.01x + 1. Over the past few months as the BoE has been conducting QE purchases. which can be entered for zero cost via 3M payers at 70bp. 2012 Francis DiamondAC (44-20) 7325-3541 francis.5 0.1 Sep 11 5 Oct 11 . especially as QE purchases look unlikely to be extended in May. and 3) we expect the risk-on dynamic to continue.50% level we expect the 10s/30s curve to become much more directional (Exhibit 5). However. The curve is 2bp away from its steepest level for the past few months and this part of the curve is the segment least directional with 10Y yields. Given our bearish duration view we recommend entering 10s/30s gilt curve flattener. the same level as priced by the forwards. % 3. previous bullmarket sell-offs*.64%).5bp per month. In addition. the flattening in 10s/30s seen so far has lagged that seen on average in the previous bull-market corrections (Exhibit 4). stop loss 2. the recent sell-off in yields looks similar to previous bull-market corrections (Exhibit 4) and we are conscious that the sell-off could fade in strength without support from improving economic fundamentals.5 15 Dec 30 Dec 14 Jan 29 Jan 13 Feb 28 Feb Rolling 5 day beta between10Y UK par yields and 10Y UST benchmark yield 14 Mar Exhibit 4: The current sell-off looks similar to previous bull-market corrections Changes in the level of gilt yields and the curve in current vs.12 Apr 11 18 Aug 11 . as a way to express a bearish view on 10Y yields and given our expectation of ultra-long supply (40-50Y gilts) in the coming months. Exhibit 3: …and the beta between gilts and US Treasuries has increased sharply over this past week 2.04 R 2 = 0% 2. although is not as rich in ASW 26 .28 Oct 11 Av erage 9 Mar 12 .0 10Y par y ield.com J. 10Y and 30Y implied vols trade at the same level and the rate carry and slide is only -1.0 current y = -0.70 level in 4s22.European Rates Strategy Global Fixed Income Markets Weekly March 16.0 0. last 12M. In addition. occurred we think 10Y yields can move higher as: 1) the move appears to be predominantly futures driven and anecdotally we think cash gilt duration positions are light. target 2. We stay long the belly of the 10s/30s/50s gilt fly.70% (currently 2.5 3. Given our curve view.64 -2.

100Y gilts not likely in our view The gilt issuance remit for FY12/13 will be announced following the Chancellor’s budget speech on Wednesday. but there is a growing possibility that this scheme could be pre-funded directly via gilt issuance. space (Exhibit 6). with participating banks paying a fee to the government to access the funds.com J. at around £150-£190bn. In Exhibit 8.This fly has shown limited directionality with the curve and level of yields. gilt 4s60 has corrected from its very rich levels and we take profit on our recommendation to be long 4Q55 vs. This scheme is expected to be up to £20bn in size.P. baseline and high issuance scenario. we think this would result in an increase in the supply short maturity gilts. we reiterate our baseline forecast of £167bn of gross gilt sales in FY12/13 but we illustrate that the potential range for gilt issuance is quite large. The 3s/7s/15s fly has a 97% r-squ with the level of 7Y yields over past 12M Exhibit 8: We see both upside and downside risks to our FY12/13 gilt issuance forecast Gross gilt issuance under a low issuance. We think that this remit could contain some surprises. We recommend paying the belly of the leveladjusted 3s/7s/15 swap fly (risk weights 66%: -100%:66%). As we have discussed previously (GFIMs. and if it were to be funded via gilts. Exhibit 6: The belly of the 3T19/4T20/4s22 fly is rich 50:50 fly in yield and ASW space. Further out. gilt 5s/25s has underperformed over the past week and we take profit on our recommendation to sell the belly of the 3T21/5s25/4T30 fly. bp -70 av erage = -78bp More on the FY 12/13 issuance remit. the 3s/7s/15s fly has shown strong directionality with the level of yields over the past year and the belly of the fly currently looks rich vs. In swap space.diamond@jpmorgan. -75 -80 -85 Mar 11 Jun 11 Sep 11 Dec 11 Mar 12 * Calculated using risk weights 66%:100%:66%. Morgan Securities Ltd. 4s60 on a cash-for-cash basis.European Rates Strategy Global Fixed Income Markets Weekly March 16. 9 Mar) we think the issuance remit could be affected by uncertainty over the size of the overshoot on the financing for the current fiscal year and the treatment of the assets of the Royal Mail Pension Fund in the national accounts. as the scheme is expected to be operational for only a few years. £bn unless stated Low Baseline High scenario scenario scenario CGNCR* Redemptions Reserv e Financing Short Term financing Adj. given that there are several uncertain factors that could drive the headline gilt sales number. which is close to its richest level over the past 12 months (Exhibit 7). 7Y swap rates. bp -5 y ield 6 ASW 4 2 0 -10 -15 current lev el in y ield = -16bp -20 Mar 11 Jun 11 Sep 11 Dec 11 -2 -4 -6 Mar 12 Exhibit 7: The level-adjusted 3s/7s/15s swap fly looks rich Level-adjusted 3s/7s/15s swap fly*. We had initially expected this scheme to allow participating banks to issue debt underwritten with a government guarantee.** Roy al Mail PF adjustment*** SME guarantee^ NS&I T-bill issuance Gross Gilt sales 128 53 6 -7 -25 0 2 2 151 128 53 10 -7 -13 0 2 2 167 128 53 10 -7 0 10 2 2 190 * CGNCR = Central Government Net Cash Requirement ** Financing adjustment from expected better fiscal outturn in FY11/12 ***Impact from absorption of the Royal Mail Pension Fund into the National Accounts ^ Potential gilt issuance from SME guarantee program 27 . In the 10-13Y sector. One additional source of uncertainty is the funding for the ‘credit easing’ scheme which is expected to be launched the day before the budget. 2012 Francis DiamondAC (44-20) 7325-3541 francis.

5 years more duration than the existing 2060 bond (Exhibit 9). bp Enter tactical 5Y swap spread narrower Swap spreads have narrowed across the curve as gilt yields have risen over the last week. 9 – 16 Mar. we think investor interest for a nominal bond with these characteristics would be limited and we think the potential size and liquidity of such a bond could be low.7 22.5 25. Dur. a 3% increase in short nominal issuance (given the low level of spot and forward years and recent strong demand). We continue to expect a tap of the 2060 line or maybe a new 2062 bond in the first few months of the coming fiscal year. R-squ: 73% Exhibit 11: Gilt 4s16 has outperformed as 3-7Y gilt swap spreads have tightened over the last week Change in swap spreads. Morgan Securities Ltd. a 1% increase in linker issuance and reductions in medium and long nominal issuance by 2% and 1% respectively. y ears PVBP 07-Dec-2042 22-Jan-2060 15/03/2112* 3. 2012 Francis DiamondAC (44-20) 7325-3541 francis.e.38 17.7 28.42 3.12 * 5Y par + 0. However. Whilst this would represent attractive funding for the government. The recent announcement that the Treasury is considering issuing 100Y gilts should be followed by the launch of a consultation process by the DMO. % Mod. leaving both 5Y and 10Y swap spreads at close to their tightest levels for the past few months.43 3. Our forecast for the maturity split for gilt issuance remains the same as we presented last week i.P.. we recommend entering tactical 5Y swap spreads narrowers as: 1) we expect the upcoming gilt remit for FY12/13 to show a modest increase in short nominal issuance (see GFIMs Mar 9). which we do not think is generally expected by investors.5% 100Y gilt compared with existing 30Y and 50Y gilts Maturity Yield.5 21. Despite the tight levels. Exhibit 9: A hypothetical 100Y nominal gilt would not offer enough of a yield pick-up or duration increase to appeal to investors in our view Estimated yield*. This bond trades rich on our par curve model as it is 28 3T19 8s15 2s16 4s16 5s18 .21 * rolling 2nd FRA/OIS + 0. given the lack of intermediary bonds between 50Y and 100Y maturity.9 29. and 2) 5Y swap spreads remain too wide based on our high frequency model (Exhibit 10).4 * derived from linear interpolation of 30Y and 50Y gilt yields Exhibit 10: 5Y swap spreads remain too wide based on our high frequency model Residual from regressing 5Y par gilt maturity matched swap spread vs. last 12M. but we think the likelihood of a 100Y gilt actually being issued is low. Given the flatness of the 30s/50s nominal yield curve a 100Y gilt would likely have a yield slightly below the current 50Y gilt yield (by simply linear interpolation) and only offer around 5. The directionality of swap spreads with the level of yields has increased markedly and we think swap spreads can continue to narrow if yields rise further. bp 15 10 5 0 -5 -10 -15 Mar 11 current = 4.European Rates Strategy Global Fixed Income Markets Weekly March 16.com J. modified duration and PVBP for a hypothetical 3. 3 2 1 0 -1 -2 -3 -4 -5 -6 4H19 4T15 1T17 8T17 At a micro level we note that gilt 4s/16s has outperformed in the 3-8Y sector of the curve as swap spreads have tightened over the past week (Exhibit 11).diamond@jpmorgan.54. We also think this announcement increases the possibility of ultra-long gilt issuance in the 50-60Y area of the curve. 5Y par yields and rolling back FRA/OIS spread*. we think this announcement does highlight the government’s desire to focus on funding costs and to that extent we think increasing long linker issuance is likely (50Y real yields are around 18bp currently).2bp Jun 11 Sep 11 Dec 11 Mar 12 * 5Y swap spread = -0.

3mn of 3Y and £17. P/L since inception is 6bp (recommended on 2 Mar).0 4. Target 2bp. • Enter 10s/30s flatteners Sell £50mn of gilt 4s22 vs. • Sell the belly of the 5s18/4H19/3T20 fly (50:50) Sell £30mn notional of gilt 4. selling £29. Target 2. We recommend positioning for our narrowing view in gilt 4s16. selling £19mn notional of gilt 4Q32 and £14mn notional of gilt 4H42 @ weighted spread of 5. P/L since inception is 24p (recommended 24 Feb).5bp. buying £25mn of gilt 4s16s and £19mn of gilt 5s18 @ -4. 1T17 on ASW Long lv l. P/L since inception is 8p (recommended 20 Jan). 30Y France BE Short ILG50 v s. • Stay long belly of 10s/30s/50s gilt fly cash-andduration neutral fly Buy £40mn of gilt 4Q40 vs.com J. Adj. stop loss @ 110bp.30%.0 2.0 110p 24-Feb-12 -105p 15-Dec-11 16-Sep-11 27-Jan-12 20-Jan-12 03-Feb-12 03-Feb-12 03-Feb-12 10-Feb-12 24-Feb-12 06-Jan-12 20-Jan-12 10-Feb-12 24-Feb-12 02-Mar-12 09-Mar-12 09-Mar-12 09-Mar-12 09-Mar-12 2. • Close short belly of the 4s16/1T17/5s18 fly (50:50) − Unwind short £50mn of gilt 1T17 vs. receiving £72.0 3. stop loss @ 1.0 3.5bp. larger than the 2017 lines.5 4.0 3.3M carry and slide is -3bp.5bp. long 5s18/4s22/5s25 Sell 4s16 v s. P/L since inception is 0bp (recommended 20 Jan). 3M carry and slide is -2bp. P/L since inception is 3bp.5mn of gilt 4H42 @ 104bp. buying £17mn notional 5s18 and buying £13mn notional of gilt 3. 2012 closed trades P/L bp unless stated TRADE DURATION Short 10Yx 5Y forw ard CURVE 5s/30s gilt flattener 10s/30s gilt flattener 5s/12s sw ap curv e steepener 5s/10s gilt steepener RELATIVE VALUE Lev el. • Sell the belly of the 3s/7s/15s level-neutral swap fly (66%:100%:66% risk weights) Sell £50mn of 7Y swaps vs. And curv e adj 3s/12s/25s sw ap fly Long belly lv l.0 10. P/L since inception is 4bp (recommended 10 Feb). Target 30bp. Target 50bp.60%. ILG47 cash-for-cash 15-Dec-11 06-Jan-12 10-Feb-12 10-Feb-12 10-Feb-12 10-Feb-12 21-Feb-12 24-Feb-12 24-Feb-12 17. 04-Nov -11 24-Feb-12 stop loss @ 15bp. 2s/15s/30s sw ap fly 30Y sw ap spread w ideners Long belly 4H19/4T20/3T20 Long belly 5s18/4s22/4Q27 Short belly 3T21/5s25/4T30 fly Short 4s60 v s. Target 95bp. 2012 Francis DiamondAC (44-20) 7325-3541 francis.5% Mar19 vs.45%.and curv e-adj.0 -10. buying £23. stop loss @ 2.P. but we would not rule out a further reopening of this bond in the next fiscal year. • Keep reds/greens swap curve steepener Pay £50mn of 2Yx1Y GBP swaps vs. • Keep paying 12Mx6M GBP swaps Pay £50mn of 12Mx6M swap @ 1. Target -75bp. buying £20mn of gilt 4Q55 @ a relative price ratio of 0. (recommended 24 Feb). • Keep paying belly of 2s/5s/10s GBP swap fly via 3M payers (buy payers on 5Y vs.0 24p 15-Dec-11 20-Jan-12 27-Jan-12 24-Feb-12 06-Jan-12 10-Feb-12 10-Feb-12 16-Mar-12 16. 29 .9612. 4Q55 cash-for-cash Close short £20mn of gilt 4s60 vs. stop loss @ -85bp.0 5.0 13.3mn of gilt 3T21 @ 114bp. receiving maturity matched swaps @ 59. stop loss @ -9bp (recommended 9 Mar). selling £16mn of gilt 3T21 and selling £25mn of gilt 4s60 @ 46bp.0 7.8mn of 15Y @ -82bp. stop loss @ 50bp. Target -3. buying £21mn of gilt 3T21 and £12mn of gilt 4T30 @ -1. 3M carry and slide is -4bp. Target 45bp.European Rates Strategy Global Fixed Income Markets Weekly March 16. P/L since inception is 0bp (recommended 3 Feb). receiving £50. 3M carry and slide – 9bp.25.75% Sep20 @ -7.0 -1.0 27-Jan-12 10-Feb-12 138c ENTRY EXIT P/L Trade recommendations • Go short 10Y gilts Sell £75mn of gilt 4s22 @ 2.P/L since inception is 0bp.diamond@jpmorgan. • Take profit on short in belly of 3T21/5s25/4T30 fly (50:50) Close short £30mn of gilt 5s25 vs. selling payers on 2Y and 10Y) − Pay £100mn of 5Y swap vs. stop loss @ 7bp.05%.37. • Stay long the belly of the 4Q32/4T38/4H42 fly (50:50) Buy £30mn notional of gilt 4T38 vs.4mn of 1Yx1Y GBP swaps @ 32bp. Target 1. stop loss @ 63bp.0p. receiving £50mn of 2Y swaps and £50mn of 10Y swaps via 3M payer options.0 7. • 5Y swap spread narrowers Sell £50mn of gilt 4s16 vs.5bp. 4Q55 cash-for-cash INFLATION Receiv e 2Y RPI Long ILG16 30s/50s RY curv e flattener Short belly ILG16/ILG17/ILG22 RY fly Long 30Y UK BE v s. Morgan Securities Ltd.0bp. • Take profit on 5s/10s gilt curve steepener Close long £50mn of gilt 1T17 vs. • Take profit on short in 4s60 vs.

5mn cash of gilt 4s16 @ a breakeven spread of 278bp.diamond@jpmorgan. Target 11bp. 2012 Francis DiamondAC (44-20) 7325-3541 francis.5bp. stop loss @ -0. P/L since inception is 0bp (recommended 6 Jan). Zero cost entry level -19bp. selling £29. • Stay short the belly of the 2Q14/2T15/4T15 fly (50:50) − Sell £30mn of gilt 2T15 vs. • Stay long ILG16 BE − Buy £10mn cash of ILG16 vs.com J. stop loss @ 255bp. P/L since inception is 22bp (recommended on 24 Feb). 30 .European Rates Strategy Global Fixed Income Markets Weekly March 16. • Stay long belly of the ILG22/32/40 real yield cashand-duration neutral fly − Buy £15mn of ILG22 vs. selling£6mn of ILG22 and £9mn of ILG40 @ spread of 21bp. spot level -22bp. Target 12bp. Morgan Securities Ltd. stop loss @ 25bp. 3M forward -19bp. buying £21mn of gilt 2Q14 and £12mn of gilt 4T15 @ weighted spread of 2bp. Target 280bp level.P. P/L since inception is 0bp (recommended on 24 Feb).

6 -3.81 -15. Morgan Securities LLC.76 0.23 19.6 7.63 * 3/15/12 level for Europe and US corporate credit spreads.232 -0.200 0.7 -21.3 -60. 3/16/12 level for all others.9 -3.390 2.0 -6.262 0. pending bank downgrades and the potential for a weaker earnings season are risks.8 -244.4 -50. Morgan tradeweighted USD index.149 0.7 -12.3 5965.025 -0. These results. and MetLife).4 31. along with supportive economic data. driven by technicals.032 -0.2 2608.50 -39.44 30.191 0.6 21. Four of the nineteen bank holding companies did not pass the test (Ally.2 -5.9% -2.6% 1. favorable bank stress test results.20 118. Stay overweight risky assets We think the sell-off in Treasuries will continue.1 -130.003 1.3% in 4Q13 (versus 10.6 -83. Citi.051 0.419 0.6 10129. SunTrust. the nineteen bank holding companies in the test were projected to maintain an aggregate tier 1 common ratio of 6. 2012 Srini RamaswamyAC (1-212) 834-4573 Kimberly L.84 -0.9 229.60 -74.7 12.* change since 3/9/12.60 Oil futures ($/bbl) 107.089 1404.4 3.P.1 200.9 • • • • Markets spring forward as winter fades Markets experienced a significant risk-on rally in a week that brought positive economic data. the results confirm that large US banks are well-capitalized.0 -9.6 16.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. As we have noted recently.2 136. the Fed’s Comprehensive Capital Analysis and Review (CCAR) confirmed that large US banks in aggregate are well-capitalized and allowed several banks to raise dividends and announce stock buyback programs These positive results.6% 88.3 92. A key catalyst for this week’s rally was the relatively strong outcome of the Fed’s stress tests for banks.916 83.1 146.114 1.P.317 0.014 0.080 -0.220 0.0 -35. with most of the nineteen banks meeting minimum capital requirements even in such an adverse scenario. quarter-to-date change.3 -27. 1.55 81.001 0.005 -0.8% -0.4 153.138 0.049 0.9 -38.037 0.9 -32.1 -15. but we believe the positive news from the stress tests and a generally supportive macroeconomic backdrop will keep the risk-on momentum going. but we look for only a modest rise in yields and maintain our 2.1 -1.6 -90.027 5.0 189.6 96% 101% 0.7 -24.5 -15. and change over 4Q11 for various market variables Current Chg from 3/09 QTD chg 4Q11 chg Global Equities (level) S&P 500 E-STOXX FTSE 100 Nikkei 225 Sovereign par rates (%) 2Y US Treasury 10Y US Treasury 2Y Germany 10Y Germany 2Y JGB 10Y JGB 5Y Sovereign CDS (bp) Spain Portugal Italy Ireland Funding spreads (bp) 2Y EUR par swap . US Cross Sector • Despite including a stringent macroeconomic stress scenario.7 -24.06 -0.9 443.8 33.5 126. government bond yields rose. known as the Comprehensive Capital Analysis and Review (CCAR). 3/2/12).6 35.1% in 3Q11).8 321. Despite the stringent nature of the stress scenario.0 -17.7 215.244 -0.34 -8.2 -1.95 0.6 221.046 -0.8 18.9 -74.par gov't spd EUR FRA-OIS spd USD FRA-OIS spd 1Y EUR-USD xccy basis Currencies EUR/USD USD/CHF USD/JPY JPM Trade-weighted USD Spreads (bp) 30Y CC MBS L-OAS 10Y AAA CMBS spd to swaps JULI portfolio spd to Tsy JPM US HY index spd to worst EMBIGLOBAL spd to Tsy MAGGIE (Euro HG spd to govies) US Financials spd to Tsy Euro Financials spd to govies 10Y AAA muni/Tsy ratio (level) 30Y AAA muni/Tsy ratio (level) Commodities Gold futures ($/t oz) 1659.3 78.23 -0.3 49.4 25.361 0.406 -0.3 -9.126 0. and the J. US Fixed Income Markets Weekly.8 393. coupled with the Fed’s 31 .6 291.293 2. but the small tweaks to the statement suggested both that QE3 is less likely at upcoming meetings and that the Fed is likely to err on the side of being slow to embrace improving data Rising energy prices. the results were surprisingly positive.0 -107.34 8. fueled a substantial sell-off in government bonds and a rally in risky assets This week’s FOMC meeting contained no surprises.50% target for 10-year yields by mid-year Exhibit 1: Back to rally mode Current level. and an unsurprising FOMC statement.par gov't spd 2Y USD par swap . while Fifth Third received limited approval to carry out its capital plans. and credit spreads narrowed sharply (Exhibit 1). Equities outperformed.017 -0.137 0.1 -11.8% 0. Harano (1-212) 834-4956 J.3 -104.3 22.0 -47.3 1674.6 1.8 616. Despite projected losses of $534bn over nine quarters under the hypothetical stress scenario. On the whole. the stress test involved considerably onerous economic and market scenarios (see Special Topic.0 -101.3 394 1376 353 618 -2 80 -16 0 12 197 -134 -135 -1 -36 13 12 0. see also Cross Sector Overview.0 -0.5% -20.

Both the Empire State and Philadelphia Fed surveys increased in the latest month.1%. 2012 Srini RamaswamyAC (1-212) 834-4573 Kimberly L.01 0. Moreover.13 0. All in all.” On inflation. Initial claims have now flattened out around a level that is favorable for the recovery (see “US: Initial claims get back down to the cycle low.1% in February.05 0. economic data were generally supportive of the risky asset rally. and continue to pose a risk to economic growth. marginally above the cycle low of 355K (Exhibit 3).3 to 74.5-2. noting that that the unemployment rate has declined “notably” recently. Exhibit 3: Both initial and continuing claims are at or near lows for the recovery Four-week average of initial claims (sa) versus four-week average of continuing claims (sa). our strategy in US markets remains the same.01 0.3% in February and the growth in January was revised up from 0. . First. In addition. continuing claims fell to a new low for the cycle.” Daniel Silver. and commenting that “strains in global financial markets have eased.P.P. 3/15/12).35 0. and a few modest changes in the statement language suggested diminished prospects of QE3 at upcoming meetings.0% annualized growth rate in 1Q12 (see “Turn-of-the-year spending pothole now looks shallower. but more importantly. sentiment indicators were less upbeat. there were enough changes in the statement to show that the Committee is watching and reacting to the data. approval for dividend increases and stock buybacks for several banks subject to the tests (Exhibit 2). manufacturing IP increased 0. while the four-week average of claims was unchanged at 356K. Harano (1-212) 834-4956 J. the Fed noted that the recent rise in energy prices “will push up inflation temporarily” but stated that it expects inflation to subsequently run “at or below” mandateconsistent levels.3 in the preliminary March reading. set a very positive tone early in the week. 3/13/12). potentially dampening risk sentiment. We continue to see a positive backdrop for risky 32 Exhibit 2: The Fed’s approval for dividend increases and stock buybacks for several banks helped set a positive tone in markets Capital actions announced for select banks in the 2012 CCAR 4Q11 Dividend ($/share) BAC BBT C FITB JPM PNC RF STI USB WFC BK STT 0. not disclosed 0 0 3101 Up YoY. One key risk remains elevated energy prices. January and December sales were revised up and now suggest that real consumer spending is tracking a decent 1.24 Buyback Approved Growth ($mn) Buyback ($mn) 0% 25% 0% 0% 20% NA 0% 0% 56% 83% 0% 33% 0 0 0 0 8. Second.30 TBA 0. supply remains a headwind in several sectors.12 0. signaling some improvement in general business conditions. In addition.01 0.13 0.” Michael Feroli.08 0. 000s 000s 700 650 600 550 500 450 400 Continuing claims 7000 6000 5000 4000 3000 Initial claims 350 2000 Mar 08 Oct 08 Apr 09 Nov 09 May 10 Dec 10 Jul 11 Jan 12 assets overall. One factor that was not necessarily supportive—but not a surprise either—was the FOMC statement. but the changes were minor enough to leave the impression that the Fed would prefer to err on the side of being too slow rather than too quick in embracing improving data (see “A quiet Fed day. The Fed did not take any balance sheet actions. inflation data remained tame. the University of Michigan confidence measure ticked down from 75. 3/13/12).20 0.22 0.000 Modest.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16.16 0. Brent oil prices have averaged $124/bbl over the past month. On the other hand. In addition. initial jobless claims fell to 351K. company data.18 Qtrly Dividend 2011 2012 Fed Approved ($/share) 0. likely due to rising energy prices. with core CPI rising 0. Morgan estimates.416 879 NA 0 0 0 Limited to event 15.1%.13 0.01 0. Third. 14% above their average levels in 4Q11. Morgan Securities LLC. at least for monetary policy.08 0.20 0.” Michael Feroli. To be sure.01 0. but not disclosed 1160 1800 Note: See Special Topic for more details.25 0. Looking ahead. Source: J. Finally. February retail sales rose 1.01 0.7% to 1. TBA = To Be Announced.862 0 0 0 336 2. risks remain. Bloomberg. and bank ratings downgrades are still expected to occur in coming weeks. but the details were mixed to slightly weaker. The Fed seemed marginally less concerned about the growth outlook.05 0.

particularly single-As (see CMBS). we recognize the risks around Moody’s pending downgrade of US banks and the potential for a weaker earnings season.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. which would likely lead to negative returns and potentially trigger outflows from spread products. However. with the market easily absorbing nearly $9bn of new issues this week.50% could easily be absorbed by spreads. the factors that have kept us bullish are largely unchanged. in high yield we believe that a rise in 10-year yields to 2. 2012 Srini RamaswamyAC (1-212) 834-4573 Kimberly L.S. With spreads now through our mid-year target. growth forecasts need to be revised significantly higher. we think further tightening potential may be limited. for two reasons. We also remain overweight emerging market sovereigns and corporates. it helps support lower medium-term default expectations (see High Yield). and given the focus on refinancing bond and loan facilities. although we remain bearish on duration. Thus. The pace of EM corporate and sovereign issuance has slowed relative to the beginning of the year while inflows remain robust. we look for only a modest rise in yields—we continue to target 2. . Second. U. Harano (1-212) 834-4956 J. and tail risks have declined (see Emerging Markets). strong bank stress test results and lower bond supply are all positive for spreads. One additional risk for spread products is a sustained sharp sell-off in Treasuries. we note that legacy CMBS has been lagging the broader market. so we remain overweight high grade (see Corporates). we think the positive news from the bank stress tests—on top of diminished near-term risks around Europe—will keep the momentum going in risky assets. either sovereign stress in Europe needs to fall further. In ABS. Similarly. we remain positive on high yield. in CMBS. However. In high grade. in sectors such as high grade. In contrast. for now. we recommend timeshare ABS given the attractive pick-up and seller-servicer support (see ABS). we think the rise in yields.50% for 10-year yields at mid-year. with A4s now largely de-correlated from equities. we view the backup in rates as a net positive. Heavy supply—already a quarterly record—is positive for two reasons: it reflects strong demand. In order for 10-year yields to retrace to 3%. and we remain broadly overweight. For investors searching for yield. we continue to highlight strong demand. we do not think this is a major concern currently. the rally in equities. Our top pick in the space remains new issue subordinates. or market expectations on the timing of Fed tightening needs to move forward (see Treasuries). 33 . Morgan Securities LLC. Although markets are close to our targets for sovereign and corporate spreads. First. since we believe that investors who have been waiting for higher yields to invest will outweigh those who may look to reduce their exposure to the asset class due to the recent negative return.P. Similarly.

Jun 14s are rich and their large foreign ownership makes them vulnerable to increased foreign selling Stay bullish on TIPS breakevens. 10-year yields increasing 26 bp.P.5% Dec-13s and 2. With the sell-off. 10-year notes are now yielding 2. and effectively wiping out 9 months of carry for investors long this sector of the curve. The outsized move reflects both bad positions (as 3.and 5-year notes were popular places to earn carry) as well as the heightened vulnerability of the 2015-2017 sector of the curve to changes in Fed expectations if the labor market continues to strengthen. look for front-end Treasury rates to retrace this week’s move targeting 2-year yields to move back below 30 bp next month Bill issuance is poised to turn negative in April.4 2. technicals are now supportive of additional follow-through.5% by mid-year.4 2.0 2. While the sell-off was led by 10-year notes. the move in the 3.5 3.9 3. dates include 7/15/03. Harano (1-212) 834-4956 J.8 * Data includes all instances since 2002 where 10-year yields first moved above their 200day moving average after trading below it for at least 3 months. Because markets that are rangebound for a prolonged period usually produce significant exposure in yield curve carry trades.and 5-year sector of the curve was even larger when looked at on a volatility-adjusted basis.5-year sector of the curve Change in Treasury yields since March 6 divided by 6-month standard deviation of 8-day yield changes 3. 4. buy 2-year Treasury notes versus OIS Sell 2.6 2.1 2.0 1. the sell-off this week was most severe in the 3.5 2.3 2.6 2.0 2y 3y 5y 7y 10y 30y • • • • Exhibit 2: Breaking the range: 10-year yields have usually trended higher for several weeks after moving above their 200 day moving average 10-year Treasury yields in the business days around instances where 10-year yields first moved above their 200-day moving average*.8 2.125% Dec-15s. and a rally in risky assets.6 3. 2012 Terry BeltonAC (1-212) 834-4650 Meera Chandan (1-212) 834-4924 Kimberly L. Threeyear Treasuries have sold off 18 bp since March 6.2 2. and 30-year yields increasing 22 bp.8 3.2 3. sell-offs that push yields outside a long-held trading range tend to create momentum. This is evident in Exhibit 2 which highlights the average 34 . we remain biased for higher intermediate rates still targeting 10-year yields to reach 2.4 -40 -30 -20 -10 0 10 20 30 Business days around first move above 200d average 40 Average 14-Mar-2012(Y1) 2. 1/25/07.9 1.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. which followed a sustained period of improved funding conditions in Europe. we remain biased for higher intermediate rates still targeting 10year yields to reach 2. The move. 12/7/10 and 3/14/12 Despite the magnitude of the sell-off.2 4.1 4. representing a 3 standard deviation move (Exhibit 1). US Treasuries • Momentum is likely to cause yields to trend higher for several weeks. but unwind tactical 10s/30s TIPS breakeven curve steepeners Exhibit 1: On a vol-adjusted basis.2 2. with yields overshooting value as investors unwind these trades. % Market views Treasury yields gapped higher this week with 2-year yields increasing 4 bp. 5/29/08. their highest since October and 43 bp above their levels at the start of the year. While fundamentals were the main catalyst for yields to break out of their narrow trading range. stronger US labor market data.625% Jun-14s versus a combination of 1. the sell-off in the front end appears overdone.0 3. 11/29/04.5% by mid-year However.7 3. Morgan Securities LLC. 5-year yields increasing 22 bp. accelerated this week as rates finally broke out of the very narrow trading range they have held since November.30%. 5/7/09.

2 Prelim.6 8. yields continue to trend higher for several weeks by an average of an additional 10-20 bp.4 1. 3/14/12).6 0. but will be released monthly going forward).4 OIS rate Unemployment rate 8.S. the preliminary data showed that China purchased $53bn coupon Treasuries. our model that links forward OIS rates to the unemployment rate suggests fair value for December 2014 OIS is still 20 bp above current levels (Exhibit 3). moreover. the preliminary monthly data have a “transactions bias” which results in distortions when trying to attribute purchases to certain countries. Exhibit A: A model for estimating final purchases of coupon Treasuries by China Variable Coeff.7 8.40% (Global FI Technical Strategist. These country-level inaccuracies are corrected to a large extent by the final survey-based holdings data.3 1. Finally. we continue to view forward OIS rates as too low given the uncertainty around the Fed’s unemployment rate forecast. given the “transactions bias” discussed above.9 28. Further improvements in the labor market. Harano (1-212) 834-4956 J. Fixed Income Markets Weekly. 2/24/12). This is broadly consistent with the near-term targets of our technical analysts.4 Estimated final purchases by China in January R2=92%. To be sure. should push these forward rates higher still.9 35 .US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. For example. including preliminary data on transactions in long-term securities (released monthly) and final survey-based holdings of long-term US securities (formerly released annually. Exhibit 3: Even with this week’s sell-off. TIC data released this week suggests better buying during January Tstat January -1. the sale of Treasuries would be recorded vis-àvis Switzerland. based on the latest preliminary data.5 8. Beyond technical pressures. December 2014 OIS appear too low given the asymmetric risk from downside unemployment surprises December 2014 OIS rate versus unemployment rate. The preliminary data for January was released this week by Treasury. Treasury 1. Morgan Securities LLC. Because China likely uses a UK intermediary for some of its Treasury purchases. a deteriorating outlook for foreign sponsorship of Treasuries supports higher rates over the medium term. net purchases by UK 0. in such instances. Indeed. net purchases by China 2.5 Nov 11 OIS fair value 8.5bn coupon Treasuries during the month. For example. Exhibit A highlights this by fitting a model of final purchases released in the annual data to the preliminary monthly data. forward OIS valuations appear rich and provide some fundamental support for the sell-off to continue given the current level of the unemployment rate. 2012 Terry BeltonAC (1-212) 834-4650 Meera Chandan (1-212) 834-4924 Kimberly L. it suffers from certain biases that could result in inaccuracies.2 1.3 8.9 8.7 0. While this data provides substantial insight into foreign buying of US securities.P. China’s actual purchases of coupon Treasuries in January were likely closer to $29bn.7 5. and shows that China purchased $7. Treasuries using a financial intermediary in Switzerland. Morgan.8 8. while the final data showed that China purchased $194bn coupon Treasuries over the same period. The model suggests that. These data suggest that.0 0. % The transactions bias in monthly TIC data Treasury collects data on cross-border flows between US and foreign residents under the TIC (Treasury International Capital) reporting system.7 7. Model fitted since 2002 Source: J. we note that this is most likely an underestimation of its actual purchases during the month. This system provides insight into international buying of US securities and has various data releases.1 1. we find that simply totaling the monthly preliminary net purchases made by China each year has grossly underestimated the change in its final holdings of coupon Treasuries over the same period. The foreign exchange reserves of the largest foreign holders of Treasuries have been largely unchanged over the last six months with no net buying of Treasuries since September (Exhibit 4).2 Jan 12 Mar 12 behavior of 10-year yields after they have moved above their 200-day moving average (which occurred on Wednesday this week). who expect momentum to push 10-year yields towards 2.S. This results in an overestimate in the net purchases made by countries that are large international financial centers (such as UK) and an underestimate of net purchases by foreign buyers who transact in US Treasuries outside the US. However. moreover. we find that their actual net purchases can be better captured from the preliminary TIC data by adding some portion of the buying attributed to the UK.3 Prelim. we estimate the fair value of December 2014 OIS will increase roughly 50 bp for a 0.P. As discussed last month. even after this week’s sharp sell-off. not Italy.8 0. Thus.6 32.5 2. Intercept -36. For the year ending June 2011. if an Italian resident purchases U.9 0.5% point decline in the expected unemployment rate for 4Q13 (see U.

China should buy more non-financial assets with its reserves to diversify risks and should seek to globalize the yuan. however. Japan. Harano (1-212) 834-4956 J... growth forecasts need to be revised 36 Exhibit 4: FX reserves of the largest holders of Treasuries have been unchanged since September Treasuries held in custody at the Fed excluding repo versus foreign exchange reserves of the largest Treasury holders*. Our short-term fair value model of 10-year yields suggests yields have now reached fair value (Exhibit 6). Member. and will wait for further . we continue to look for weak demand for Treasuries from China and view the selling in 4Q11 as a structural shift rather than a temporary flow.5% (Exhibit 7). and because flight-toquality risks from Europe remain somewhat elevated with semi-peripheral spreads still twice their levels compared to one-year ago. China will continue to strengthen its foreign exchange reserves diversification. $bn 6000 5900 5800 5700 5600 5500 5400 5300 5200 Mar 11 Sep 11 Mar 12 FX reserves Treasury custody holdings at the Fed 2680 2660 2640 2620 2600 2580 2560 2540 * Includes FX reserves of South Korea. with the aim of seeking stable and sound financial returns. Member. while keeping risk control a top priority. we would highlight that the near-term magnitude of any selloff from current levels should be relatively modest absent a change in Fed expectations. and reduce investment in U. 2012 Terry BeltonAC (1-212) 834-4650 Meera Chandan (1-212) 834-4924 Kimberly L. Russia and Taiwan. U. now $3. dollar Treasuries..2 trillion "The incremental parts of our of our foreign reserve holdings should be invested in physical assets. we will continue our investment in Europe. Treasury bonds "Infrastructure is under-invested in European countries and the US Infrastructure represents a suitable choice for sovereign wealth funds to invest directly or through fund managers. While these factors are supportive of higher rates. PBOC Lou Jiwei. dollar. former vice chairman of the Standing Committee of the 9th and 10th National People's Congress Li Daokui. The nation should also optimize the structure of its foreign exchange reserves by diversifying away from U. however. " China should use some of its foreign exchange reserves to purchase energy and metal minerals that are of “strategic importance”.Once the US Treasury market stabilizes we can liquidate more of our holdings of Treasuries" China is purchasing European bonds in a bid to diversify its foreign exchange reserves and reduce global dependence on the U. PBOC adviser and monetary policy committee member Cheng Siwei. liquidity and potential revenues are three major factors affecting the government's thinking. Concerns over safety.S. Brazil. or about $1. Monetary Policy Committee. Morgan Securities LLC. Official press agency Aug-11 Xia Bin. Under such principles. and maybe we should invest in these types of companies in a proactive way.S." Called on China to increase its gold reserves as a long-term strategy to diversify its foreign exchange reserves and promote yuan's internationalization Foreign-exchange reserves. Intel. we maintain our mid-year target on 10-year yields at 2. PBOC adviser in a publication Xu Nuojin. This will lessen the world's dependence on the U. China. or market expectations on the timing of Fed tightening needs to move forward.2 trillion. Sep-11 Sep-11 Xinhua News Agency. Comments from senior PBOC officials support this and suggest that China’s reserve managers have begun acting on their numerous statements on the need to diversify out of US Treasuries into physical assets and other currencies (Exhibit 5).S. "China should urgently assess risks from being the main foreign investor in U. debt and diversify its foreign-currency reserves more quickly. significantly higher.5 bn and could have been as large as $30 bn (see grey box).S. should instead total 20 percent of GDP. Looking ahead. Vice governor of the PBOC's Guangzhou branch Jun-11 Source: China Daily. For now.We would like to buy stakes in Boeing. Monetary Policy Committee. either sovereign stress in Europe needs to fall further. and Apple. Exhibit 5: Recent comments from Chinese officials on FX reserve diversification Date Mar-12 Mar-12 Mar-12 Feb-12 Jan-12 Nov-12 Name/ description PBOC official statement Yi Gang.P. dollar as the sole global reserve currency and begin a shift toward a more multipolar reserve system. PBOC Comment It will make continued efforts in 2012 to manage the country's reserve assets with "new ideas" and in a more "effective" manner. Chairman of CIC Xia Bin. increase investment in euro-denominated assets. Bloomberg including net purchases from China that were reported at $7. Valuations remain low compared to early last year both because consensus growth forecasts have fallen.S. compared to the $118 bn of selling in 4Q11. In order for 10-year yields to retrace to 3%. This buying is small. China will continue to diversify its investments in foreign bonds.. vice-governor of the PBOC and head of the State Administration of Foreign Exchange Li Daokui.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16.S.

2 3.4 2. Morgan positions index – 0.40 0. we look for front-end Treasury rates to retrace this week’s move targeting 2-year yields to move back below 30 bp next month.09 0.4 3.45 0. 2y Tsy/ OIS spread. Nov 11 Jan 12 Mar 12 Exhibit 9: Look for 2-year Treasuries to richen versus 2-year OIS given our outlook for negative bill supply 2-year Treasury spread to OIS (bp) versus monthly net issuance of T-bills* ($bn) bp $bn 18 16 14 12 10 8 6 4 2 0 Nov 10 May 11 Nov 11 May 12 * Grey box is used to highlight J.10 0. While we remain biased for higher intermediate rates. The 2-year Treasury/OIS spread is near the upper end of its trading range and has been well correlated with bill supply (Exhibit 9). Harano (1-212) 834-4956 J. with 2year notes reaching June 2011 levels earlier this week.60 0. we recommend buying 2-year Treasury notes versus OIS (see Trade recommendations).357 * 5yx5y inflation swap rate (%) + 0.02 0.30 1. a seasonal increase in bill supply causing GC repo rates to spike.6 Jun 11 Sep 11 Actual Fair value Dec 11 Mar 12 Exhibit 8: The recent increase in front-end rates has been partly driven by outflows from government money market funds *10-year Treasury yield fair value modeled as 1.P.25 2.02 0.10 0. Morgan Securities LLC.45 0.6 2.178 * 1-year ahead J.10 0. Morgan rate forecast % Actual Rates Effective funds rate 3-mo LIBOR 3-month T-bill (bey) 2-yr Treasury 5-yr Treasury 10-yr Treasury 30-yr Treasury 1m ahead 2Q12 3Q12 4Q12 16 Mar 12 16 Apr 12 30 Jun 12 30 Sep 12 31 Dec 12 0.35 3. the sell-off in the front end appears overdone to us.60 3.288 * J.P.0 2.454 * 3mx3m OIS rate (%) + 0.50 0.36 1. $bn 100 80 60 40 20 0 -20 -40 -60 37 . Exhibit 6: 10-year Treasury yields are back to fair value Actual versus fair value* of 10-year Treasury yields.29 1. Morgan GDP growth forecast (%) – 0. Quarter end cyclicals are also modestly supportive as GC repo has tended to narrow into quarter end.P.13 0. as government money fund flows have stabilized and bill supply is poised to turn sharply negative as Treasury tax receipts increase in April. Going forward.50 3.P. Morgan projections. $bn 960 940 920 900 880 860 840 820 800 Sep 11 Source: iMoneyNet Government funds Prime funds 1510 1500 1490 1480 1470 1460 1450 1440 1430 1420 improvement in the labor market before revising that target higher.003704 * semi-peripheral Europe 5-year CDS spreads (bp) Assets under management under government and prime money market funds.P.6 3.8 1.41 0.47 0.50 3.30 1.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16.50 0.30 1. and technically driven de-risking this week as rates broke out of their trading range and investors unwound carry trades.25 2.50 3.15 2. bp Tbills net issuance.04 0.10 0.8 2.02 0. % Exhibit 7: J. A key driver of this move is front-end supply. 2012 Terry BeltonAC (1-212) 834-4650 Meera Chandan (1-212) 834-4924 Kimberly L.0 1.30 3. To position for declining front-end supply.11 2.60 0. Front-end Treasury rates have weathered a one-two-three punch in recent weeks with outflows from government money funds weakening demand for front-end Treasuries (Exhibit 8).25 2.2 2.97 + 0.

Treasury 5% 2.625 2. A notable exception is 2.4 1. outlays and budget deficit thus far in FY 2012 relative to FY 2011. the budget deficit has totaled $581bn.8 1.375 2.3 2.6 9. Looking ahead.9 0.0 1. Thus far in FY2012.7 0. Source: J.7 0.6 1. or 9.625 2.625% Jun-14 is rich on the curve and is likely to cheapen if foreign investors continue to reduce their Treasury holdings. US Budget Outlook Treasury released details of its February budget this week.4 4. The exhibit shows that three out of the four off-the-run 5-year notes with high foreign ownership on this list have cheapened recently. Thus. if foreign selling persists. which have not cheapened despite foreign ownership of $21bn.6 0.0 0.125 2. 2012 Terry BeltonAC (1-212) 834-4650 Meera Chandan (1-212) 834-4924 Kimberly L. Rem. Exhibit 10 shows a list of the 15 issues with the largest foreign purchases at auctions.1 1.7bn during the month.3 8.2 2.625% Jun-14s.4 3.7 2. $bn Cpn Mat 3m zscore 80 60 40 20 0 1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16 1Q17 3Q17 1Q18 3Q18 1Q19 3Q19 3.4 2.0 1. we recommend underweighting 2. helped by both higher revenues and lower outlays (Exhibit 12).2 -3.8 2.3bn and $4.8% On the yield curve.625% Jun-14s versus a 86:22 risk weighted barbell of 1.0 1.5 -1.4% Deficit Finally.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16.3 0.7 7.6 1. The 2.375 2.3 3m chg in yld error (bp) 0.75 3.7 Exhibit 11: Foreign ownership of issues maturing in late 2014 and 2016 is particularly high Foreign purchases at auction grouped by maturity date.125% Dec-15s on a curve and level neutral basis. Treasury does release data on the percentage of issue size foreign investors take down in each auction. foreign ownership of issues maturing in that part of the curve is especially large.3 1. highlighting that the budget deficit was $231.0 2.625 2.125% Dec-15s was only $4. and recommend selling this issue versus other issues that are not held in size by foreign investors.4 0.7 -0.2 4.125 3.9 0.P.6 -0.2 1. Morgan.3 1.4% -5% -10% Receipts Source: Treasury Outlays -9. Exhibit 10: Off-the-run 5s and 7s with high foreign ownership have cheapened Top 15 Treasury issues with the highest foreign purchase at auction Orig.and level-neutral basis.4 0.2 0.5% Dec13s and 2.4 1.8bn at auctions.5 and greater. Harano (1-212) 834-4956 J.4 2. As shown in Exhibit 11. term Term (yrs) (yrs) 10 3 5 10 5 10 3 3 5 10 7 10 7 10 5 8.625% Jun-14s versus a combination of 1.625 1. the CBO also released updated .9 0.3 9.1 -0.6 0. we recommend selling 2.8 -2. we think it is likely that foreign selling could extend to the 2.P.3 0. Morgan Securities LLC.125 2. and currently have yield error z-scores of 1.5 Amt.7 1.7 -0.125% Dec-15s (see Trade Recommendations).125 2.1 -0. While CUSIP-level data on foreign ownership of notes and bonds is not available.625% Jun-14s.625 1. bought by foreigners at auction ($bn) 26 21 21 21 21 20 17 17 17 16 16 16 15 15 15 Yld error (bp) -1.5% Dec-13s and 2.7 0. In addition.5% Dec13s and 2.7 8.2 -0. Foreign buying of 1.375 2/15/21 12/15/12 11/30/14 8/15/20 6/30/14 11/15/20 11/15/12 3/15/13 10/31/14 8/15/21 6/30/16 5/15/21 11/30/16 8/15/19 8/31/14 0.5 are bolded.5 -0. % Issues with 3-month yield error z-score of greater than 1.4% below the same period in FY 2011.375 1. and currently appear modestly cheap versus the Jun-14s on a curve.8 -0. 38 0% -2. we note that issues maturing in late-2014 and 2016 could stay vulnerable in the near term.3 -0.4 1.8 Maturity Source: Treasury Exhibit 12: The FY 2012 budget deficit is running nearly 10% below the same period in FY 2011 Percentage change in receipts.25 3.4 -0. respectively.

5 5. the report still implies that carry will be attractive in April. a record low. The key events for the TIPS market were the Fed purchase operation on Wednesday and Friday’s CPI report. Thus. In addition. However. We think the low amount of TIPS offered to the Fed reflects strong investor demand for TIPS. One potential reason why the Fed bought an unusually small amount of TIPS is because investors offered them an unusually small amount—only $2. Looking ahead.2 3.45 4.5 4.5bp they have widened so far.0 Mar 10 5-10 year ahead Oct 10 Apr 11 Nov 11 1 year ahead 3. budget projections for FY 2012-2022 incorporating recent changes in to the legislation. this curve no longer looks mispriced relative to the nominal 10s/30s curve and oil prices. with the Fed buying $1bn in the 28-30-year sector.0 2. we continue to look for wider breakevens.5 4. Exhibit 13: Consumers’ inflation expectations have increased recently Consumers’ 1-year ahead and 5-10year head median price expectations as reported in the University of Michigan sentiment survey.and 30-year breakevens widened by 4bp. over the very near term. today’s University of Michigan consumer sentiment report showed that consumers’ inflation expectations have been rising in recent months. below expectations of a 0.0 5. 10-.0 3. % % 5.57% gain. respectively. Indeed. 8/11-2/12. If the risk-on rally continues as we expect. The CPI report for February was slightly disappointing.90 R² = 0. as Exhibit 14 shows.0 4. purchases were concentrated at the long end. 2012 Terry BeltonAC (1-212) 834-4650 Meera Chandan (1-212) 834-4924 Kimberly L. Second. versus the 3. over the past eight months (post-QE2). All in all. $bn after the operation. the weaker-than-expected CPI report. we remain bullish on TIPS breakevens. 39 . Morgan Securities LLC. Separately.8 2.6 TIPS The risk-on rally and sharp sell-off in nominal Treasuries helped push breakevens wider this week.5 2.0 y = -8. Once again.4bp and 2. Third. and the Fed purchase operation caused the breakeven curve to steepen this week: 5-. with longs in 5-year and 10-year breakevens carrying positively by 6.27x + 35. breakevens will likely continue to grind wider. On the curve.1 3.0 3. In the purchase operation. showing that headline CPI rose 0. we recommend unwinding our tactical 10s/30s breakeven curve steepener now that the nearterm steepening effects from the Fed purchase operation and nominal 30-year bond auction are likely behind us (see Trade recommendations).US Fixed Income Strategy Global Fixed Income Markets Weekly March 16.5 Amount of TIPS offeredin Fed purchase operation. bp 15 10 5 0 -5 -10 -15 3. the modest decline in oil prices.P. including $0.2bp. Harano (1-212) 834-4956 J. 16bp.2tn. 12bp.9 2. Their FY 2012 budget forecast (released January) was revised up by $93bn to $1. To the extent that consumer expectations reflect broader inflation expectations.0 2.7 2. or 7. breakevens have tended to widen after Fed purchase operations with small offered amounts. 20.1bn TIPS. respectively. the Fed purchased only $1. and 17bp. This relationship suggests that 10-year breakevens could widen about 12bp Exhibit 14: Breakevens have tended to widen after Fed purchase operations where the amount offered to the Fed was low 1-week change in Jan-21 TIPS breakevens after a Fed purchase operation regressed against the amount of TIPS offered in the operation.9bn.44% in February.6bn Feb-42s.2tn.5% lower than that in the prior year. we also recommend unwinding our Jan-14/Apr-14 TIPS yield curve steepener now that this curve looks close to fairly priced relative to the broader curve. The recent data from both sources is broadly consistent with our own FY 2012 budget deficit forecast of $1. this increase is likely supportive of wider breakevens. especially their near-term expectations (Exhibit 13). the smallest purchase since Operation Twist began. we think the results of the Fed’s purchase operation argue for wider breakevens.5 3.

or 2.625% June-14s have relatively high foreign ownership. Compared to history. Furthermore. − Buy 86% risk.8 -4.5mn notional of T 2. Exhibit 15: Ten-year real yields are slightly higher than they were in January.3mn notional of T 2.352%.2 226.0 4.0 235.88 2. or $16.0 -3.2 158.8mn notional of T 2.117%).79 Primary 56% 55% 44% 51% 40% 59% 68% 56% 45% 34% 42% 50% 50% Direct 3% 8% 4% 3% 2% 3% 7% 3% 14% 36% 12% 13% 9% Indirect 41% 37% 52% 47% 58% 38% 25% 41% 42% 30% 46% 36% 41% Tail (bp) -0. however. • Unwind underweight in Apr-14 TIPS versus Jan-14 TIPS After the recent steepening.4mn notional of T 2% Nov-21s (yield: 2. or $9. One-month weighted carry is 0.26%). Quarter-end cyclicals are also modestly supportive as GC repo has tended to narrow into quarter end.5% Dec13s (yield: 0.2bp.80 2. or $100mn notional matched maturity OIS at a spread of 11bp. or $136.75% Feb-42s (yield: 0.931 0. or $25mn notional of TII 0.4 188. (US Fixed Income Markets Weekly. this curve no longer looks mispriced relative to the nominal curve and oil prices. We stop out of this trade at a loss.37 2.125% Feb-16s (yield: 0.452 0. Morgan Securities LLC. − Buy 100% risk.7bp of yield. Unwind long 50% risk. If this pattern holds. or $122. One-month weighted carry is 0. This trade is weighted to level and curve neutral.3bp and roll is 0. bpv: $234/mn).65 3.4 -3.729 -0. they also appear modestly cheap relative to Jun-14s.4 217. current cycle statistics as of 3/16/12 Size Auction date 01/11/10 04/05/10 (re) 07/08/10 09/02/10 (re) 11/04/10 (re) 01/20/11 03/24/11 (re) 05/19/11 (re) 07/21/11 09/22/11 (re) 11/17/11 (re) 01/19/12 Average 03/22/12 (re) 13 ($bn) 10 8 12 10 10 13 11 11 13 11 11 15 BE before Yield before 244.8 241.25% Nov-13s (bpv: $169/mn) versus 100% risk.97 2.7mn notional of TII 0. Harano (1-212) 834-4956 J.3 auction (bp) auction (% ) cover dealer % bidder % bidder % Trade recommendations • Sell 2.242 0.91 2.205 0.847%).0 -0. or $14. Unwind underweight on 100% risk.125% Feb-42s (yield: 3.352 1. while breakevens are considerably wider than their January levels Auction statistics for 10-year TIPS.2 232. this curve now looks close to fairly priced relative to the broader curve. Not only do Dec-13s and Dec-15s have relatively low foreign ownership.66 2.62 2.298%).7mn notional of T 3. 1/27/12). that over the past two years the first reopening of the year for 10-year TIPS has attracted the highest bid-to-cover ratio and the most negative tail of the year.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16.788%. Buy 22% risk.5 173.868%).037 -0.0 -4.5 1. while breakevens are substantially higher than their January levels (Exhibit 15).5bp and roll is 0.770 0. or $25mn notional of T 4.8 196. Sell 100% risk.625% Jun-14s versus 1. or $101.681 1. Unwind short 50% risk. Looking ahead to next week.8 238. (US Fixed Income Markets Weekly.1 1.0 205. reflecting the negative convexity in the trade.997 0. • Stop out of weighted 4s/25s steepeners hedged with reds/10s flatteners This carry trade has become extremely directional with the level of rates.5 6.2mn notional of T 2% Feb-22s (yield: 2.958 0. − Unwind overweight on 96% risk.258%). P/L since inception: -25. Unwind overweight on 100% risk. • Buy 2-year Treasuries versus OIS The 2-year Treasury/OIS spread is at the upper end of its trading range and is likely to narrow as bill supply turns negative in April.5% Dec-13s and 2.91 2. valuations are mixed: 10-year real yields are slightly higher than they were before the January auction.625% Jun-14s (yield: 0.3bp. It is interesting to note. the key event for the TIPS market will be Thursday’s 10-year TIPS reopening.2bp. so we recommend unwinding this trade.61 2. 2012 Terry BeltonAC (1-212) 834-4650 Meera Chandan (1-212) 834-4924 Kimberly L.75% Feb-37s (yield: 3.43 2. bpv: $383/mn).1 -3.7mn notional of T 1.125% Dec-15s The 2. bpv: $180/mn). and could come under pressure like other off-the-run 5s in this sector with high foreign ownership.553 -0. − Unwind short 100% risk.9 236.434%. P/L since inception: +4.7bp of yield.6 212.018 0. or $76.732 EDM3 contracts (price: 99. Unwind long 100% risk. we are likely to see a strong auction and subsequent widening in breakevens. or $156.0 0. .0 1. or $6. Weighted spread is -4.P.33).408%). 40 Unwind underweight on 78% risk.8 1.64 2.114 Bid/ 2. • Unwind tactical 10s/30s breakeven curve steepener We recommend unwinding our tactical 10s/30s breakeven curve steepener now that the near-term steepening effects from the Fed purchase operation and nominal 30-year bond auction are likely behind us. 3/9/12).125% Dec15s (yield: 0.1mn notional of T 0.125% Jan-22s (yield: -0.

P/L since inception: +5. or $148. or $50mn notional of T 2% Feb-22s (yield: 2.6mn notional of T 0. 41 .875% Jan-17s (yield: 1. P/L since inception: -2.4bp of yield.361%).88). or 1. Stay underweight 100% risk. 2/3/12). P/L since inception: +5. − Stay overweight 75% risk. 2/24/12).3bp of yield. P/L since inception: +1.103%).1mn notional of T 0.25% Feb-15s (yield: 0.7 Misc. 2/24/12).842%).7mn notional of T 2. Harano (1-212) 834-4956 J. or $50mn notional of T 3. Stay overweight 42% risk. or 1.25% Apr-14s (yield: -1.555%). P/L since inception: 0. or $25mn notional of T 6. • Maintain 5s/10s and 5s/30s flatteners − Stay underweight 100% risk.875% Mar-18s (yield: 1.389%). Stay underweight 98% risk.625% Feb-27s (yield: 2.8 -14.8 5. 3/9/12).3mn notional of T 0. or $307.375% Feb-19s (yield: 1. reds/greens flatteners 7s/30s flatteners 3s/7s flatteners 4s/25s steepeners hedged with reds/10s flatteners 01/20/12 02/10/12 -11. Stay underweight 100% risk.2 3. • Maintain exposure to belly cheapening trades − Stay overweight 94% risk. (US Fixed Income Markets Weekly. Stay underweight 98% risk.4 Stay overweight 100% risk. (US Fixed Income Markets Weekly. P/L since inception: +4.361%). or $25.9bp of yield.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16.1bp of yield. (US Fixed Income Markets Weekly.408%).339%). − Unwind long 100% risk.2 -0. or 3. 3/2/12). 3/9/12).0 44.1mn notional of T 0.625% Feb-27s (yield: 2. − Stay underweight 100% risk. or $50mn notional of T 3.535%). or $157. or $475.937%).7mn notional of T 3.6bp of yield. or 3.1 EXIT P/L 12/09/11 10/14/11 01/06/12 09/23/11 01/06/12 02/10/12 02/12/12 01/27/01 01/06/12 01/06/12 01/27/12 01/06/12 01/27/12 02/24/12 02/24/12 03/16/12 0.9bp of yield. or $50mn notional of T 1.9 -2.25% Feb-14s (yield: 0.3bp of yield.4mn notional of TII 1.7bp of yield.664%).4mn notional of T 2. • Stay overweight 4s and 8s versus 6s − Stay overweight 69% risk. Morgan Securities LLC. or $170.25% May-16s (yield: 0. 2/24/12). Stay overweight 63% risk.875% Oct-17s 7s/30s flatteners Buy Nov-21 Cs versus Ps 4s/6s steepeners vs. or $281. (US Fixed Income Markets Weekly.25% Nov-17s (yield: 1. or $151.6mn notional of T 0.5 8.25% Jan-19s (yield: 1. Stay overweight 85% risk.166 EDZ4 contracts (price: 98.7mn notional of T 0.834%). or $25mn notional of TII 2% Jan-14s (yield: -1.565). or $50mn notional of T 2.375% Nov-19s (yield: 1.0 1/32nds 12/16/11 01/20/12 03/09/12 03/16/12 02/24/12 03/16/12 -12.25% Jan-15s (yield: 0. JGBs swapped into USD 08/12/11 02/10/12 Buy the March CTD Bond basis 12/09/11 02/24/12 TIPS Sell 5-year TIPS on a breakeven basis 10s/30s breakeven curve steepener Underweight Apr-14 TIPS versus Jan-14 TIPS 0.682%). Stay overweight 54% risk. (US Fixed Income Markets Weekly.75% Feb-18s (yield: 1.875% Jan-17s (yield: 1.33). (US Fixed Income Markets Weekly.7 5. Stay underweight 33% risk. Unwind short 100% risk.375% Jun-18s versus 1.842%). or $112. or $168. 2012 Terry BeltonAC (1-212) 834-4650 Meera Chandan (1-212) 834-4924 Kimberly L. Stay overweight 40% risk.725 EDM4 contracts (price: 99.8mn notional of T 1.565). or $25mn notional of T 6. P/L since inception: -0.125% Feb-42s (yield: 3. Stay overweight 71% risk. (US Fixed Income Markets Weekly. Closed trades in 2012 P/L reported in bp of yield unless otherwise indicated TRADE ENTRY Nominal Treasuries 10-year duration shorts Curve Underweight 4s versus 3s and 7s Buy 2. Stay underweight 100% risk.831%).103 %).P. • Maintain 2s/6s steepeners hedged with 9th/11th Eurodollar flatteners − Stay overweight 100% risk.936%).5 -25. • Stay in 2s/7s steepeners hedged with reds/ greens flatteners − Stay overweight 100% risk.41%). (US Fixed Income Markets Weekly. 3/9/12). Sell 2s versus OIS 12/09/11 01/06/12 Buy 5s versus OIS 01/06/12 02/04/12 Sell 2-year Treasuries vs.354 EDZ4 contracts (price: 98.296%). P/L since inception: +2. Stay underweight 100% risk.0 3. or $191.327 EDM3 contracts (price: 99.3 4.25% Feb-14s (yield: 0.

P/L since inception: -0. (US Fixed Income Markets Weekly. (US Fixed Income Markets Weekly.375% Feb-31s (yield: 3. Stay underweight 100% risk.051%).290%). 2/3/12). Harano (1-212) 834-4956 J. or $39mn notional of T 6. Stay underweight 70% risk.258%).9mn notional of T 5% May-37s (yield: 3.9bp of yield. • Stay overweight 6. Stay overweight 100% risk.825%).8bp of yield. P/L since inception: -3.430%). or $100mn notional of T 0. 1/20/12).25% Aug-23s (yield: 2. (US Fixed Income Markets Weekly. Stay underweight 38% risk. 42 . 1/27/12). or $50mn notional of T 3. or $50mn notional of T 4.139%).5% Nov-26s versus a weighted barbell of Aug-23s/Feb-31s − Stay underweight 62% risk. or $50.350%). or $48.125% May-21s (yield: 2. (US Fixed Income Markets Weekly. • Stay underweight May-38s versus May-37s − Stay overweight 100% risk.535%).6mn notional of 2% Feb-22s (yield: 2. 2012 Terry BeltonAC (1-212) 834-4650 Meera Chandan (1-212) 834-4924 Kimberly L. or $16. Morgan Securities LLC.3bp of yield.   • Stay in weighted 2s/3s steepeners − Stay overweight 100% risk. Stay overweight 100% risk.P. P/L since inception: +1. or $50mn notional of T 6.296%). 2/10/12). or $219.25% Jan-15s (yield: 0.8mn notional of T 0.5% May-38s (yield: 3.5% Nov-26s (yield: 2. • Stay underweight on-the-run 10s versus triple olds − Stay underweight 100% risk.3bp of yield.5mn notional of T 5.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. P/L since inception: +0.125% Dec-13s (yield: 0.

These dates represent the first date in each contiguous period where 10-year Treasury yields rose above the 6month maximum as of the previous day.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16.2 4. 2012 Srini RamaswamyAC (1-212) 834-4573 Praveen Korapaty (1-212) 834-3092 Alberto Iglesias (1-212) 834-5116 J.2 3.3bp in the long end of the curve.454. but upsize the short duration hedge Exhibit 1: Yes Virginia. there is still negative convexity to hedge … Estimated dollar duration of the aggregate mortgage servicing rights universe.Mar 15.01% standard error = 12. averaged around dates when rates first broke out of their 6-month range on the upside • 15 • 10 5 • 0 -5 Swaps Swap spreads mostly narrowed in the past week. The modest compression in swap spreads belies the more violent nature of the move in yields.to 10-year sector. 12/14/2010 and 2/4/2011.0065 period = Mar 15.0 3.9358 R² = 93.8 3. as we highlighted last week. regressed against mortgage current coupon yields. and this week’s spread narrowing—in the face of sharply higher yields—is partly a reflection of issuance-related pressures on swap spreads.6 2. Treasury yields are about 30bp higher in the 7.6 3. US Interest Rate Derivatives • Turn neutral on intermediate maturity swap spreads. issuance-related narrowing pressures remain. bias in intermediate sector swap spreads has been mainly motivated by the intra-year seasonal pattern of rising corporate supply (and the associated swapping activity) in the March-to-May period.P. producing positive spread directionality in a continued selloff Rolling 1-month beta between daily changes in 7-year swap spreads and 7-year Treasury yields. despite a considerable rise in yield levels.4 MBS 30-year current coupon yield.8218 X1 . This factor remains a valid one.to 5-year sector and 2bp in the 10-year sector. and 10-year yields are now near their six-month highs. Our narrowing -20 -10 0 10 # business days around range-break date* 20 * Dates used are 5/31/2007. Maturity matched swap spreads in the belly of the curve are narrower by 23bp in the 3.8 4. % • • Y = 89. 3/25/2010. the pace of issuance remains well above average. we now recommend turning neutral 43 . but wider by 0. . In the intermediate sector. $bn of 10-year equivalents -60 -80 -100 -120 -140 -160 -180 -200 -220 -240 2. Notwithstanding the likely continuance of such narrowing pressure. due to the fact that skews were realized to a greater extent than has been the norm recently This is typical of periods when yields are poised to breakthrough the recent range to the upside— stay short gamma in the 10-year sector. 5/22/2009. we now recommend taking profits on spread narrowing positions.11 . Morgan Securities LLC.0 4.12 • • Exhibit 2: … and mortgage related paying flows could increase if yields break out of their range.4 3. making for attractive entry points into option-based limited-risk bullish trades … … buy 3Mx5Y receiver swaptions struck at spot levels versus selling an equal amount of receivers at a lower strike to position for the possibility that yields return to recent average levels Initiate EDM4/EDU5 flatteners hedged with EDH5/EDM6 steepeners to earn attractive carry on a well hedged basis Short volatility positions in the 3Mx10Y sector experienced much greater sensitivity to yields than has been typical. but growing asymmetric risk of paying flows from servicers and REITs is a tactical offset Stay positioned for wider long-end spreads We continue to recommend trades designed to profit from yield curve renormalization—initiate 3s/7s steepeners hedged with weighted 2s/Blues flatteners The rise in yields has pushed 5-year yields well above recent averages.

Inc. to estimate the current risk exposure of REITs in the aggregate. REITS on aggregate benefit from yield curve steepening. 54. Nonetheless. Nonetheless.0 Oct 11 Nov 11 Jan 12 Feb 12 106.917 Exhibit 4: A composite index of the top 5 REITs’ stock prices has tracked the MBS index price in recent months … The J. Inc.058 and 0. First.P. on average.784 12.5 18. As our mortgage strategists have noted often in recent years.019 11.05.414 201. 0.0 18. Second. versus a weighted average of the top 5 REITs’ stock prices* 20. leading to sizeable hedging flows on an episodic basis. the business model for REITs centers on levered carry and allows for greater ability to run duration risk in comparison to the GSEs.Morgan MBS index price. 106. with weights of 0.252 25 3.372 (26) 3. Weights based on shares outstanding. q/q change and annual change as of 2011 year-end Agency Holdings ($MM) REIT 2011Q4 Q/Q Change Y/Y Change Annaly Capital Management.0 19. Over the past 5 years.5 20. it is reasonable to assume that such investors might look to de-risk their portfolios in periods where rates appear likely to break out of a regime.444 (75) 1.394 (582) 4.5 107. and is one tactical reason to be cautious regarding spread narrowing trades.to 3-year range in recent months. 0. 2012 Srini RamaswamyAC (1-212) 834-4573 Praveen Korapaty (1-212) 834-3092 Alberto Iglesias (1-212) 834-5116 J. meaning that if REITs hedged duration using 5-year and 10-year instruments (liquid points in the . Nonetheless. Some evidence for this is seen in Exhibit 2. three observations are worth making. In addition. on intermediate swap spreads.512 41.0 107.155 Capstead Mortgage Corporation 12.420 American Capital Agency Corp. 0. Inc.5 19.318 CYS Investments. Inc. because of growing (and asymmetric) risk of paying from mortgage hedgers and REITS. paying flows from servicers could pick up going forward if yields continue to rise and break through the upper end of the relatively tight range they have held since August 2011. if rates continue to drift higher. coefficients are not stable over longer periods. as numerous other factors could affect traded REIT prices.463 Two Harbors Investment Corp. 5. 6.069 (1. This risk is likely asymmetric from current yield levels. 1. REITs have emerged as important marginal buyers of Agency MBS. they are not necessarily dynamic hedgers. the hedging flows from mortgage portfolios and servicers in this week’s sell-off have likely been relatively modest. While surprising at first glance.232 Dynex Capital.062 Anworth Mortgage Asset Corporation 8. We then regressed rolling 3month changes in the index (in order to cancel out dividend accretion effects) against rolling 3-month changes in market variables. hinting at rising mortgage-related paying flows. Such an analysis is no doubt imperfect.056 (627) 4. 10. To be sure.273 Hatteras Financial Corp. thus. Morgan Securities LLC. We estimate that the aggregate duration of the mortgage servicing universe lengthens by about $1bn 10-year equivalents per each 1bp rise in current coupon mortgage yields (Exhibit 1). there is still negative convexity to hedge. 10-year Treasury yields have broken out of their 6-month trading range on five occasions. To be sure. 44 Exhibit 3: REITs have become a key marginal buyer of MBS in recent months and years Amounts of Agency MBS held by the top mortgage REITs. evidenced by the relatively small coefficient with respect to rates.625.965 (107) 773 Top 10 Total Top 5 Total 240. 17.0 17.193.840 ARMOUR Residential REIT. we created a composite market value index of the top 5 REITs from Exhibit 3.5 Mar 12 * We used prices of the top 5 REITs in the previous table. it may reflect the fact that MBS index durations have remained in the 2.420 10. with GSE portfolios shrinking.P.074. with the Fed owning one quarter of the Agency MBS market. The results are shown in Exhibits 4 and 5. A second risk to spread narrowing positions has to do with potential hedging flows from mortgage REITs.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. 9.5 Sep 11 MBS index price Weighted average REIT index price 108. .751 Invesco Mortgage Capital Inc.792 34 8.5 108. REITs on aggregate seem to hedge a significant portion of duration risk.517) 25.315 84.417 100. Inc. the subsequent beta between intermediate swap spreads and Treasury yields has tended to pick up.762 18 1. with relatively sizeable holdings in aggregate (although they remain small in comparison to the two GSEs—see Exhibit 3). and with prepayments structurally slower due to refi capacity constraints and negative home equity. Assuming that half of this negative convexity is dynamically managed. To assess the likely hedging flows from REITs. 7.027 MFA Financial. but this is unsurprising given that REIT holdings of Agency MBS have risen sharply mainly over the past year or so.524 363 6.

but remain exposed to a widening in MBS spreads Estimated aggregate exposure* of the top 5 REITs to rates. Exhibit 6: Stay positioned for a renormalization of the yield curve 115 110 105 100 95 90 85 80 3Mx7Y minus 3Mx3Y plus (0. Exhibit 5: REITs on aggregate appear to hedge duration risk.58*5Y swap yield.334*3Yx1Y) swap yield spread. One such trade that currently appears attractive is a 3s/7s swap curve steepener. (For a more detailed discussion of 75 Mar 11 Jun 11 Sep 11 Dec 11 Mar 12 this theme. As we highlighted last week.347% versus a 1-month average (as of a week ago) of 1.4 MBS OAS.4 Long options return* -33.646*3Mx2Y) minus (0. long convexity returns and MBS index OAs. In addition. the emerging and asymmetric risk of mortgage–related paying if yields continue to rise is a powerful tactical offset.2 -1. bp Weighted spread Prior mean Recent mean Swap yield curve On the swap yield curve. 3/9/2012).13%.1mn in a 3-month period where a $1bn notional long 3Mx10Y straddle position produces $1mn in daily-delta-hedged P/L. REITs could become more active in hedging some part of their spread exposure. but instead drift back lower to recent averages. this trade exhibits all the above characteristics. hedged with a weighted 2s/Blues flattener. At the same time. we now turn tactically neutral on swap spreads. The first two observations suggest that REITs are relatively well hedged currently. however.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16.P. 2012 Srini RamaswamyAC (1-212) 834-4573 Praveen Korapaty (1-212) 834-3092 Alberto Iglesias (1-212) 834-5116 J. and exposed to a widening in the MBS basis. closing at 1. Treasury futures / swap markets).1 -2.0 2s/10s curve (adjusted for yield). this week’s sharp rise in yields also creates attractive opportunities to position for a reversal towards lower yields (if that were to occur) via options. we recommend a receiver swaption spread. while this new yield curve is the result of markets taking the Fed’s projections at face value and treating it as a de facto commitment. but should have experienced a discrete shift in their mean levels as part of the change in yield curve regime. meaning that they could become active in hedging any material increase in MBS durations. and recommend unwinding spread narrowers in the 10-year sector (see Trade recommendations). US Fixed Income Markets Weekly. Adjusted curve calculated as 2s/10s curve minus 0. However. given their considerable mortgage spread exposure. given the correlation between mortgage OAS levels and swap spreads. 45 . although issuance remains elevated and threatens to bias intermediate swap spreads narrower.8 R-squared 88% Data range Past six months * All coefficients estimated using regression of rolling 3M weighted REIT index price change versus rolling 3M change in 5Y swap rates. 5-year spot swap rates have risen by over 20bp this week. . As seen in Exhibit 6. adjusted 2s/10s swap curve.0 12. Morgan Securities LLC. we now recommend initiating 3-month forward 3s/7s swap curve steepeners. the curve. To position for the possibility that rates do not continue their upward renormalization. Therefore. we continue to recommend efficient ways of positioning for a renormalization. But perhaps most important. In our view. in conjunction with currently tight OAS levels and diminished prospects for QE3-related MBS purchases. This will likely mean paying in swap spreads. Aggregate REIT exposure to: Coefficient T-stat 5Y swap yield. given the uncertain timing of any renormalization (although this week’s sharp move upwards in December 2014 forward OIS rates definitely suggests that such a renormalization is already underway). Therefore. see Interest Rate Derivatives. $mn/bp -3.6 -2. the Fed’s communications of its funds rate projections has caused the yield curve to shift to a new regime since August 2011. trades designed to position for such a renormalization should have several characteristics – they should be relatively non-directional and meanreverting. it also suggests that REITs may be operating under tighter net duration risk limits than generally assumed. For instance. $mn/bp 54. and has essentially flat carry and slide. risks to the expectation of a flat-until4Q14 funds rate are growing as the labor market continues to strengthen. In sum. REITs are (unsurprisingly) short convexity. Interpretation of the convexity return coefficient is as follows: REITs stand to lose $33. Third. they would implicitly be in yield curve steepening positions. hedged with a weighted 3Mx2Y/Blues flattener (see Trade recommendations). convexity and MBS spreads. $mn/bp -27. such trades should ideally have flat or positive carry & slide.

FV. as we did in December. the recent average level (see Trade recommendations). In particular. Bond Index replication With March Treasury note and bond futures close to expiry. and with most investors having rolled into June. .P. bp of total return Index 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 -49 208 417 -109 -117 268 403 121 Synthetic asset -36 207 394 -109 -117 264 374 62 Excess return 13 -1 -23 -1 0 -4 -28 -60 19 93 113 * Quarters defined to begin on first delivery day.46 0.P. As was the case last quarter.48 0.e. bond contract as a way to mitigate this long-end Treasury curve exposure in synthetic assets.44 0. Morgan Securities LLC. bp of total return bp 30 25 20 15 10 5 0 -5 Dec 11 Cumulative excess return 15s/30s Treasury par curve 0. The maximum profit in this position.38 Jan 12 Feb 12 Mar 12 * See previous exhibit.42 0. we recommend a 10th / 15th ED flattener hedged with a 13th / 18th ED steepener (1:1 weighted). The weighted spread corresponding to this trade is attractive from an entry-level perspective (near its YTD highs).7bp of yield. Exhibit 7: Synthetic strategies that combine cash investments with Treasury futures positions outperformed the bond index returns in 1Q12 Quarterly returns* on the J. as seen in Exhibit 9.52 0. 10-year note futures and bond futures (weighted to match the partial-bpvs of the J. we review the performance of synthetic assets created with Treasury futures during 1Q12.P. The ultra-long bond contract’s CTD is in the 25-year sector. We also recommend adding exposure to well-hedged carry trades.Morgan US Government Bond Index. This would have been true in 1Q12 as well. As shown in Exhibit 7. Futures positions rebalanced monthly. . ** Replication strategy constructed using a cash investment in 3M Agency discount notes. the performance of the synthetic asset has closely followed the movements of the 15s/30s Treasury curve during 1Q12. quarterly returns on a synthetic replication strategy** and excess returns on the synthetic strategy. The former extends out to 30-year maturities while the latter has a CTD in the 15-year sector.50 0.8bp. Thus. synthetic asset strategies that use the ultra-long bond contract instead of the bond futures contract should produce a more stable replication of the index. For instance.13%—i.40 0. which would occur under a return to recent yield levels. The total return of the synthetic asset in 1Q12 was 113bp or about 19bp more than the returns in the index. Looking ahead. we now recommend initiating EDM4/EDU5 flatteners hedged with EDH5/EDM6 steepeners (see Trade recommendations). offers about 6bp of slide over 3 months. and selling an equal-notional amount of receiver swaptions struck at 1.. 2Q11 refers to the period from 3/1/2011 – 5/31/2011.Morgan US Government Bond Index) have outperformed the index for the first time in the past eight quarters. 2012 Srini RamaswamyAC (1-212) 834-4573 Praveen Korapaty (1-212) 834-3092 Alberto Iglesias (1-212) 834-5116 J. Maximum loss on the position is 7bp of yield. TY and US Treasury futures. Risk on this trade (measured as the 2year standard deviation of rolling 3-month change in the weighted spread) is 8.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. and mimicking index risk with TU. leaving exposure to the 15s/30s curve as an implicit consequence. The outperformance has thus been in line with that expected from a replication of the long-end bucket of the bond index using bpv-weighted bond futures contracts. outperforming as the curve steepened (Exhibit 8). is 21. synthetic Treasury assets created by combining cash investments in 3-month Agency discos and long positions in 2-. Therefore. we continue to recommend replacing positions in the bond futures contract with a bpv-equivalent position in the ultra-long 46 Exhibit 8: The outperformance of the synthetic strategy is a consequence of the steepening of the 15s/30s Treasury curve … Cumulative excess return on synthetic strategy* over the J. and is likely to be a better proxy for the long-end maturity bucket of the bond index. 5-. and is well hedged (it moved by barely 1bp during this week’s sell-off).Morgan US Government Bond Index versus the 15s/30s Treasury par curve.P. specifically. we recommend buying 3Mx5Y receiver swaptions struck at the 5-year spot swap yield.

This appears true of the current 47 .6 6. abp 20 15 10 3m10y 5 3m2y 0 2y tails -5 0 1y tails 5 10 15 Expected change in swaption implied volatility*. meaning that any increases in normal implied volatility (unless otherwise hedged out) results in vega P/L.7 4.2 -22.1 -58. evaluated as twice the difference between the implied volatility at a strike equal to the ATMF rate plus the yield change over the week.7457x . The rise in implieds came as yields rose to recent highs and threatened a further breakout from their recent range. supporting our a priori decision to not explicitly hedge the skew. Morgan Securities LLC. Morgan Volatility Index.7 6. in fact).Morgan US Government Bond Index.8 4. bp of total return Exhibit 10: Short volatility positions underperformed this past week P/L* from short straddles in various options instruments since 3/9/12 and current levels of volatility.1. would show close to a zero beta (slightly negative. Thus. but retraced later in the week.7 -23.2 5. bp of notional** Return Return Theta Adj** Gamma PL Vega PL Current Implied Vol Current Realized Vol 30 Ultra 20 Bond 10 6M2Y -7 -75 -1.7 2. proved quite damaging to short volatility positions.4 2.. our delta-hedging assumes the use of normal deltas. even net of the short-duration hedge that we had recommended to address the intrinsic directional exposure of realized volatility (but not the directionality of implied volatility as priced into the skew). including short volatility positions. ** Adjusted to a theta-neutral amount of 6Mx10Y swaptions.2 -23. coupled with elevated delivered volatility. What is more notable is that even with these sharp increases week-on-week.9 4.P.5 Front TY -33 -38 5.P.7 6. to the exercise in Exhibit 11. Options are re-struck at the start of each month.0 5. 2012 Srini RamaswamyAC (1-212) 834-4573 Praveen Korapaty (1-212) 834-3092 Alberto Iglesias (1-212) 834-5116 J. but for the 3-month period ending as of a week ago.7 5.704 Options Implied volatility rose sharply into the middle of the week. which assumes daily delta rebalancing and zero transaction costs. our short-duration hedge. first. abp 20 y = 0.to 30-year underlying swap rates.6 6M10Y -41 -41 -9. implied volatility largely rose by less than what might have been expected. our short 3Mx10Y volatility positions lost money this week. 0 Exhibit 11: Swaption volatility actually underperformed the skew this week Dec 11 Jan 12 Jan 12 Feb 12 -10 Dec 11 * Baseline strategy creates a synthetic asset by combining 3M Agency discos with partial bpvweighted positions in TU/FV/TY and US bond futures.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. Exhibit 9: … an exposure that can be mitigated by using the ultralong bond futures contract in place of the bond contract in synthetic asset strategies Cumulative excess return on two synthetic strategies* over the J. versus expected change*. proved largely inadequate this week.2 Front FV -24 -63 0. Rangebound markets tend to produce increased exposure to carry trades. Second. and the implied volatility at a strike equal to the ATMF rate. Although this must be deemed an underperformance of implied volatility. The second strategy replaces positions in the classic bond futures contract with bpv-equivalent positions in the ultra-long bond futures contract.1 5. The reason is two-fold. .6438 R² = 0. on 1.6 * Returns calculated using the J.1 6M30Y -74 -32 -15.3 -5. as seen in Exhibit 11. and unlikely to be realized—an analysis analogous * Derived from the swaption skew as of 3/9/12.4 Front US -56 -30 -33. implied volatility across the vol surface generally rose by about 75% of the amount priced into skews as of a week ago.3 -31.8 4.7 6M5Y -30 -78 -6. we had viewed skews as rich. particularly ones delta-hedged using normal deltas as seen in Exhibit 10.0 -37.P. as investors seek to take advantage of stable markets to earn excess returns. Actual change in swaption implied volatility levels since 3/9/2012 for options expiring between 1 month and 5 years.8 6. given exante skews. Rising implied volatility. which was empirically estimated over the past 18 months when skews were generally flatter than now. So why were skews realized to a greater extent this week? We believe it is to a great extent because yields are now much closer to breaking out of the recent range.

averaging nearly 0. producing greater sensitivity of implied volatility to yield levels (assuming yields break out of the range towards the upside). This weighted spread exhibits little directionality with front-end . Hedging the directionality of implied volatility for the fixed-strike option that we are short requires an additional swap notional of $10mn. In this regard. 2012 Srini RamaswamyAC (1-212) 834-4573 Praveen Korapaty (1-212) 834-3092 Alberto Iglesias (1-212) 834-5116 J. with yields poised to break further out of recent ranges. This is likely to be the case in the current context.3 -0. this growth in short volatility exposure can also mean that when yields break through ranges. coupled with the fact that sharp increases in realized volatility tend not to persist unless supported by fundamentals. thus. . the major US bond funds.4 0. environment—as seen in Exhibit 12. Where does this leave us? Going forward. as also seen in Exhibit 13.1 -0. daily change in red ED and 10-year yields.7mn to $20mn notional of a pay-fixed 10-year swap position (see Trade recommendations). we would expect implied volatility levels to exhibit greater sensitivity to yield levels at least tactically. This is illustrated in Exhibit 13. For reference.4bp/day.P.4 0.2 0. our Treasury 48 strategists are bearish but expect 10-year yields to stabilize near 2.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16.1 Overall average Conditional average Conditional chg in rates * Defined as any day when the yield level exceeds the six month maximum as of the prior day. averaged over (i) the past 5 years. have likely maintained a short gamma bias for all of the first quarter. the “excess” weekly increase in implied volatility was positive.2 -0. The average change in 10-year swap yields (%) in those episodes is also presented for reference 0. where we show the average difference between the weekly change in 3Mx10Y implied volatility and the change expected based on yield changes and the ex-ante skew. the corresponding average conditional change in rates was about 26bp.5 0.1 0. investors might seek to cover short vol exposure. Exhibit 12: Given the recent range-bound nature of rates the market appears to have been generally short gamma Rolling 1-month partial beta of the returns for the top 20 mutual funds versus returns from short 6Mx5Y swaption straddles*.3 0. Trade recommendations • Initiate 3Y / 7Y steepeners hedged with weighted 2Y / Blues flatteners We continue to recommend trades that provide an attractive way to position for a possible renormalization of the yield curve to a pre-August 2011 regime–a likely outcome if future employment reports continue the strong trend. our model framework also requires the directionality of short straddle returns to be properly hedged.2 0. conditioned upon upside rangebreaks (which we define as any day when the 3Mx10Y swap yield exceeded its 6-month maximum as of the previous day).1 0.5%. as well as (ii) conditionally averaged in episodes where yields have broken out of a range to the upside*. but with an upsized rate hedge. Exhibit 13: Implied volatility has tended to exhibit increased sensitivity to yields in episodes where yields have broken out of ranges to the upside Weekly change in 3Mx10Y implied volatility minus the change priced into ex-ante skews (bp/day). However. but recommend upsizing the short duration hedge from $10.0 -0.0 -0. means that short gamma positions tend to outperform following a spike in implied volatility.4 Jun 11 Sep 11 Dec 11 Mar 12 0. we recommend maintaining short gamma positions.3 0. for instance. However. We have often noted that the reactive nature of implieds to a sharp rise in delivered volatility. making skews more likely to be realized. and our model projects that maintaining short gamma positions going forward should prove considerably profitable. * Partial beta calculated from rolling 1-month regressions of return of daily returns versus daily delta hedged return from selling 3Mx10Y straddles. and daily change in MBS and credit spreads.6 0. Morgan Securities LLC. we recommend maintaining a short gamma bias. This average has been essentially close to zero over the past five years. However.

swap end date 04/24/2017) and stop paying fixed in $21. defined as EDM4 yield minus EDU5 yield + EDM6 yield minus EDH5 yield. • Buy 3Mx5Y receiver spreads Considering the possibility that rates do not continue their upward renormalization.13% strike.13%. we recommend upsizing the short-duration swap hedge. swap end date 04/25/2022). we recommend positioning for a reversal towards lower yields via options.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16.5bp of yield (US Fixed Income Markets Weekly.646*3Mx2Y minus 0. • Stop receiving in 10-year swap spreads hedged with 20% risk in September FRA-OIS wideners Having changed our view on intermediate swap spreads to neutral due to growing risk of paying from mortgage hedgers and REITs in a selloff. • Stop receiving fixed in the belly of a 3-month forward weighted 5s/10s/30s swap butterfly This weighted yield spread has converged to the 6month average value at inception of the trade.25% June 16 spreads versus receiving in 3. we recommend unwinding this trade.464%) @ a premium of 34bp of notional.8abp. − Stop receiving fixed in $100mn notional of a 3Mx10Y forward starting swap (swap start date 04/24/2012. Therefore. Thus.485 weights) (US Fixed Income Markets 49 .3 notional of a 06/30/2016 swap.646/0. • Stay short delta-hedged 3Mx10Y swaption straddles. − Buy 1000 EDU5 futures versus selling 1000 EDM4 futures and also buy 1000 EDH5 futures versus selling EDM6 futures @ a yield spread of 2bp. P/L since inception: loss of 5. Three month carry on this trade is 6. maturity date 6/13/2022. • Initiate EDM4 / EDU5 flatteners hedged with EDH5 / EDM6 steepeners We recommend adding exposure to well-hedged carry trades such as the 10th / 15th ED flattener hedged with 13th / 18th ED steepener (1:1 weighted).334 weights) at a weighted yield spread (defined as 3Mx7Y minus 3Mx3Y + 0. Carry and slide on this trade is approximately flat over 3 months. 1/20/12).7bp of yield (US Fixed Income Markets Weekly. and stop paying 20% of the risk (or $18035/bp) in September 2012 3M FRA-OIS spreads @ a profit of 2. given the greater likelihood of skews being realized as yields rise. and stop receiving fixed in $96. • Maintain Reds / 10Y steepeners hedged with weighted 2Y / Blues flatteners − Maintain 1Yx1Y/3Mx10Y swap curve steepeners hedged with weighted 3Mx2Y/3Yx1Y curve flatteners (1. buy the 5Y spot 1. . ATMF at 1.P.13% 3Mx5Y receiver swaption spread (1:1 weighted. cover shorts in $98mn notional of 31/4% of July 16 and stop receiving fixed in $103.9mn notional of a 3Mx30Y forward starting swap (swap start date 04/24/2012. swap end date 6/13/2022) (US Fixed Income Markets Weekly. 2/24/12). − Stop receiving in $100mn notional of 2% Feb 22 maturity matched swap spreads (cover shorts in $100mn notional of 2% Feb 22s. − Unwind longs in $100mn notional of 3-1/4% June 16 and stop paying fixed in $105. but upsize duration short We continue to recommend selling 3Mx10Y vol hedged for rates.11/0. • Stop paying in 3. However. flat carry. swap end date 04/24/2042) @ a profit of 2. This trade is also attractive from an entry level perspective.189%) versus paying fixed in $20mn notional (upsizing our previous recommendation of $10. which has considerably corrected. notification 06/18/2012. and is likely to continue to trend higher as the yield curve eventually normalizes. − Initiate 3Mx3Y/3Mx7Y swap curve steepeners hedged with weighted 3Mx2Y/3Yx1Y curve flatteners (0. we recommend unwinding it. stop paying fixed in $133mn notional of a 3Mx5Y forward starting swap (swap start date 04/24/2012. − Buy $100mn notional of a 1.9bp of yield (US Fixed Income Markets Weekly.334*3Yx1Y) of 87.2mn notional of a 2/15/2022 swap). rates.347%/1. buy 3Mx5Y receiver swaptions struck at the current 5Y spot swap yield.4bp. Morgan Securities LLC. 2012 Srini RamaswamyAC (1-212) 834-4573 Praveen Korapaty (1-212) 834-3092 Alberto Iglesias (1-212) 834-5116 J.7mn notional) of a 3Mx10Y forward starting swap (swap start date 6/13/2012.25% July 16 maturity matched swap spreads This trade was designed to take advantage of the dislocation in the swap spread curve term structure for old 7-year in the Apr-June 2016 maturity sector. maturity 06/20/2017. 03/02/12).5bp. we recommend unwinding this trade. ATMF and strike 2. 03/02/12). and sell an equal-notional amount of receiver swaptions struck at the 1-month average of 1. − Stay short $100mn notional of 3Mx10Y swaption straddles (notification date 6/11/2012.347% strike and sell the 1. but instead drift back to recent averages.5mn notional of a 7/31/2016 swap @ a profit of 0.

ATMF 1. yield 0.506%. ATMF 0.8bp of yield. strike 1.4mn notional of a 01/31/2017 swap (US Fixed Income Markets Weekly. (US Fixed Income Markets Weekly.25 calls (FVM2 @ 12304. • Maintain conditional belly cheapening positions in a sell-off on the EDU3/7Y/25Y butterfly using ED midcurve puts and payer swaptions − Stay long $100mn notional of 6Mx7Y payer swaptions (notification 09/14/12. • Maintain belly cheapening position on the 1-year forward 2s/5s/10s swap butterfly − Continue to pay fixed in $100mn notional of a 1Yx5Y forward starting swap (swap start date 02/14/2013.506%/0.845%).3mn notional of a 02/15/2041 swap). and in annualized bp of volatility for option trades.000 FVM2 123.75% of Feb 2041 spreads (stay long $100mn notional of the 4. also stay short $998. unless otherwise specified Trade Swap spreads 10-year swp sprd widener Front end swap spread wideners via options Pay Aug 20 vs Feb 20 sprds (hedged) Rec in 10Y swp sprds (hedged) Pay 3.354%) (US Fixed Closed trades in 2012 P/L reported in bp of yield for swap spread. notification 5/10/2012. yield 2.875% of Jan 2017s and continue to pay fixed in $67.1bp of yield. P/L since inception: loss of 3. P/L since inception: profit of 0.P. EDU3 strike 99.4) 1. (US Fixed Income Markets Weekly.7 P/L 18. • Maintain 5-year swap spread wideners in a rally − Stay long 1. and continue to pay fixed in $110. P/L since inception: profit of 2. P/L since inception: loss of 0.2bp of yield.375 puts (midcurve option expiry 09/14/12. maturity 5/14/2013.9 P/L (3.1) (9.7 2.797%). 03/09/12). P/L since inception: loss of 0. ATMF and strike 2.5bp of yield. swap start date 5/8/2012.883%) versus staying short $500mn notional 3Mx2Y payer swaptions (notification 5/3/2012. • Maintain conditional 2s/30s steepeners via 3-month expiry options.3mn notional of 6Mx25Y receiver swaptions (notification 09/14/12.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16.073%.6mn notional of a 11/15/2041 swap.2 (0. yield curve and miscellaneous trades. • Stay long 3Mx1Y payer spreads − Stay long $100mn notional of a 0. swap end date 02/17/2015. • Maintain 30-year swap spreads wideners − Continue to pay in 4.8) (4.1bp of yield. Weekly. P/L since inception: profit of 1. maturity 09/18/37.375). also.5 0.6) Income Markets Weekly.25 Jul16 swp sprds Yield curve 5s/10s swp sprd crv steepeners 3m fwd 1s/15s crv flatteners via rec swptns Buy belly of EDZ2/EDZ3/EDZ4 bfly Buy wtd WN calendar sprd PL in 32nds Rec in belly of 3M fwd wtd 5/10/30s swap bfly Options relative value Sell 10s/30s YCSO vs 6Mx2Y swptn strddls Buy 6Mx5Y vs 9Mx5Y swptn strddls Entry 01/06/12 01/06/12 01/20/12 02/24/12 03/02/12 Entry 11/04/11 01/06/12 01/20/12 02/10/12 01/20/12 Entry 10/28/11 01/20/12 Exit 1/20 2/3 2/3 3/16 3/16 Exit 2/3 2/3 3/2 3/2 3/16 Exit 1/27 2/10 P/L (1. maturity 8/31/16.125% of Nov 2041s and pay fixed in $51. swap start date 07/05/12. swap maturity date 5/8/2042. • Maintain synthetic conditional trade by selling 10s/30s YCSO caps versus 10Y receiver swaptions − Sell $500mn notional (i.7bp of yield.4bp of yield. hedged with 5-year swap spread wideners and the 5s/30s Treasury yield curve − Stay long $50mn notional of 3. 2/24/12).25 strike) (US Fixed Income Markets Weekly. swap end date 02/14/2018.734%) and continue to receive fixed in $29.5mn notional of 3-month expiry 1-look caps on the 2s/30s CMS curve (end date 5/8/2012.6bp of yield.. buy the ATMF strike and sell the A+. stay short 1598 0EU2 99. versus selling 3-month expiry caps on the 2s/30s CMS curve − Stay long $50mn notional 3Mx30Y payer swaptions (notification 5/3/2012. 2/24/12). 1/27/12). strike 123. 2/3/12). continue to receive fixed in $138.25. • Maintain 30-year matched maturity swap spread wideners. stay long $95mn notional of 0.3mn notional of a 1Yx2Y forward starting swap (swap start date 02/14/2013. swap start date 5/8/2012. 03/02/12). 2/10/12).9) 1. maturity 09/18/19.25 Jun16 vs rec 3. . $50K/bp forward DV01) of single-look 6-month caps on the 10s/30s swap curve 50 . yield 1.e. swap maturity date 5/8/2014. strike 1. and stay short $22. ATMF CMS 10s/30s yield spread and strike at 239. 2/10/12). P/L since inception: profit of 10. 2012 Srini RamaswamyAC (1-212) 834-4573 Praveen Korapaty (1-212) 834-3092 Alberto Iglesias (1-212) 834-5116 J.5) (16.5275%). Morgan Securities LLC.7bp) (US Fixed Income Markets Weekly.098%) (US Fixed Income Markets Weekly.9 2. strike 2. P/L since inception: loss of 2. swap end date 02/14/2023.756% 3Mx1Y payer swaption spread (1:1 weighted.75% of Feb 2041.6mn notional of a 1Yx10Y forward starting swap (swap start date 02/14/2013. ATMF and strike 0. expiry 5/25/2012) and stay short $129mn notional of a 05/25/12x8/31/16 receiver swaption (notification 05/25/12.513%).

849%) and stay short $100mn notional of 6Mx10Y swaption straddles (notification date 8/24/2012. swap end date 6/13/2014) (US Fixed Income Markets Weekly. P/L since inception: loss of 5.P. ATMF and strike 2.64%) (US Fixed Income Markets Weekly.4bp of yield.6mn notional of a 3Mx2Y forward starting swap (swap start date 6/13/2012. . 2/24/12). 2012 Srini RamaswamyAC (1-212) 834-4573 Praveen Korapaty (1-212) 834-3092 Alberto Iglesias (1-212) 834-5116 J. maturity date 06/13/22. 03/09/12).3mn notional of 6Mx10Y receiver swaptions (notification date 06/11/12. P/L since inception: loss of 3. strike and ATMF 10s/30s CMS yield spread at 60. ATMF and strike 2.7mn notional of 6Mx30Y swaption straddles (notification date 8/24/2012.620%) and continue to receive fixed in $28.220%) (US Fixed Income Markets Weekly.335) (US Fixed Income Markets Weekly. P/L since inception: loss of 0.1bp) versus buying $21. maturity date 6/13/2014. (end date 6/11/12. • Stay long delta-hedged 3Mx2Y swaption straddles layered with a duration long − Stay long $100mn notional of 3Mx2Y swaption straddles (notification date 6/11/2012. ATMF and strike 2.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. maturity date 8/30/2022. P/L since inception: profit of 0. • Stay short 6M single-look CMS curve straddles on the 2s/10s swap curve − Stay short $250mn notional of 6-month curve straddles on the 2s/10s CMS curve (end date 09/06/2012. Morgan Securities LLC. maturity date 08/29/2042. • Stay long 6Mx30Y versus 6Mx10Y swaption straddles − Stay long $43.8abp. ATMF and strike 0.7abp. 03/02/12).3abp. 12/09/11). 51 . ATMF CMS 2s/10s yield spread and strike at 1.

Japan Rates Research Global Fixed Income Markets Weekly March 16. as was widely expected. considering the fact that the medium-term sector had remained very firm after the BoJ’s meeting in February 2012 5Y JGB yield since April 2011. some had expected an indication of further easing in the bank’s statement or at Governor Shirakawa’s press conference after the meeting. Most had expected to see usual rangebound moves this week.40 0. as was widely expected.35 0. The futures price drove the selling came on the following day and the futures price . Ltd Japan • The bank left the policy unchanged. After all. but… …the sell-off in US Treasuries following the FOMC statement triggered a sell-off in JGB futures. 3) the short-to-intermediate yields will likely remain relatively low and stable as long as the BoJ continues to buy JGBs under the Asset Purchase Program (APP). yen 144 143 142 141 140 139 138 Apr '11 • • JGB Futures price 200 day moving average Jun '11 Aug '11 Oct '11 Dec '11 Feb '12 • Source: Bloomberg. The picture dramatically changed after the sell-off in US Treasuries following the FOMC statement on 13 March.25 0. which probably switched on selling by trend-following speculative investors (Exhibit 1).60 0. The sell-off in the US equivalent triggered the sell-off in JGBs. J. probably switching on selling by trend-following speculative investors Front JGB futures price and 200-day moving average. we do not expect a large sell-off or a consistent rise in yields from here. Morgan • Exhibit 2: The 5Y yield broke the range higher and closed at 0. most had expected to see usual rangebound moves this week.30 0. and 4) equities may have a fall-back We unwind the 5s/8s flattener while maintaining long 7Y via weighted 5s/7s/10s butterfly The rise in gamma volatilities appears to provide a good opportunity for selling short expiry options..35 • • Jun '11 Aug '11 Oct '11 Dec '11 Feb '12 Overview The week started on a slightly bullish tone despite the strong US payroll numbers last Friday. However.20 Apr '11 0.45 0. which translates to 4.28 0. and 3) the long-lasting range-bound JGB market and skewed positioning Going forward. it appears that there was no such hint. We here recommend selling 3Mx10Y payers swaption with the strike of ATMF + 20bp Exhibit 1: The futures price broke lower than the 200-day moving average.3bp in 7Y yields.37% on 15 March.55 0.P. CFA (81-3) 6736-1493 JPMorgan Securities Japan Co. The move was impressive. % 0. such as 1) Greece completing the debt exchange. Although no change in the policy was the consensus view. The futures were sold off by 139 cents in two days The concept of relative values was lost and that of momentum gained grounds. The futures were sold off by 46 cents on the next day. The futures price broke lower than the 200-day moving average. because 1) there are still another 3 months until Operation Twist ends.50 0. Some investors might have expected further monetary easing in the BoJ’s Monetary Policy Meeting on 12 and 13 March. 2) trend-following speculative investors must cover the shorts at some point in the future. Another wave of selling came on the following day and the futures price declined by another 85 cents. the BoJ did not surprise the market. 2) the significant rally in equities and depreciation of the JPY since the beginning of this year. The bank left the policy unchanged. 2012 Takafumi Yamawaki (81-3) 6736-1748 Yuya Yamashita. The implied volatilities in the gamma sectors exploded There had existed some backgrounds that could accelerate sell-offs. With no apparently strong 52 market drivers.

it broke the range higher and closed at 0. considering the fact that the medium-term sector had remained very firm after the BoJ announced the expansion of the APP in February. The gamma volatilities spiked and the rise was more than what had been implied by the skew.35% on 14 March.Japan Rates Research Global Fixed Income Markets Weekly March 16. causing a richening in the super-long end ASWs Swap rate change over this week. the actual 10bp rise in the ATMF this week resulted in a 0.. The futures sector (7Y-8Y) was sold off by more than 10bps and the shape of the yield curve around 7Y now appears extreme.00 4. with the average yield coming 1bp through the offer side of the morning close. especially in the gamma sectors. CFA (81-3) 6736-1493 JPMorgan Securities Japan Co. The futures price drove the cash market. but the extent was a lot smaller than in the gamma sectors (Exhibit 5). bp 12 10 8 6 4 2 0 1 2 3 4 5 6 7 8 910 12 15 20 Maturity 25 30 40 Exhibit 4: The super-long end swap curve moved higher in a relatively parallel fashion. Meanwhile.28-0. The super-long sectors remained firm amid the considerable sell-off in the shorter sectors JGB yield change over this week. the auction result turned out to be extremely strong. the market once again followed the recent pattern of heavy upside after strong auction results.50 4. The super-long end swap curve moved higher in a relatively parallel fashion (Exhibit 4). Ltd declined by another 85 cents. We think these facts indicate that the price actions in the volatility market might have reflected simply the short-term price movements in the underlying interest rates and not Exhibit 3: The futures sector (7Y-8Y) was sold off by more than 10bps.94bp/day rise in the implieds. while the rise in the vega sector volatilities was relatively limited 3Mx10Y and 2Yx10Y ATMF implied volatilities since 2011.00 2. but the 20Y sector was choppy before and after the 20Y auction. For example. the curve massively bear flattened. the 30Y and 40Y sectors remained strong in the super-long sectors as well as on the entire curve. Although the earlier expectation was negative.00 3. However. The super-long sectors remained relatively strong on the curve. Then. Although the 5Y yield managed to stay within the recent range of 0.50 2. The rise in the vega sector volatilities also outperformed the same skew prediction.37% on 15 March (Exhibit 2). causing a richening in the super-long end ASWs. The swap curve was also shifted upwards but the striking difference from the JGB curve is in the super-long sectors. It seems that real money investors took the sell-offs as a good opportunity to build positions before fiscal year-end (end of March) It appeared that the concept of relative-values was lost and that of momentum gained grounds. However. 2012 Takafumi Yamawaki (81-3) 6736-1748 Yuya Yamashita. The move was impressive.00 1. the skew of the 3Mx10Y payers swaption a week ago had predicted an approximately 0.50 3. The implied volatilities exploded. bp/day 5.50 Jan '11 May '11 Sep '11 Jan '12 2Y x 10Y 3M x 10Y 53 . and the new 20Y JGB were sold off by about 4bp. bp 9 8 7 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 101112131415161718192021222324252627282930 Exhibit 5: The gamma volatilities spiked and the rise was far more than what had been implied by the skew. The super-long sectors remained firm amid the considerable sell-off in the shorter sectors (Exhibit 3).1bp/day rise in implied volatility per every 10bp increase in the ATMF.

Ltd investors’ long-term or structural views such as Japan’s fiscal concerns. the JGB market had been range-bound for so long and investors’ positions could have been skewed too much towards longs. and some market participants expect additional easing measures such as a further upsizing of the JGB purchase under the programme or an extension of the maturity of JGBs eligible under the programme. It would be difficult to do so after the plan was once approved by the party and then officially by the cabinet. Still. There could still be some portfolio adjustment activities of domestic investors. 2012 Takafumi Yamawaki (81-3) 6736-1748 Yuya Yamashita. Third. Yen 12000 11000 10000 9000 8000 7000 6000 Jan '09 Jul '09 Jan '10 Jul '10 Jan '11 Jul '11 Jan '12 bill to the Diet this month and the party is now discussing specifically the bill on consumption tax hike. All of the loss is due to the 7Y long but the . While the sell-off in US Treasuries after the FOMC statement did trigger the sell-off in JGBs. prompting us to think of the possibility of a fall-back (Exhibit 6). we maintain long 7Y via weighted 5s/7s/10s butterfly. First. According to news reports. there did exist some background that could accelerate sell-offs. if the futures price auctions this week were driven by trendfollowing speculative investors. rally in debts and equities can take place under global monetary easing. was already approved within the DPJ in January 2012 as part of the integrated tax and social welfare reform plan. some members showed opposition to additional clauses that enable further tax hikes (above 10% after 2015). However. there are reports that the party leadership could amend or delete such additional clauses so that the party puts together the tax plan and submits the bill within this month. Second. Then. The outline of the consumption tax hike itself. In addition. the other reason is that we underestimated the effect of the BoJ’s announcement last month. the short to intermediate yields even lowered and remained to be low. and trend-following speculative investors may make another round of shorts on the futures. However. We unwind the position at a loss. making it easy for investors to buy risky assets instead of safe assets. Most of the loss came from this week’s sell-off.4bps since we initiated the trade but the loss was partly offset by its good rolldown. the rally in equities and the depreciation of the JPY since the beginning of this year was significant and could have been a good reason for bond investors to reduce positions. the rally in equities since the beginning of this year appears very quick and large when compared with the past movements. Even if the futures price rebounds. Third. The Democratic Party of Japan (DPJ) is now doing the preliminary review for the bill on the consumption tax hike. prompting us to think of the possibility of a fall-back Nikkei 225 since 2009. After the announcement. CFA (81-3) 6736-1493 JPMorgan Securities Japan Co. Second. as we believe they were. Meanwhile. there are some reasons to expect a rebound of the moves. but we need to keep monitoring progress on this issue ahead of the bill’s submission to the Diet. Going forward. Upside in JGB yields could be limited. they must cover the shorts at some point in the future. where the rate is hiked to 8% in April 2014 and to 10% in October 2015. The trade underperformed by 3. at least in the near future. short-to-intermediate yields will likely remain relatively low and stable as long as the BoJ continues to buy JGBs under the APP. but not to the originally planned tax hike. the BoJ’s support may keep the 5Y yields at a low level and the flattening of the 5s/8s curve may be limited. there is still another 3 months until Operation Twist ends. We continue to think that the probability for another ‘Ozawa Shock’ is very low. Greece finally completed the debt exchange. First. the plan was officially approved by the cabinet in February 2012. Trade idea updates The 5s/8s flattener was particularly hit hard by this week’s future led sell-offs. we do not expect a large sell-off or consistent rise in yields from here. Prime Minister Yoshihiko Noda reportedly plans to submit the 54 Exhibit 6: The rally in equities since the beginning of this year appears very quick and large when compared with the past movements. Finally. as long as the Fed purchases the longterm US Treasuries and stabilises UST yields. The possibility of sudden and disruptive risks had significantly lowered..1bps since initiation. as we suggested last week.Japan Rates Research Global Fixed Income Markets Weekly March 16. The 5s/8s curve flattened by 8. in hindsight.

Third.6 1. Second.1 1.Japan Rates Research Global Fixed Income Markets Weekly March 16.70 7Y JGB Yield (%) 0.20 0.10 0. We recommend selling 3Mx10Y payers swaption with the strike of ATMF + 20bp. expect a reversal. the weighted butterfly spread was pushed up to the extreme level (Exhibit 7) not only by the 5s/7s but also by the flattening of 7s/10s curves (Exhibit 8). Ltd loss has been limited due to the reduced weight in the belly.P.25 0. we expect a rebound in the futures price with short covering some time in the future. the payer skew has been widening since September 2011 and is at around the widest level since 2011 (Exhibit 9).30 0. First.05 0.9 Jan '10 Jun '10 Nov '10 Apr '11 Sep '11 Feb '12 Source: J.5 1.00 Jan '10 May '10 Sep '10 Jan '11 May '11 Sep '11 Jan '12 Exhibit 7: The weighted butterfly spread was pushed up to the extreme level… JGB weighted 5s/7s/10s butterfly since 2012.2 1. 2012 Takafumi Yamawaki (81-3) 6736-1748 Yuya Yamashita.0 Spot 10Y swap rate Break-even Weighted 5s/7s/10s butterfly -30 -35 -40 -45 -50 -55 0. We recommend the trade for the following reasons.50 0. bps -25 Exhibit 10: The breakeven swap rate level of 1. the current ATMF 20bp is about 1.90 1.30 0. as we explained previously.35% and the breakeven swap rate after the premium paid upfront is considered is 1.. As we explained above. In addition. The rise in gamma volatilities appears to provide a good opportunity for selling short expiry options.15 0. bps 55 50 45 40 35 30 25 20 15 10 '11/1 '11/3 '11/5 '11/7 '11/9 '11/11 '12/1 '12/3 7s/10s 5s/7s Exhibit 9: The payer skew has been widening since September 2011 and is at around the widest level since 2011 Difference between ATM payers vol and 20bp OTM payers vol since 2010. Morgan *the weighted buttefly = -100% x 5Y + 168% x 7Y -100% x 10Y 55 .4 1.3 1. Though there could be still some sell-offs. CFA (81-3) 6736-1493 JPMorgan Securities Japan Co. The premium paid upfront is currently about 37 cents (mid).38%. The level was reached only under extreme environments since mid2010 such as the sell-off backed by the Fed’s QE2 and the profit-taking selling after the Great Tohoku Earthquake (Exhibit 10). bps 1.35 0. and therefore. Exhibit 8: …not only by the 5s/7s but also by the flattening of 7s/10s curves JGB 5s/7s and 7s/10s curves since 2011.38% was reached only under extreme environments since mid-2010. such as the sell-off backed by the Fed’s QE2 and the profit-taking selling after the Great Tohoku Earthquake Spot 10Y swap rate since 2010.10 0. we view that the outperformance in the gamma sectors simply reflected the bearish price moves in the underlying interest rates and not investors’ longterm or structural views. we expect the trade to finally perform. bp/day 0.

Japan Rates Research Global Fixed Income Markets Weekly March 16. CFA (81-3) 6736-1493 JPMorgan Securities Japan Co.. 2012 Takafumi Yamawaki (81-3) 6736-1748 Yuya Yamashita. Ltd Recommended trades • • • • • • • • • Maintain neutral stance on duration Maintain JGB steepeners (such as 8s/30s) Maintain paying 10Y swap via 5s/10s/20s butterfly Maintain FX LIBOR basis 1s/5s steepener Maintain weighted 20s/30s swap spread curve flattener Maintain paying 3x2 forward swap with long JGB futures Maintain long 7Y JGB via weighted 5s/7s/10s butterfly Unwind JGB 5s/8s flattener Sell 3M x 10Y payers swaption with the strike of ATMF + 20bp 56 .

Our US rates strategy team retains a bearish bias and targets US 10Y yields to reach 2. are neutral duration and curve spreads at these levels. but if policy were to change this year. We think this trade should perform well when implemented in either real or nominal space Our preferred trade. it would be biased towards lower rates. after a run of broadly better data earlier in the year. after a run of broadly better data earlier in the year.P. as such. Our current view is that the RBA will be on hold for an extended period. the RBA’s expectation is centred on trend growth and inflation consistent with the target band. but the recent data pulse suggests that growth disappointment could be the theme (once again) in 2012.auld@jpmorgan. We recommend entering a 2s/9s swap curve steepener.com J. the data pulse has turned rather quickly of late (Exhibit 1). Morgan Securities Australia Limited Australia & New Zealand • Our current view is that the RBA will be on hold for an extended period. It is interesting to observe that the Norges Bank cited a strong currency when it delivered a surprise rate cut this week.50%. but on the other hand. Obtaining a decent read on the domestic economy is difficult at present. 1Y forward We think NZ outrights and curve spreads are largely fairly priced given the macroeconomic and policy backdrop and. housing finance. it would be biased towards lower rates.” 57 • • • . as our FX Strategy team noted. Our technical strategists also have a bearish view. with the data providing mixed signals on the economy. currently. given that the market has moved from a ‘trading range market’ to a ‘trending market’ We continue to believe that AUS-US 10Y spread compression trades are one of the better strategic trades for the Australian market. albeit with a weaker bias of late (consumer confidence. Indeed.4bp). Also. The recent sell-off in NZD rates means that carry and slide in received positions is starting to look attractive again (for example. especially distinguishing between the effects of structural changes and cyclical forces. these trades will perform well if the US curve continues to bear-steepen (the near-term risk. the AUD seems to have decoupled from commodity prices somewhat. especially if high-frequency data momentum is any indicator.a. the data pulse has turned negative rather quickly of late Our tactical short-duration position has worn some mark-to-market volatility since we last published. the theme of growth rotation (away from EM Asia/Australia towards the US) may continue. At the moment. In addition. but has performed well over the course of the week as UST 10Y yields finally broke their recent trading range. “The message for investors is not to ignore currency adjustments to the extent that these become a problem for policymakers – the group of countries that are erecting ever-higher barriers to prevent excessive currency appreciation just got larger today (a Nordic front for the currency wars that extends from Switzerland to Brazil. These positions do not have too much negative roll-up to spot. We would look to enter received positions in 1Y/1Y swap at 3. GDP). the RBA’s expectation is centred on trend growth and inflation consistent with the target band. term yields remain close to all-time lows. Bloomberg Monetary policy update: how long can the RBA’s tough love last? The broader macro backdrop has not changed much. 1Y/1Y swap offers 3-month carry and slide of 14. as we note above) or if the RBA ultimately delivers more easings.European Rates Strategy Global Fixed Income Markets Weekly March 16. In a broad sense. Morgan. Indeed. dwelling starts. is a forwardstarting steepener in AUD swaps. the exact stance of policy is harder to determine post crisis: fiscal policy will be contractionary if the government’s budget forecasts are achieved (Exhibit 2).P.42%) Exhibit 1: Economic surprise index for Australia Index 100 80 60 40 20 0 -20 -40 -60 -80 -100 Jan-10 Sep-10 May -11 20 day m. and could yet take in other countries such as NZ).6% (current: 3. At the moment. but the recent data pulse suggests that growth disappointment could be the theme (once again) in 2012. Jan-12 • Source: J. but if policy were to change this year. given the flatness of the forward curve structure. 2012 Sally AuldAC (61-2) 9220-7816 sally.m.

2012 Sally AuldAC (61-2) 9220-7816 sally.auld@jpmorgan. considering one measure at least. Exhibit 2: Aggressive fiscal consolidation One-year change in budget balance as a % of GDP.0 1.00 0. In this context. we have decided to take profits at current 58 50 30 10 -10 -30 -50 -70 Mar-95 ANZ new spaper job ads. inv erted -2. rhs. Morgan Securities Australia Limited When thinking about the broader stance of policy.00 3. pushed fw d. while the current level of the real cash rate looks low by historical standards.5 0. the path of monetary policy is likely to be guided largely by the path of the unemployment rate – even the RBA’s Deputy Governor has said as much: “Of course.7-ppts in 72mths 3. If so. We are taking a small profit on our OIS curve steepener and have now reduced conviction in this trade. enter forward-starting swap-curve steepeners Our tactical short-duration position has worn some mark-tomarket volatility since we last published but has performed well over the course of the week as UST 10Y yields finally broke their recent trading range. Our technical strategists also have a bearish view.6-ppts in 18mths 2.00 2. ppts 3 2 1 0 -1 -2 -3 -4 -5 1971-72 1979-80 1987-88 1995-96 2003-04 2011-12 Exhibit 3: Real cash rate cycles – the last tightening cycle was % 6.5 1. If the unemployment rate were to rise persistently. 14 March 2012). If this were to turn out to be the case.P.5 -1.00 4.” (Our emphasis) This suggests that the best guide to policy will be leading indicators of the labour market – in particular. given that the market has moved from a ‘trading range market’ to a ‘trending market’ (see M. given risks to the economic and policy outlook.5 Uses Feb reading for Q1 data Feb-00 Jan-05 Dec-09 2. Further.50%. with the unemployment rate having been in the 5 to 5¼ per cent range over the past year. Krauss.m.0 0. it might suggest that the contractionary effect of the high exchange rate was more than offsetting the expansionary effect of the investment boom and the terms of trade.8-ppts in 12mths 1.00 5.0 -0. Ultimately. So. the recent read on ANZ newspaper job ads was telling (Exhibit 4). lhs.European Rates Strategy Global Fixed Income Markets Weekly March 16. The rise in the real cash rate since the cyclical trough in 2009 has been one of the sharpest tightenings since the early-1990s – a 350bp rise in two years (Exhibit 3).0 -1.com J. the unemployment rate. monetary policy would have the flexibility to respond provided the inflation outlook remained benign. Despite this. Our US rates strategy team retain a bearish bias and target US 10Y yields to reach 2. Global FI Technical Strategist.5-ppts in 24mths Aug-97 Jan-02 Jun-06 Nov -10 Exhibit 4: ANZ newspaper job ads look soft oya % ppts Strategy update: take profits on tactical shorts and OIS curve steepeners.00 Mar-93 2.0 .00 -1. 6 mths Annual change in the u-rate.00 -2. then risks to the policy and economic outlook would be heavily biased towards a significantly higher unemployment rate at some point in 2012.00 1. the tightening cycle of the past couple of years was quite aggressive. it is possible for exchange rates to overshoot … An important indicator here is the labour market. a longterm chart of the real cash rate is telling. It will be interesting to see whether the March data on job ads (due on 10 April) will validate the latest data print. it probably does not look so low if the currency is taken into account.

4bp. Target: 180bp).5 1. There are a number of reasons for this.a. largely because we are no longer so confident about the broader policy backdrop being strongly in favour of a neutral rates environment. 3m. and place a stop at +63bp. inv erted 3. US Index 150 100 50 0 -50 -100 -150 Jan-10 Sep-10 May -11 20 day m.0 0. we have also taken profits on our AUD OIS curve steepener. especially if highfrequency data momentum is any indicator (Exhibit 5). 2012 Sally AuldAC (61-2) 9220-7816 sally. these positions do not have too much negative roll-up to spot. is a forward-starting steepener in AUD swaps.0 0. As we noted above.0 5. lhs RBA cash rate. pushed fw d 5q 7. Morgan Securities Australia Limited levels on our short in 3Y bonds.m.0 1. We hold our 10Y spread narrowing trade (Entry: 203bp. Foreign investors now own a record 76.5 0.0 4.0 Aug-02 Oct-05 Dec-08 Feb-12 Exhibit 7: 2s/9s curve.5 1. lhs Real GDP spread. The trade offers 3-month carry and slide of 1. pushed fw d.0 2. Indeed.0 -3.0 1.0 Mar-00 Offshore holdings of ACGBs reach a new record-high at the end of 2011 The release of the Balance of Payments data for the December quarter of 2011 showed a new high in offshore ownership of ACGBs. lhs. if we think about relative inflation-term risk premia.European Rates Strategy Global Fixed Income Markets Weekly March 16. a spot spread of +69bp). Current: 197bp. In terms of forward-starting curve spreads. We think this trade should perform well when implemented in either real or nominal space.4bn in the fourth quarter of 2011 (Exhibit 9).com J. 1Y fw d.0 Jun-99 10y AUS-US real y ield spread. rhs. the theme of growth rotation (away from EM Asia/Australia towards the US) may continue. currently.0 0. the relative central bank stance (and credibility) should once again favour the AUS 10Y nominal bond over and above the US 10Y nominal bond. Exhibit 7 illustrates that the curve tends to be well correlated with moves in the RBA cash rate. we prefer to implement the trade by receiving 1Y/2Y swap against 1Y/9Y swap: Enter a steepener by receiving 1Y/2Y swap against 1Y9Y swap at a spread of +73bp (vs. Second. given the flatness of the forward curve structure. We continue to believe that AUS-US 10Y spread compression trades are one of the better strategic trades for the Australian market. AUS vs.0 -1. Net inflows into the market from offshore recorded their fourteenth consecutive quarterly increase – net inflows were $21.5 -1.0 3.0 6.P. Exhibit 5: Relative economic surprise indices.5 0. First.auld@jpmorgan.0 4. seeing as yields have reached the top of the recent trading range. 1Y fwd vs.5 2.5 -1.0 5. 2s9s sw ap curv e.0 7.3% of the Australian government’s bond market (Exhibit 8). Our preferred trade. In a broad sense. Exhibit 7 illustrates scope for ongoing real-yield compression in 10Y spreads.0 Oct-03 May -07 Dec-10 59 . Further. US out-performance Jan-12 AUS out-performance Exhibit 6: AUS-US 10Y real yield spread ppts ppts 2. RBA cash rate ppts % 1. these trades will perform well if the US curve continues to bear-steepen (the near-term risk.0 6.0 -2. target a move to +95bp.0 8.0 -0. as we noted above) or if the RBA ultimately delivers more easings.0 -0.

while offshore holdings have increased by $110bn over the same period. We would look to enter received positions in 1Y1Y swap at 3. we think the currency and fiscal adjustments imply a ‘low for longer’ environment for New Zealand term rates. and we like receiving on dips The RBNZ’s Monetary Policy Statement was more dovish than most expected.6% (current: 3. The recent sell-off in NZD rates means that carry and slide in received positions is starting to look attractive again (for example. 1Y1Y swap offers 3M carry and slide of 14. AUDbn 30000 25000 20000 15000 10000 5000 0 -5000 Dec-88 Feb-93 Apr-97 Jun-01 Aug-05 Oct-09 RBNZ at peace with higher NZD and lower rates: curves will trade directionally. Australia still retains one of the highest term structures of yields of any AAA-rated sovereign issuer. which. Exhibit 8: Foreigners hold 76% of ACGBs in issue – a new high Proportion of ACGBs held offshore. Our analysis suggests that a 1ppt increase in offshore holdings of ACGBs lowers the fair value estimate of 10Y bonds by around 4. ACGBs outstanding have increased by $125bn over the past two years.P.m.5 0. the coming fiscal adjustment in New Zealand is significant (Exhibit 10). all other things being equal.5bp. 2) swap spreads will be structurally wider. In addition.1 Sep-88 Jun-93 Mar-98 Dec-02 Sep-07 Exhibit 9: No sign that interest in ACGBs is waning $Quarterly net inflows into ACGBs. this alone appears to be a compelling justification for investment in ACGBs.com J. Curve spreads should trade directionally and strategically – we would favour being better receivers of NZD rates.8 0. interest from private retail and institutional investors. given the macroeconomic and policy backdrop and. are neutral duration and curve spreads at these levels. and 3) the 3s/10s spread will be structurally flatter.4 0. Taken together.2 0. Structurally higher foreign demand for ACGBs implies that 1) the term structure of rates in Australia will remain lower than has historically been the case. The RBNZ appears to have finally accepted that the higher NZD is a structural phenomenon.European Rates Strategy Global Fixed Income Markets Weekly March 16.auld@jpmorgan. increasingly. ppts 0. 2012 Sally AuldAC (61-2) 9220-7816 sally.3 0. 60 Exhibit 10: Relative fiscal consolidation – NZ leading the pack ppts Germany Japan France Canada Euro-area Italy Spain UK United States Australia New Zealand 0 2 4 6 8 Change in budget balance 2011 to 2013 (ppts) . for many investors. as such. all other things being equal. We think NZ outrights and curve spreads are largely fairly priced. We continue to expect offshore demand for ACGBs to keep term yields suppressed in Australia (financial repression does not necessarily respect borders).42%).4bp). Domestic bank holdings of ACGBs have remained largely stable over the past couple of years (at around $20bn).6 0. foreign demand for ACGBs continues to be driven by central bank reserve diversification and. with the RBNZ citing sustained strength in the currency as reducing the need for future increases in the OCR. Morgan Securities Australia Limited Generally speaking. has generated tighter financial conditions. In our view. demand from offshore has largely absorbed most of the net supply in ACGBs over the past two years.7 0.

0bp 96. Morgan. Take Profits.60 94.0bp 63.2bp +4.0bp -21.0bp -12. 1-Mar -17. Source: J.0bp Current 197.0bp flat 1-Mar -13.0bp 73.47 96.0bp New Trade. We now have less conviction that this position adequately reflects risks to the policy and macro backdrop.5bp 29.5bp -13.10 9-Feb 44. 2012 Sally AuldAC (61-2) 9220-7816 sally. *Price is YMM2.1 +15.0bp 95.0bp 16-Mar 73.P.20* +23. 12month) Buy KfW Jan-16s vs.7 P/L +5.8bp -25.European Rates Strategy Global Fixed Income Markets Weekly March 16.com J. We like the spread narrowing trade as a strategic position to reflect AUS outperformance.0bp Comment Hold Trade. 8 Feb Sell YM1 QTC ASW flattener (Jul-22s vs.0bp 0.6bp +0. The trade has reached our target level.P.5bp 34.3bp Stop 213.4bp 50. 1Y forward 96. Nov14s) AUD OIS steepener (3-month vs. EIB Apr-15s on ASW AUS 2s/9s swap curve steepener. Take Profits.0bp Target 180.auld@jpmorgan. P/L takes into account the futures roll 61 . Morgan Securities Australia Limited Trade Updates Current Trades Date 7-Feb Trade AUS-US 10Y spread contraction trade Entry 203. Hold Trade. Outrights have reached the bottom of the recent trading range.1bp -7.0bp Take Profits.m.

European Rates Strategy Global Fixed Income Markets Weekly March 16.25 4.50 4.25 4.33 4.25 4.20 4.com J.20 3. Bloomberg (current values) 62 .25 4. Morgan (forecast values).25 4.40 4.40 2.75 4.50 4.30 4.m.30 3.30 Jun-12 Sep-12 Dec-12 Mar-13 Source: J.auld@jpmorgan.P.P.00 4. 2012 Sally AuldAC (61-2) 9220-7816 sally. Morgan Securities Australia Limited Forecast Table Current Australia RBA cash rate 10-year yield New Zealand RBNZ OCR 10-year bond 2.25 4.25 4.20 2.

75 3M 0.00 4.0.15 1.25 4.25 1.23 1.97 94 92 186 0.40 Govt curve 0.47 0.20 3.81 1.25 4.33 4.06 2.chordia@jpmorgan.50 4.35 1.25 30Y 2.00 0.European Rates Strategy Global Fixed Income Markets Weekly March 16.34 0.25 Libor 3M 0.15 102 100 202 63 .05 0.25 1.85 0.95 2.71 2.00 2.15 1.30 1.05 1.0.0.37 1.10 2.0.07 1.75 0.50 Govt curve 2s/10s 197 205 10s/30s 104 95 2s/30s 301 300 2Y 81 80 5Y 49 45 Swap spreads 10Y 19 20 30Y -12 -10 Japan O/N call rate 2Y 5Y 10Y 20Y 30Y 2s/10s 10s/30s 2s/30s 10Y 4.10 10Y 2.25 0 .35 1.85 2.60 3.05 1.0.75 0.40 3.30 0.45 0.37 0.50 Govt curve 30Y 3.30 5Y 1.75 4.50 Libor 3M 1.05 2Y 0.25 4.50 0. 2012 Aditya ChordiaAC (44-20) 7777-9841 aditya.50 1.25 0 .30 0.50 1.50 0.P.80 2.40 1.05 0.13 0. Interest rate forecasts Euro area Refi rate Euribor 16-Mar-12 Jun-12 1.30 2.20 2.55 30Y 3.25 0 .13 0.70 170 70 240 85 65 45 10 Mar-13 0.60 3.45 2.20 2.25 0 .25 10Y 2.50 2.00 0.04 1.05 0.30 5Y 1.50 0.50 2.48 0.50 1.40 190 100 290 80 40 20 -15 United States 16-Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Fed funds 0 .25 4.60 3.65 0.00 2.50 1.95 2s/10s 172 195 10s/30s 66 70 2s/30s 237 265 2Y 84 70 5Y 65 50 10Y 37 30 30Y 1 5 Sep-12 0.30 0.40 190 100 290 80 40 20 -15 Mar-13 0.50 2.25 4.65 2Y 0.05 2.com J.80 180 70 250 75 55 35 5 Sep-12 0.32 2.75 0.25 1.50 2Y 0.75 175 70 245 80 60 40 10 Dec-12 0.40 3.50 205 95 300 80 40 20 -15 Dec-12 0.20 2.30 1.30 New Zealand Cash rate Govt curve 10Y 2.30 4.40 2. Morgan Securities Ltd.30 3.75 0.13 1.x.30 10Y 2.12 0.11 0.43 3.05 1.00 0.20 4.80 2.00 0.60 2s/10s 195 220 220 220 220 10s/30s 111 110 110 110 110 2s/30s 306 330 330 330 330 2Y 24 22 22 22 22 5Y 22 25 27 27 27 Swap spreads 10Y 6 6 6 7 7 30Y -28 -28 -27 -27 -27 Australia Cash rate Govt curve Govt curve Swap spreads United Kingdom 16-Mar-12 Jun-12 Base rate 0.55 3.50 1.30 0.05 92 100 192 0.50 4.70 0.00 2.05 0.50 5Y 1.00 103 85 188 0.25 4.05 0.50 1.00 92 95 187 0.40 1.13 0.95 2.49 3.25 4.

13 1.77 0.05 0.29 1.87 2.39 0.07 0.19 3.96 1.86 1.98 3.59 0.44 0.06 2.07 2.16 1.chordia@jpmorgan.74 1.59 1.82 1.86 1.30 2.07 1.76 1.77 74 58 58 55 51 17 12 12 10 10 177 154 154 148 130 74 67 67 62 60 74 76 74 74 57 86 88 88 86 79 Swap spreads 16-Mar-12 1W ago 2W ago 1M ago 3M ago 16-Mar-12 1W ago 2W ago 1M ago 3M ago 2Y 24 25 25 29 48 24 23 23 24 26 5Y 22 24 25 26 40 16 16 15 13 13 10Y 6 7 8 7 16 5 3 3 0 -1 30Y -28 -30 -29 -33 -28 -3 -7 -6 -11 -17 2s/5s -2 0 0 -3 -8 -8 -7 -8 -10 -13 2s/10s -18 -18 -17 -21 -32 -20 -20 -20 -24 -26 10s/30s -34 -37 -37 -41 -44 -8 -10 -9 -11 -16 64 . Morgan Securities Ltd Recent curve movements EUR Govt.34 0.34 0.94 0.81 0.58 1.99 0.04 1.23 0.73 2.43 0.48 0.62 0.34 0.96 0.97 1.50 3.15 2.European Rates Strategy Global Fixed Income Markets Weekly March 16.43 3.92 1.07 2.98 1. 2012 Aditya ChordiaAC (44-20) 7777-9841 aditya.37 0.49 3.30 0.00 56 45 46 41 43 46 34 35 30 25 127 118 118 113 107 133 116 120 114 103 27 28 27 24 8 73 73 75 75 67 Swap spreads 16-Mar-12 1W ago 2W ago 1M ago 3M ago 16-Mar-12 1W ago 2W ago 1M ago 3M ago 2Y 84 91 86 88 112 81 80 77 87 96 5Y 65 74 71 73 92 49 52 53 58 61 10Y 37 43 40 42 55 19 25 24 24 24 30Y 1 8 6 6 11 -12 -11 -11 -15 -9 2s/5s -19 -17 -15 -16 -21 -33 -28 -24 -28 -35 2s/10s -47 -48 -46 -47 -57 -63 -55 -53 -62 -72 10s/30s -36 -35 -33 -36 -44 -31 -36 -35 -39 -33 USD Govt.96 0.33 2.17 1.23 1.30 1.89 1.52 1.49 2.46 2.18 1.11 0.86 0.58 0.23 0.11 3.42 2.44 2.71 2.30 1.59 1.55 2.23 0.37 3.22 3.81 2.86 0.04 1.53 2.42 2. curve 2Y 5Y 10Y 30Y 2s/5s 2s/10s 10s/30s Swap curve 2Y 5Y 10Y 30Y 2s/5s 2s/10s 10s/30s GBP 16-Mar-12 1W ago 2W ago 1M ago 3M ago 16-Mar-12 1W ago 2W ago 1M ago 3M ago 0.30 1.10 1.52 0.23 1.80 1.36 1.13 0.37 0.01 0.25 2.93 76 58 57 57 58 26 19 19 19 22 195 172 171 170 162 94 88 88 84 86 111 115 113 116 101 92 97 95 98 95 16-Mar-12 1W ago 2W ago 1M ago 3M ago 16-Mar-12 1W ago 2W ago 1M ago 3M ago 0.22 2.53 0.09 74 61 62 63 59 75 59 57 59 59 172 163 164 164 165 197 164 167 171 175 66 65 62 61 52 104 114 116 119 104 16-Mar-12 1W ago 2W ago 1M ago 3M ago 16-Mar-12 1W ago 2W ago 1M ago 3M ago 1.35 0.21 0.90 1.07 2.40 0.11 0.48 2.79 1.90 0.15 0.P.85 1.85 0.54 2.42 2.99 0.16 0.50 1.11 2.78 1.11 0.11 0.30 0.45 2.32 0.38 3.47 2.14 1.29 0.17 3.11 2.x.38 1.30 0.99 1.89 2.34 0.02 0.12 2.28 0.94 1.12 3.78 0.96 1.82 2.03 1.06 1.39 2.17 1.46 0.32 2.05 2.com J.72 0.12 3.80 1.37 2.98 3.64 2.47 0.59 1.11 1.34 1. curve 2Y 5Y 10Y 30Y 2s/5s 2s/10s 10s/30s Swap curve 2Y 5Y 10Y 30Y 2s/5s 2s/10s 10s/30s JPY 16-Mar-12 1W ago 2W ago 1M ago 3M ago 16-Mar-12 1W ago 2W ago 1M ago 3M ago 0.01 1.31 3.39 2.22 3.52 1.99 0.86 2.35 2.

4 60 0.8 16-Mar-12 1W ago 2W ago 1M ago 3M ago Austria 81 100 102 112 142 Belgium 127 164 160 173 278 Finland 41 49 55 55 68 France 77 95 91 106 121 Netherlands 39 49 47 53 55 Ireland 419 445 441 432 711 Italy 280 303 288 390 545 Portugal 1475 1529 1539 1367 1394 Spain 276 285 277 316 364 Wtd. peri.chordia@jpmorgan.5 47 -0.4 282 1.3 141 1.5 39 0.2 310 -1.P.3 156 -0. Italy and Spain (weighted by the size of their outstanding bond market).6 11 0. 2012 Aditya ChordiaAC (44-20) 7777-9841 aditya. Portugal.6 98 -0.European Rates Strategy Global Fixed Income Markets Weekly March 16.2 227 -1.8 133 -0. 65 .3 89 0.3 120 -0.4 124 -0.4 148 -0.com J. Morgan Securities Ltd Recent sovereign cash spread movements Cash spread to Germany.x.1 13 0.6 2 2.9 133 -1.1 101 -0.2 16-Mar-12 1W ago 2W ago 1M ago 3M ago Austria 78 87 86 88 85 Belgium 125 153 160 159 203 Finland France 103 115 116 116 116 Netherlands 15 14 12 12 9 Ireland Italy 287 314 316 355 459 Portugal 792 815 798 725 676 Spain 318 327 318 347 370 Wtd. peri. spread* 286 285 281 366 517 1Y max 139 469 51 150 70 2164 713 2216 548 737 1Y avg 47 148 17 48 17 824 315 1355 266 390 1Y SD 1Y z-score 30 0.2 17 0.4 16-Mar-12 1W ago 2W ago 1M ago 3M ago Austria 83 98 103 115 113 Belgium 132 168 171 174 243 Finland 47 50 50 53 56 France 92 107 107 117 121 Netherlands 45 45 40 45 37 Ireland 492 514 513 512 658 Italy 290 314 321 380 505 Portugal 1132 1167 1157 1003 1068 Spain 311 318 307 343 375 Wtd.5 10 0.0 *Weighted peripheral spread computed against Germany for Ireland. peri.0 73 -0.4 37 0.0 39 0. spread* 357 386 387 422 520 1Y max 189 357 80 188 65 1142 575 1406 500 566 1Y avg 85 181 45 85 38 678 334 957 313 390 1Y SD 1Y z-score 38 0. bp 2Y 1Y min 9 33 4 4 3 380 83 644 102 154 5Y 1Y min 30 84 6 21 6 416 102 685 155 181 10Y 1Y min 31 72 24 30 22 494 125 517 170 188 30Y 1Y min 28 75 32 6 153 302 185 173 16-Mar-12 1W ago 2W ago 1M ago 3M ago Austria 43 58 54 57 70 Belgium 95 110 106 130 236 Finland 16 18 20 22 14 France 45 46 40 47 80 Netherlands 20 22 17 18 30 Ireland 412 434 424 387 769 Italy 192 200 198 313 500 Portugal 1560 1484 1476 1413 1423 Spain 189 197 186 242 308 Wtd.9 21 0. 30Y does not contain Ireland and Finland.0 87 -0.3 8 0.0 61 -0.3 180 1.0 32 -0.6 93 -0.0 69 0.0 73 -0. spread* 311 355 353 381 451 1Y max 158 297 199 16 515 919 448 500 1Y avg 66 159 85 10 323 594 306 340 1Y SD 1Y z-score 30 0. spread* 359 380 369 432 559 1Y max 219 433 93 187 83 1509 675 2079 495 670 1Y avg 88 200 44 77 39 749 350 1212 308 413 1Y SD 1Y z-score 47 0. peri.8 327 0.

Morgan Securities Ltd Recent sovereign CDS spread movements CDS spread*.7 70 0.2 16 -0.5 83 -0. bp 15-Mar-12 1W ago 2W ago 1M ago 3M ago US 29 29 29 29 29 UK 23 23 24 29 54 Germany 26 28 27 34 49 Austria 107 109 102 110 146 Belgium 169 181 175 206 300 Finland 32 32 33 35 39 France 117 119 111 123 163 Netherlands 50 51 47 50 71 Ireland 633 633 597 645 955 Italy 320 324 329 385 588 Portugal 1961 1756 1683 1566 1655 Spain 354 350 318 363 417 Wtd. Germany.chordia@jpmorgan. Portugal and Spain.3 9 0. Ireland. Netherlands and US.com J.6 85 0.8 118 0. 100bp running coupon used for UK.9 141 0.x.3 49 0.4 150 0. France. 2012 Aditya ChordiaAC (44-20) 7777-9841 aditya. Belgium.7 12 -1.6 185 -1.European Rates Strategy Global Fixed Income Markets Weekly March 16.9 25 -0.4 34 0.2 19 0. Austria.4 56 0. peri. weighted by the size of their outstanding bond market.1 15 -0. peri.4 20 0.1 219 1.5 70 -0. Spreads for all the countries except US are in $ CDS and for US it is in € CDS. 66 . **Weighted peripheral spread computed as CDS spread of Ireland.3 * 25bp running coupon used for Finland. Italy.1 15-Mar-12 1W ago 2W ago 1M ago 3M ago US 40 40 40 40 40 UK 63 63 66 75 97 Germany 73 77 75 85 101 Austria 162 165 155 167 199 Belgium 220 232 222 240 326 Finland 64 64 65 69 78 France 175 179 166 180 222 Netherlands 97 99 92 98 126 Ireland 615 615 580 570 740 Italy 368 372 355 401 547 Portugal 1341 1200 1151 1071 1125 Spain 405 400 355 383 433 Wtd. Greece. spread** 445 433 422 464 628 2Y 1Y min 21 21 10 20 62 12 29 10 597 71 569 142 148 5Y 1Y min 40 47 36 50 115 24 63 28 510 125 539 197 189 1Y max 50 58 62 174 382 45 180 75 1606 627 2306 473 657 1Y avg 36 37 32 82 193 28 98 37 915 338 1341 318 423 1Y SD 1Y z-score 10 -0.1 395 1. spread** 449 442 415 446 563 1Y max 65 104 120 243 408 90 252 146 1199 583 1522 488 595 1Y avg 51 77 75 132 234 57 151 79 716 357 980 349 412 1Y SD 1Y z-score 10 -1.4 48 0. Italy and Spain.5 170 -0.P.1 55 0. Portugal.5 110 -0.

including MTNs but excluding short-term (maturity of less than one year) and self-funded deals (deals where there is only one bookrunner and it is also the issuer).European Rates Strategy Global Fixed Income Markets Weekly March 16. Belgium. P. Banks 0 2 0 0 0 0 0 0 0 0 0 0 0 0 0 3 0 2 0 0 0 1 3 0 1 2 1 15 Italy Sov. Ireland. Finland. Euro-area**** Sov. Source: J. Banks 1 0 0 1 1 1 2 1 1 0 1 1 0 9 Ireland Sov. Banks 0 5 27 1 2 17 12 11 20 13 30 0 21 0 154 2 6 3 2 2 4 6 4 10 3 10 6 63 Portugal Sov. Banks 0 4 18 6 0 2 0 5 28 13 0 12 19 0 5 22 0 0 105 0 5 9 1 3 14 3 11 76 Germany Sov. Germany and Netherlands. ** Maturities in all currencies and jurisdictions and include secured. Banks 0 1 0 0 10 1 0 0 0 0 1 0 0 0 13 0 1 2 2 0 0 0 0 0 0 2 0 9 Spain Sov. *** Austria.x. Banks 0 2 0 10 0 4 0 2 15 2 0 0 0 0 0 16 0 0 31 3 2 1 1 1 9 3 5 46 Core Euro-area*** Sov. France. Banks 0 6 12 0 0 13 0 2 20 0 0 14 0 0 62 15 10 25 8 3 7 5 10 5 11 7 9 120 Peri. Banks 1 0 0 2 0 2 0 1 10 1 0 0 0 1 0 0 0 0 13 0 2 1 1 2 0 1 2 14 Belgium Sov.chordia@jpmorgan. unsecured and securitised issuance. Banks 4 0 0 0 0 2 0 1 0 0 1 11 0 0 7 0 0 13 37 1 0 3 1 0 2 7 6 24 Finland Sov. Morgan Securities Ltd Euro area conventional bond* and bank debt** redemptions €bn Austria Sov. floaters zero coupons and international bonds.P. linkers. 2012 Aditya ChordiaAC (44-20) 7777-9841 aditya. Banks 0 0 0 1 0 0 0 1 0 0 1 6 0 0 0 0 0 0 7 1 0 0 0 0 0 1 0 4 France Sov. Portugal.com J. **** Greece. Banks 24 17 34 22 0 12 19 20 81 25 2 50 35 1 29 61 0 31 368 10 21 23 9 9 42 26 36 272 Mar-12***** Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Total Mar-12***** Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Total Greece Sov. Spain. Banks 19 10 16 3 0 2 19 9 27 10 0 21 16 0 17 24 0 18 177 5 11 9 5 3 18 12 11 108 Netherlands Sov. The data also include any government guaranteed issuance by the banks but no direct issuance by government or government sponsored institutions. Morgan. Dealogic 67 . Banks 0 15 39 1 12 31 12 13 40 13 32 14 21 0 229 21 17 33 12 5 12 12 18 15 16 22 16 215 * Marketable bonds include: conventionals. ***** For the remaining part of the month. Italy.

x.P.com J.chordia@jpmorgan. 2012 Aditya ChordiaAC (44-20) 7777-9841 aditya. Schlesw ig-Holstein BoE rate announcement Eurogroup meeting (17 finance ministers) G8 summit in Chicago BoE Quarterly Inflation Report EU Council Meeting (EU heads of state) ECB rate announcement BoE rate announcement French legislativ e election (round 1) French legislativ e election (round 2) Eurogroup meeting (17 finance ministers) Ecofin meeting (27 finance ministers) EU Council Meeting (EU heads of state) Election calendar Period 2012 22 2013 2014 2015 2016 Date Month ?? April Election in Greece France Austria Germany Italy Belgium Netherlands Finland Portugal Spain Ireland 68 .European Rates Strategy Global Fixed Income Markets Weekly March 16. Morgan Securities Ltd Event risk/election calendar Event risk Month March 2012 April 2012 Day Mon Tue-Thu ?? Wed Thu Wed Fri-Sun Sun May 2012 Thu Sun Sun Thu Mon Tue-Tue Wed Fri June 2012 Wed Thu Sun Sun Mon Tue Thu-Fri 4 5 11 20-22 22 3 6 6 10 14 15-22 16 25 6 7 10 17 18 19 28-29 Date 19 27-29 Country/Region Event Greece Greece Greece Euro area UK Greece IMF/World Bank France Euro area France Germany UK Euro area G8 UK Euro area Euro area UK France Euro area Euro area Euro area Euro area Greek CDS auction Bond holder meeting dates for foreign law bonds in the Greek PSI Greece parliamentary elections ECB rate announcement BoE rate announcement Ex pected settlement of Greek PSI for foreign law bonds IMF/World Bank spring meeting in Washington French Presidential election (round 1) ECB rate announcement French Presidential election (round 2) State elections.

3) Citigroup requires both S&P and Moody’s rating to be below IG.9 -3.6 -4.chordia@jpmorgan. Autumn 2011.0 -0.1 -0.8 23.com J.8 Amount offered for sterilization (€bn) 218. Balance Gross debt Curr.0 -3.0 -5.3 8.0 2.3 -0.0 0.1 -4.9 (% of GDP) 2012 -3.5 0.9 2.4 2. Morgan's EMU IG index requires any 1 of 3 credit ratings (S&P's.9 14.8 9.0 8.5 -3. DEV .4 0.0 0.x.0 -3.1 1.5 219.5 219. Outlook:NEG .0 First Last First Last 29-Feb 22-Feb 15-Feb 08-Feb 01-Feb 06-Mar 28-Feb 21-Feb 14-Feb 07-Feb 05-Mar 27-Feb 20-Feb 13-Feb 06-Feb 09-Mar 02-Mar 24-Feb 17-Feb 10-Feb Cumulativ e amount till 31 Jan 2012 “*” represents under watch.4 -7.5 -5.3 * HICP.5 -2.0 -4.9 -3. 8 August 2011.negative outlook.2 -5.0 0. %) 2012 0.566** GDP growth Inflation* Budget balance^ Prim.0 3.4 -4.3 -1.5 0.0 0.8 -3. acc.3 4. EC European Economic Forecast.0 -8. 2 – Markit iBoxx uses an average rating methodology (S&P.6 -2.3 1.8 (% of GDP) 2012 -0.5 219.617 623 169 1.5 -0. bal.3 0.0 0. rate (%) Latest 4. Source: Bloomberg Note: Every Tuesday ECB sterilizes SMP purchases during the period between the Wednesday two weeks back (first trade date) and the Tuesday of the previous week (last trade date).European Rates Strategy Global Fixed Income Markets Weekly March 16.3 1.0 7.1 224.1 -4.5 10.9 2. The ECB started buying Italian and Spanish bonds on Monday. Eurostat and ILO Sovereign ratings S&P Austria Belgium Cy prus Finland France Germany Greece Ireland Italy Netherlands Portugal Slov akia Slov enia Spain AA+ AA BB+ AAA AA+ AAA SD BBB+ BBB+ AAA BB A A+ A NEG NEG NEG NEG NEG NEG NEG NEG NEG NEG NEG Moody's Aaa Aa3 Baa3 Aaa Aaa Aaa C Ba1 A3 Aaa Ba3 A2 A2 A3 NEG NEG NEG NEG NEG NEG NEG NEG NEG NEG* AAA AA BBBAAA AAA AAA BBBB+ AAAA BB+ A+ A A NEG NEG NEG NEG NEG NEG NEG NEG Fitch SMP purchases Trade date Settlement date Weekly (€bn) 0.1 0.4 7.094 9.1 0.5 1.5 -1. This is equivalent to SMP purchases which settle on Monday (first settlement date) to Friday of the previous week (last settlement date).415 15.8 19.7 -5. Moody’s. 2) Barclays Capital requires 2 of the above 3 credit ratings to be below IG. IMF.8 0.5 -7.6 (oya. POS – positive outlook.3 3.P.9 Amount matured (€bn) 1.1 -1.9 -0. Fitch) to be below IG.3 8. Moody’s and Fitch) for a country's exclusion.0 6. 2012 Aditya ChordiaAC (44-20) 7777-9841 Aditya. grey highlight: below IG. Morgan Securities Ltd Euro-area fact sheet / SMP purchases Euro-area fact sheet GDP (€bn) 2012 Austria Belgium Finland France Germany Greece Ireland Italy Netherlands Portugal Spain GDP-weighted avg US UK 310 382 198 2.P.6 -0.0 0.7 -0.028 2. %) 2012 2.0 7.3 -1.3 -1.0 -7. (oya.5 219.7 3.495** 1. Source: ECB 69 .5 1.2 4.2 0.0 -3.4 0.4 -8.3 -3.9 GDPpc (EU=100) 2012 124 116 123 104 108 63 119 90 126 54 80 101 Unempl.3 1. National index if not available **Local currency *** IMF Estimate ^ Net lending (+) or net borrowing (-) Source: EC European Economic Interim Forecast Feb-12.0 0.0 219.9 14.0 0.0 5.9 1.8 2.6 2.2 1.developing outlook and blank represents stable outlook Notes: 1 – Rules for a country to be excluded from its index: 1) J.3 2.623 212 159 1.6 (% of GDP) 2012 73 99 52 89 81 198 118 121 65 111 74 91 105*** 89 (% of GDP) 2012 2.

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conf.C.2 %oya 1100 CBI industrial trends Mar United States 0830 Housing starts Feb 685. conf. sa 1100 Industrial new orders Jan 1600 EC cons.6%oya Auction 2-month bill United States 1000 NAHB survey Mar 29 0835 NY Fed President Dudley speaks about economy and participates in roundtable 1340 on Long Island 20 March Germany 0800 PPI Feb Netherlands 0930 CBS cons. Mar Euro area 1000 PMI flash Mar Mfg 49.European Rates Strategy Global Fixed Income Markets Weekly March 16. sa Japan 0830 Reuters Tankan Mar 0850 Trade balance Feb -185 billion yen. 30 March France 0845 PPI Feb 0845 Consumption of mfg goods Feb Germany 0800 Retail sales Feb Italy 1000 PPI Feb 1100 CPI prelim Mar 1200 Contractual wages Feb Japan 0815 PMI manufacturing Mar 0830 All household spending Feb 0830 Unemployment rate Feb 0830 Job offers to applicants ratio Feb 0830 Nationwide core CPI Feb 0850 IP preliminary Feb 1400 Housing starts Feb 1400 Construction orders Feb United Kingdom 0001 GfK cons.000 1000 FHFA HPI Jan 0. Morgan representative for an update/more details.0 Index.5 Index. sa Services 50. Feb United States 0830 Personal income Feb 0945 Chicago PMI Mar 0955 Consumer sentiment Mar final Selective list as of 16 March. 72 .C. conf. nsa 1110 BoJ board member Morimoto’s address in Hyogo prefecture Netherlands 0930 GDP final 4Q United Kingdom 0930 Retail sales Feb Auction IL 2042 United States 0830 Initial claims w/e prior Sat 355. Mar Germany 0955 Employment Feb 0955 Unemployment Mar Spain 0900 HICP flash Mar Belgium 1115 CPI Mar Italy Auction BTPs Japan 0850 Total retail sales Mar Auction 2-month bill United Kingdom 0930 M4 & M4 lending final Feb 0930 Net lending to individuals Feb 0930 Index of services Jan BoE credit conditions survey 1Q United States 0830 Initial claims w/e prior Sat 0830 Real GDP 4Q final 1100 KC Fed survey Mar Auction 7-year note $29 bn 1245 Chairman Bernanke speaks in Washington.0%m/m. Forecasts are m/m.P.x. conf. Louis 21 March Germany Auction Schatz Mar14 & IL Apr23 Japan 1330 All sector activity index Jan -1.com J. Louis Fed President Bullard speaks in Beijing 28 March Euro area 1000 M3 Feb France 0730 GDP final 4Q Germany 1000 CPI 6 states and prelim Mar Italy 1000 ISAE bus. Mar Japan 0850 Corporate service prices Feb 1400 Shoko Chukin small firm survey Mar United Kingdom 1030 Business investment final 4Q 1100 CBI survey of distributive trades Mar United States 0900 S&P/Case-Shiller HPI Jan 1000 Consumer confidence Mar 1000 Richmond Fed survey Mar Auction 2-year note $35 bn 1245 Chairman Bernanke speaks in Washington. nsa. 2000 St. Mar Netherlands 1030 CBS bus.5 Index. Mar Japan 1110 BoJ board member Miyao’s address in Chiba prefecture United Kingdom 0930 GDP final 4Q 0930 BoP 4Q United States 0830 Durable goods Feb Auction 5-year note $35 bn 29 March Euro area 1100 EC bus. Mar United States 1000 Pending home sales Feb 1030 Dallas Fed survey Mar 0700 Philadelphia Fed President Plosser speaks on monetary policy in Paris 0800 Chairman Bernanke speaks to business economists 27 March Germany 0900 Gfk cons. conf.000 1245 Chairman Bernanke speaks in Washington. sa Germany 0930 PMI flash Mar Mfg 50.C. D. unless stated & times are local. Highlighted data are scheduled for release on or after the date shown. Mar Spain Trade balance Jan United Kingdom 0930 CPI Feb 3.3% (-1. 0930 Public sector finances Feb 7.000 Permits 685. conf.1%oya) 1000 Leading indicators Feb Auction 10-year TIPS (r) $13 bn Announce 2-year note $35 bn Announce 5-year note $35 bn Announce 7-year note $29 bn 1000 Fed Governor Tarullo testifies on regulation and Volcker Rule 1600 Chicago Fed President Evans speaks on monetary policy in Washington. Telephone your J.2 Index.65 mn 22 March Belgium 1500 BNB bus. sa Auction 3-month bill United Kingdom 0930 UK Spring Budget MPC minutes Mar A 9-0 vote for unchanged policy is expected. conf.5 Index.2 Index.000 1430 Atlanta Fed President Lockhart speaks in Washington. D.2 Index. nsa United States 1000 Existing home sales Feb 4. 23 March France 0845 INSEE bus.9%bal. prelim Mar -19. 1730 Minneapolis Fed President Kocherlakota speaks in St.2 Index.P. Conf. Morgan Securities Ltd Global Market Movers 19 March Euro area 1000 BoP Jan Italy 1100 Industrial new orders Jan Japan 1430 Department store sales -0.0 Index. D. sa France 0900 PMI flash Mar Mfg 50.C. 2012 Aditya ChordiaAC (44-20) 7777-9841 aditya. sa Services 53.C. D. D. sa Composite 53. conf.8 £bn. 26 March Germany 1100 IFO business survey Italy 1000 ISAE cons. sa Services 49. Times shown are local. Mar 1100 EC cons.chordia@jpmorgan. conf. sa Composite 49. conf. sa Composite 50. Mar Spain 0900 PPI Feb Japan 0850 Flow of funds 4Q Auction 3-month bill United Kingdom 0930 BBA mortgage lending Feb United States 1000 New home sales Feb 320.

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