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–

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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
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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

we find that maturity is by far the most important variable. 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*. ** See footnote in Exhibit 1. 2 We use the percentage of principal required to invoke collective action clauses assuming a 100% response rate. J.1 81. Size and minority protections have a more modest but still intuitive impact. and €1-2 points to bond price. Adj R-squared = 57%. respectively (Exhibit 2). each 10% increase in CAC voting threshold boosts bond price by around €8 Regression statistics* for Greek foreign-law bonds**.3 -1. 2012 Pavan WadhwaAC (44-20) 7777-3370 Kedran Panageas (44-20) 7777-0326 J. Source: Bloomberg. there are just a handful of bonds that meet multiple criteria. and Each 10% increase in the CAC voting threshold2 boosts bond price by around €8 (Exhibit 3).1 -9.P. or 2) strong creditor rights (defined as requiring at least 75% of principal to change bond terms via CACs). assuming a 100% response rate to any bondholder proposals. Exhibit 4 illustrates bonds that have less than 12 months to maturity and either 1) small size (defined as less than €500mn outstanding). with a 100% approval threshold for changing bond terms. The OASA Mar2013 has extremely strong minority protections. SE = €10. in price terms (€) Beta T-stat Intercept LN(months to maturity ) Face v alue (€bn) Voting threshold (%)*** 10. First.7 0. *** We use the percentage of principal required to invoke collective action clauses assuming a 100% response rate. or December 2012 (Exhibit 1).5bn in notional terms.2 2. each 1M reduction in maturity adds about €5-10. €2-3. 4 . We clean the data to some extent as follows. Each €1bn reduction in outstanding bond size boosts bond price by around €2 points. Source: Bloomberg. however it matures a year from now which is longer than ideal. The price/maturity curve starts to kink at around the 9 month maturity. 3-5. If not.European Rates Strategy Global Fixed Income Markets Weekly March 16.5 -5. we use Bloomberg pricing if it appears reasonable. (admittedly an illiquid and low visibility market)1. based on a cross-sectional regression we estimate that: • For 1-2.9 • • * Cross-sectional regression on current bond prices.Morgan Overall. Exhibit 3: Size and minority protections have more modest but still intuitive impact. Morgan Securities Ltd. and 6-12 months to maturity. For instance. bond prospecti. 1 We caveat that available bond pricing for existing Greek foreign-law bonds is extremely unreliable. number in parentheses is the voting threshold required to employ CACs**.2 -2. or 2) a 75% voting threshold for CACs** ** CAC voting threshold as a % of principal. The highlighted bonds tally about €1. we take the average of the best bid and offer prices from actual (and reasonable) screen quotes. we discard the price.P. If no reasonable quotes are available. 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.

regardless of maturity. there is a reasonable chance that Greece is willing and able to pay out on this small group of bonds. The bet is that Greece would choose to settle on more favorable terms rather than default outright. as discussed above. if a government-guaranteed state agency bond gets accelerated. but Greece is likely to default if too many pursue this strategy). the majority do have cross-default clauses. any bondholder can choose to accelerate the bond. We would ballpark the probability at somewhere between 1/3 and 1/2. or 3 For example. Cross-default means that when Bond A is not paid its interest or principal. 5 . or can cross-default with each other. This is also true. Bloomberg 4 For example. as we estimate them. due to the domestic-law PSI exercise which just went through (Exhibit 6). If exchange participation is high. This means that principal becomes immediately due and payable. Whether Greece chooses to do so depends in part on other creditor strategies. If each such bond has this clause. we think that voluntary participation is the optimal strategy for all medium to large bond issues. if a large group of bonds attempt to accelerate their payment. Morgan Securities Ltd. 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. so do not meet the foreigncurrency criterium. or Hellenic Railways. if other bonds don’t participate. The chain is as follows: • A number of government-guaranteed state agency bonds (OSE. • Thus. most likely outcome highlighted in blue afford to pay out. 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. 2012 Pavan WadhwaAC (44-20) 7777-3370 Kedran Panageas (44-20) 7777-0326 J. In this eventuality." 5 OSE and OASA bonds are €-denominated. o Foreign-law debt issued to foreign holders (FL/FH). Office of Athens Urban Transport) include a restructuring of the guarantor’s debt as an event-ofdefault (EOD). see Hedge funds find loophole to trigger Greek default. depending on 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. Bond B also suffers an EOD. 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. On the other hand. Finally. albeit less so.European Rates Strategy Global Fixed Income Markets Weekly March 16. but also don’t force the issue by attempting to accelerate in large size. • Greek government foreign-law bonds do not include this restructuring language. As far as we can tell by looking at available bond prospecti. and OASA.4 Following an EOD. and o Guarantees of other issuers’ debt that meet either of the above conditions5. 8 March 2012. These optimal strategies for different bondholders. However. the Greek cross-default clauses are all defined with respect to “External Debt”. but most commonly includes the following: o Foreign-currency (FX) debt. are summarized in Exhibit 5. For instance. it means that around €3bn of debt has the ability to accelerate already. This category of debt is defined in various ways. we think the optimal strategy for other bondholders would be to participate voluntarily. it will likely lead Greece to default or pursue a more severe restructuring which involves all holdouts (discussed below).P. Then Bond B principal can also be accelerated.3 This is most attractive to small issues which mature late (it moves them up in the queue.

as well as for need to control 25% of the outstanding principal. 60% of Greek railway bonds. which increases the odds that Greece chooses to default rather than pay out. the optimal strategy for investors in medium to large bond issues (which we define as anything over €500mn) is to tender into the exchange. 2012 Pavan WadhwaAC (44-20) 7777-3370 Kedran Panageas (44-20) 7777-0326 J. government bonds are more difficult to accelerate than state agency bonds. First. it is probably better to wait until after the 11 April foreign-law exchange settlement. when the foreign-law exchange settles.P. FL/FH generally means foreign-law bonds initially issued to foreign holders. (Delaying has the risk of getting roped into CACs however). requiring 25% of principal rather than a single holder. or participation looks to be on the low side. Acceleratable in an EOD by ** Amt Ty pe Greek International Hellenic Railw ay s Urban Transport Total (€bn) €17.4 €2. bond prospecti. which should reduce the outstanding principal considerably. or some small bonds which mature late to accelerate. Greek investor. In fact. This is not a trivial hurdle to meet given that 61% of principal is already reported to have been tendered into the exchange. We sample around 85% of Greek international bonds.6 €20.***: FX and FL/FH 7% 0% 0% 6% FX or FL/FH 85% 100% 100% 87% * Based on sampling of available prospectus. Second. If many investors attempt to accelerate. ** Only shown for bonds which have cross-default clauses. plus moral suasion applied to highly regulated investors. so that one may own a higher proportion of existing debt. Overall we ballpark the odds of an acceleration strategy working at something like 1/5. In particular. the euro. The acceleration strategy is more risky than the quiet holdout strategy. Morgan Securities Ltd.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**. which in turn might allow some small bonds which mature early to hold out. Exhibit 6: Some Greek international bonds may be able to accelerate principal payment based on cross-default clauses with railway and public transport bonds. Investors should consult their own counsel. • As discussed above. *** FX (foreign-currency) generally means any currency other than that of the Greek Republic.e. which should limit the amount of headline risk posed over the near term. Source: Bloomberg. we think that the vast majority of Greek foreign-law bondholders would be better served by tendering. For this reason. weighted by principal amount outstanding*. i. This implies that holdout attempts are likely to be fairly small in size. This. it is more aggressive and as such is more likely to prompt a political backlash. and 33% of public transport bonds by principal amount.European Rates Strategy Global Fixed Income Markets Weekly March 16. then other foreign-law bonds can potentially accelerate as well. 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. in this strategy “two’s company. it becomes more preferential to tender in order to avoid potentially more severe treatment (Exhibit 5). 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. However. • 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).4 €0. Note: The above summary is based on our reading of available bond documents and is not intended to represent legal advice. which if it snowballs is likely to lead Greece to default outright. should cause exchange participation to be high. three’s a crowd”: one acceleration is likely to encourage others to accelerate as well (for defensive reasons).4 w / Neg w / Cross. it is probably preferable to wait until after 11 April. 6 . Both categories include guarantees of another issuer’s debt which meet the applicable criteria.

have a steepening bias on curve. Germany 4s/10s Italy flattener Long 2Y Belgium vs.P. hold short duration in 10Y Bunds. fly Pay 10Y in 5s/10s/20s swap wtd fly 1s/5s FX basis steepener 20s/30s wtd. fixed) Rec. − In UK. Trade recommendations • Duration − In Euro. − In UK. maturity matched swaption gamma Neutral Pay 5Yx10Y HICP (rec. • Curve − In Euro. Euro HICP swaps Long BTANi16. 10Y French CPI vs. Germany Long 5Y Italy vs. 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. take profits on 5s/10s gilt steepeners and enter 10s/30s flatteners. 3Mx5Y straddle Short Schatz vs. turn bearish on duration and sell 10Y Gilts. 2012 Pavan WadhwaAC (44-20) 7777-3370 Kedran Panageas (44-20) 7777-0326 J. Morgan Securities Ltd.European Rates Strategy Global Fixed Income Markets Weekly March 16. 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 . 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. OBLi13 & OATei15 b/e Long 9Y Finland vs.

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

External Debt is defined as debt or debt guarantees.Sovereign immunity is waived. (2) Negative pledge clauses: YES --.Any holder of Bearer or Registered notes can accelerate --. It also has a restructuring EOD (albeit somewhat ambiguously written). Morgan Securities Ltd. the Portuguese Loan Stock maturing in 2016. 2012 Pavan WadhwaAC (44-20) 7777-3370 Kedran Panageas (44-20) 7777-0326 J. 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). is a small issue that has relatively strong investor protections.Quorum = at least 2 holders holding >75% of total principal --.Non-payment of principal on any MTN note.Moratorium --. • 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. or b) 75% of those voting at a bondholders’ meeting.Portugal enters into debt restructuring with or for the benefit of any creditor (4) Acceleration by any holder (5) CACs exist.Non-payment of interest on any MTN note.Voting threshold not clear --.Any other covenant failure on any MTN note. The voting threshold to implement a bond modification is not clear. terms NA *The above summary is based on our reading of available bond documents and is not intended to represent legal advice. 9 6 . except for in the 2016 Loan Stock Summary of financial covenants in Portuguese MTN program* (1) Governing Law = ENGLISH --.P. Exhibit A2 summarizes these bond terms.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 --. Investors should consult their own counsel. but is likely to be either a) 75% of total principal outstanding. which is defined as debt placed with investors outside the Republic of Portugal (3) Events of Default: cross-default ONLY with other MTNs --. with a 30D grace period --.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 --.Non-payment of interest.Sovereign immunity is waived.Any event that could lead to acceleration of any External Debt (including loans). with a 30D grace period --. with a 30D grace period --. (2) Negative pledge clauses: YES --. with a 30D grace period. even if the EOD is not acted upon (but remains uncured). It has negative pledge and crossdefault clauses which apply to External Debt. External Debt is defined as above --. with a 30D grace period --.Morgan • Another bond. with a 30D grace period (4) Acceleration by any holder --. investors should consult their own counsel.European Rates Strategy Global Fixed Income Markets Weekly March 16. J.Pertains to all External debt or debt guarantees.Non-payment of interest or principal on any External Debt (including loans). We caveat that the above is based on our interpretation of available bond documents and is not intended to represent legal advice. where External Debt is defined as above --. and because the bond was issued in 1986.6 Exhibit A2: Financial covenants in most of Portugal’s foreign-law bonds are fairly limited. but public property used for public purposes or assets in the public domain are not liable for attachment.P.Collective action clause operates across the MTN platform --. but public property used for public purposes or assets in the public domain are not liable for attachment.Pertains to all External Debt --.Any other covenant failure. 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 --. Source: Bloomberg.

Morgan Securities Ltd.20% (see GFIMs. 2012 Gianluca SalfordAC (44-20) 7325-4334 Aditya Chordia (44-20) 7777-9841 J. We 10 48 Jan-10 May -10 Sep-10 Jan-11 May -11 Sep-11 Jan-12 2. albeit with limited risk.95%.00 argue against extrapolating too much into the future the recent strength in the data. given the newsflow We still recommend 2Y Belgium duration longs. but not the beginning of a bear market The risk-on trade gained traction on the week. consensus on 1Y ahead global real GDP growth index % • 58 56 54 Global consensus 3. and selling protection in short-dated peripheral CDS Light bond supply over the next two weeks.20% in 10Y Bunds. hurting the short end of the curve. we remain sceptical about the possibility of a meaningful sell-off beyond the 2. process w ill be gradual. has arsenal of 15-Mar Now otny options.60 • • 3. but favour Italy over Spain and Finland over the Netherlands." "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. 4s/10s BTP flatteners. finally hurting AAA fixed income markets across the globe. consensus on 1Y forward growth has lagged the message of contemporaneous activity indicators (Exhibit 2). and we believe the current adjustment should not be faded. adding a domestic component to the US-driven sell-off." 11-Mar Benoît Cœuré • • Source: Media articles • Exhibit 2: … but we would be cautious about extrapolating too much from current conditions. but I w ould say that time is not ripe now .20% level. we believe most investors are already positioned on the short side. The ECB chatter about the need to be ready to exit non-standard measures increased in volume (Exhibit 1). pose no threat to price stability . as for the past two years. timely ex it from recent 15-Mar Liikanen central bank steps. 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. How far can the sell-off go? Our fair value target is 2. efficient functioning of capital and money markets.20 2." "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. Ex it w ill depend on price stability ." "Euro crisis solution requires controlled. we have been highlighting for a while that valuations for Bunds and US Treasuries were stretched. how w e w ill limit the risks that w e hav e taken during the crisis. In the sell-off. as 2s/5s steepened 13bp and 5s/10s flattened 4bp. In GFIMs. The 5Y underperformance looks excessive and now leaves 5Y around 3bp cheap on the .40 Pressure for higher yields.80 52 50 Global PMI 2. therefore we do not expect the 10Y Bund yields to sell-off beyond the 2. We put a stop at 1.20% level Global composite PMI vs. We believe recent market moves have corrected many of the RV themes we have been highlighting since the beginning of the year. targeting 2. 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. In addition.P. Long term refinancing ops had "decisiv e impact on market". 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.European Rates Strategy Global Fixed Income Markets Weekly March 16. 2 March 2012) and a round of convexity hedging in the US might also help (see US sections for details)." "ECB discussing strategy to ex it crisis mode. with the exception of 2019 expensiveness We remain positioned for tighter intra-EMU spreads. As discussed at length in the past. as the conditions for a more restrictive monetary policy are not in place. the 5Y part of the curve suffered the most.

13*5Y – 0.European Rates Strategy Global Fixed Income Markets Weekly March 16. we focus on valuations and newsflow. * 50:50 2s/10s/30s = 0. Germany 2Y spread to Germany as % of 10Y spread to Germany regressed against 10Y spread to Germany. In line with the theme of the past few weeks. At the same time. bp 300 350 ITL ESP FRF y = 0.43*2s/30s -0. R-squared: 87%. In our country selection. 1 January 2012 level indexed at 100.58. We favour countries like Italy and Finland against Spain and the Netherlands. 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. given attractive valuations. Belgium warrants an honourable mention: OLOs were the best performers despite the pricing of €4bn of a new 20Y bond.06*2s/10s -0. * 50:50 2s/5s/10s = 0. Exhibit 3: After the recent sell-off. In addition. The Sep21 remains the most expensive bond. and we continue to highlight the cheapness of the short end of Belgium. % 80% BEF 60% NLG 40% FIM 20% 0 50 100 150 200 250 10Y spread to Germany . index 120 110 100 90 80 70 60 Jan-12 FIM-DEM KFW-DEM FRF-DEM Feb-12 Mar-12 11 .58*1s/2s OIS + 0. after months of expensiveness (Exhibit 3).11 R 2 = 63% ATS Exhibit 5: The 8-10Y sector of the Finnish curve has failed to tighten vs. We provide a country-by-country update on our favourite themes for the most liquid markets.P. whereas at these levels. given attractive valuations: stay long 2Y Belgium vs. 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. we are neutral on the rest of the curve. 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. Morgan Securities Ltd. We believe the best value can be found at the short end of the curve. bp curve. Italy was a relative outperformer and Spain a relative underperformer.14*Ln(x ) . Increased risk appetite has prompted some investors to reconsider their consensus on France underweight. Belgium Belgium’s recent outperformance was concentrated in the 5-10Y part of the curve. given the market segmentation accentuated by the 3Y LTROs. 2018 and 2019 RAGBs remain stubbornly cheap on the Austrian curve and vs. we believe spreads can tighten further from here. Germany since the beginning of the year despite the risk-on mood RFGB Apr21-Bund Jan21. R-squared: 69%. As discussed above.20. Exhibit 4: We find value in the short end of the Belgian curve.0. The only remaining theme is the 3bp expensiveness of 2019 Bunds. around 20bp cheap (Exhibit 4). intra-EMU spreads were generally tighter. However. 20Y has outperformed 10Y and 30Y after we highlighted its cheapness a week ago. 2012 Gianluca SalfordAC (44-20) 7325-4334 Aditya Chordia (44-20) 7777-9841 J. past 1Y. we do not find any domestic reasons to change our cautious stance on French bonds: in our view. most of the cheapness of the 10Y sector has been eroded. respectively. France. Selling protection in short-dated CDS remains another very interesting theme. OAT Apr21-Bund Jan21 and KFW Jan21-Bund Jan21 yield spread evolution since 1 January 2012. 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*.

and France underweight remains fairly consensus. Bund Jan21. but it has been trading special in repo. both 4-5Y and 15Y (Exhibit 6). on Monday. recent data was not favourable: the January budget balance number was -€9. with only Germany tapping the conventional market for €5bn (Exhibit 7). Finland. We find the best value in the 3Y part of the curve. Finland We recommend overweight in Finnish bonds. we believe Spain’s underperformance vs. the low price 2037. Morgan forecast. ISDA will hold an auction in respect of outstanding Greek sovereign CDS transactions. so we do not recommend short-selling. peripheral supply highlighted in grey. (on Wednesday). -€4. We stick to 4s/10s flatteners and plan to reopen 10s/15s steepeners after the month-end 10Y auction.0 3. Morgan Securities Ltd. We also find 5Y fairly cheap after the auction-induced cheapening. . which looks cheap vs.0 Medium Long Ultralong 21-Mar Germany 29-Mar Italy Exhibit 8: 1Q12 supply came in marginally higher than expected. but the election risk is well flagged. both 4-5Y and 15Y 5Y par Italian government rates.7bn in 2011) and house prices declined by a record amount in 4Q11 (-11% on the year).0 3. Italy We are positive on a continuation of spread compression in BTPs. Italy can continue in the short term. Also. Indeed. The Netherlands A combination of poor growth prospects. official announcements and J. J. Our favourite sectors are 3Y as it is not pricing any LTRO premium (in contrast with the Spanish curve) and 10Y.P.P. 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. % 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. and 2) 2020 and 2021 RFGBs have failed to tighten vs.0bn at the 29 March auction.P. €bn Date Issuer Short Mar14 5. Morgan Q1 supply forecast made at the starting of the year. the Oct21 is around 3. the Apr21 and the Apr22. Our favourite play on the Spanish curve is to sell the high price Bono 2032 vs.3bn (vs.5bp expensive vs. Exhibit 7: Euro area conventional bond issuance calendar for the next two weeks Euro area conventional bond issuance calendar. Spain As discussed last week. France We recommend a token underweight in France: we believe fundamentals require wider spreads than Austria’s. especially in 2020 and 2021 maturities as 1) the country’s fundamentals remain very solid. 2012 Gianluca SalfordAC (44-20) 7325-4334 Aditya Chordia (44-20) 7777-9841 J. We recommend underweight. On the T-bill side. Germany since the beginning of the year despite the risk-on mood (Exhibit 5).European Rates Strategy Global Fixed Income Markets Weekly March 16. 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. Exhibit 6: 10Y part of the BTP curve looks cheap vs. higher-thanexpected deficit and political noise do not justify relative valuations vs. whereas in longer maturities. €bn 1Q12 JPM 1Q12 Country Diff. Germany also plans to issue around €2bn of a new 10Y linker maturing in April 2023 (on Wednesday). mainly due to aggressive front-loading by Spain Gross conventional bond issuance in 1Q12* vs. We therefore recommend investors to open longs in RFGBs Apr21 vs.

estimates of current values based on publicly available sources. bringing the total outstanding size to €10bn. Belgium also issued more than expected. reinforces private investors’ fears that in case a Greek-style PSI were decided. 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. 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. 3) to recapitalise the domestic banking sector. which engaged in aggressive issuance frontloading. 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. that applying the same debt restructuring format to other peripheral countries would achieve even more limited improvement in the debt/GDP ratio.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. We show.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. 2) to safeguard official bond holdings. Germany will tap the 2Y benchmark Schatz Mar14 for €5bn. Portugal and Spain. 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. €bn General govt debt (Maastricth def. Morgan Securities Ltd. Italy has been lagging in terms of issuance. issuing only €40bn over the quarter vs. but on the other hand. our forecast of €27bn. Italy started the year on a cautious note and issued in small sizes. we take the opportunity to review the issuance dynamics of the Euro area countries during the quarter. and 4) technical issues linked to general government consolidation. Portugal and Spain.911 175 736 280 80 1.) 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. Ireland. … Estimate of the impact of a Greek-style debt restructuring* for Greece. 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. 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. Based on the supply so far and official announcements/J. govt consolidation Total debt reduction after Greek-style PSI Total reduction as % of GDP Greece Ireland Italy Portugal Spain 355 169 1. As 1Q12 comes close to an end. % of GDP General govt debt (Maastricth def. estimates of current values based on publicly available sources.5% reduction in principal to the stock of government bonds. 9 March 2012) discussed how the Greek PSI provided more disadvantages than advantages for the stability of the region. but the supply has gained momentum since the second 3Y LTRO at the end of February. 2) A 75% NPV reduction in the value of government bonds. but a downward revision to borrowing needs in the following years. Italy. sector recapitalisation 4) Impact of gen. Germany announced an upward revision to net new borrowing in 2012 from €26bn to €35bn (due to early ESM payments).European Rates Strategy Global Fixed Income Markets Weekly March 16. the total supply by Euro area countries will be around €219bn.25% coupon for its retail BTPi Mar16 bond that will be sold next week. The bond will be tapped again in April. as it took advantage of the improved market sentiment and launched two syndicated deals in 1Q12 (in the 10Y and 20Y sectors). 2) A 75% NPV reduction in the value of government bonds. marginally higher than our start-of-the-year forecast of €209bn (Exhibit 8). 2012 Gianluca SalfordAC (44-20) 7325-4334 Aditya Chordia (44-20) 7777-9841 J. sector recapitalisation 4) Impact of gen. issuing around €38bn of conventional bonds (the highest ever in one quarter) vs.P. 3) Recapitalisation needs for the domestic banking sector equivalent to 80% of the NPV loss. very harsh haircuts would be needed even for countries with a much lower debt/GDP ratio than Greece. The upside surprise came mainly from Spain. On the other hand. Italy has set a 2. Morgan projections of the sizes of the upcoming auctions.P. We will publish a new quarterly update on supply in the coming days. On Wednesday. with the least impact in Ireland 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. * Assumptions: 1) A 53. Italy.5% reduction in principal to the stock of government bonds. Ireland. our forecast of €45bn. Greece’s limited reduction in debt/GDP after the debt restructuring is attributable to four factors: 13 . in a theoretical simulation. 3) Recapitalisation needs for the domestic banking sector equivalent to 80% of the NPV loss.

short €19. where central bank holdings are considerably less important than domestic bank holdings. with the exception of Spain.5% notional reduction on all debt would have reduced the debt/GDP ratio by almost 90%. a reduction in international investor support will continue to be offset by domestic bank purchases. Morgan Securities Ltd. 2) A 75% NPV reduction in the value of government bonds. P&L since inception (2 March): -0bp.5% reduction in principal to the stock of government bonds. private and official loans were spared a notional reduction (keeping in mind that official loans have seen maturity extension and interest-rate reductions). the eventual decision to target only government bonds would be the most important factor reducing the effectiveness of a Greek-style debt restructuring. • Keep Bono Jul32-Jan37 flattener − Keep long €25mn of Bono Jan37 and short €23.05%. Arguably. P&L since inception (9 March): 7bp. SMP purchases or official lending. and especially so in Spain. In conclusion. reducing the decline by a further 15%. a 53. • Keep long 2Y Belgium vs. recapitalisation needs might be necessary for other financial institutions like insurance companies. We make a final additional observation. If. in line with Greece. the problem of de facto subordination of private bond holders will grow with time. SMP purchases and previous bonds held by the Euro system in investment portfolios were not subject to the haircut. European public institutions such as the ECB. national central banks. . P&L since inception (24 February): 62bp. the decision to focus only on bonds meant that the decline was reduced by 18% of GDP. P&L since inception (2 March): 19bp. 3) Recapitalisation needs for the domestic banking sector equivalent to 80% of the NPV loss.P. but we do not want to further complicate the analysis. a restructuring of securities held by the public social security fund has no impact on the debt/GDP ratio. Therefore. 2012 Gianluca SalfordAC (44-20) 7325-4334 Aditya Chordia (44-20) 7777-9841 J. • Keep 4s/10s BTP flattener − Keep long €25mn of BTP Sep22 vs short €50mn of BTP Aug16 @ 158bp. The need to recapitalise the domestic banking sector subtracted another 14%. For Greece. • Keep short 10Y Bund − Keep short €100mn of Bund Jan22 @ 2. • Keep long 5Y Italy vs. and the EIB were spared from the PSI. P&L since inception (24 February): 16bp. Germany − Open long €25mn RFGB Apr21 vs. 3M carry and slide: -6bp. 3) Part of the savings from the debt restructuring was offset by the need to recapitalise the domestic banking sector. as has been the case recently. 3M carry and slide: 0bp. the general government debt/GDP ratio consolidates between different sectors of the public administration. further reducing the improvement in the debt/GDP ratio. The impact of preserving Euro system bond holdings and the required 14 recapitalisation of the banking system would be similar in most cases. whereas the impact of the consolidation of the social security fund’s holdings was lower. Exhibits 9 and 10 show our estimates based on various public sources. short €25. however. at 6%. Germany − Keep long €25mn OLO Mar14 vs. To gauge the relative importance of these factors for Greece and other peripheral countries. the role of international investors is therefore key: the more they disengage from peripheral countries.5mn of Bono Jul32 @ 1. the more they tend to create effective subordination for the remaining investors. For the other countries. 2) Among bond holders. A Greek-style debt restructuring would have an impact on the debt/GDP ratio of around 30% in Italy. Spain is also peculiar in its significant bond holdings by the social security fund. 3M carry and slide: -10bp. Once the four factors are taken into account. Trade recommendations • Open long 9Y Finland vs. the reduction in the debt/GDP ratio drops dramatically to 34% of GDP. more than 20% in Portugal. 1) Only one type of debt was involved – bonds – whereas T-bills. 4) Finally.5mn Bund Jan21 @ 57bp. but much less in Ireland. 3M carry and slide: 21bp. France − Keep long €25mn BTP May17 vs. 3M carry and slide: -2bp. 3M carry and slide: 14bp.8mn OAT Oct17 @ 188bp. we assume: 1) A 53.European Rates Strategy Global Fixed Income Markets Weekly March 16. short €26mn Schatz Mar14 @ 95bp.5bp.

• Keep short protection on 3Y Spain CDS − Keep short protection on $25mn Spain 3Y CDS protection @ 371bp.European Rates Strategy Global Fixed Income Markets Weekly March 16. 3M carry and slide: 30bp. • Keep BTP Dec13 vs. selling maturity-matched CDS protection − Keep short €25mn of BTP Dec13 @ 2. 2s/30s steepener 3s/10s flattener COUNTRY SELECTION/RELATIVE VALUE Short 25Y Italy v s. P&L since inception (3 February): -36bp. 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 . beta adj. Morgan Securities Ltd.10% and short $32mn of Dec13 CDS protection on Italy @ 300bp. Spain Long 8Y Austria v s. RFGB Apr21 Long BTP Nov 23 v s.P. Aug23 Long 10Y Spain v s. 3M carry and slide: +5bp. P&L since inception (20 January): -49bp. Germany and Spain Short 3Y Spain v s. 2012 Gianluca SalfordAC (44-20) 7325-4334 Aditya Chordia (44-20) 7777-9841 J. Trades closed in 2012 TRADE DURATION Short 10Y Bund Jan22 CURVE 5s/10s flattener v s. Germany Italy 5s/10s flattener Long Bund Jan21 v s.

45 8 6 • • 0. on a risk-adjusted basis.P. Exit short 3Mx10Y gamma at a loss. Dec12 EONIA sold off 10bp from its lows and is currently trading around 0. 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. 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.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. taking late 2012/early 2013 ECB OIS rates to their highest level since the beginning of the year (Exhibit 1). The recent bear steepening of the EONIA curve has clearly increased the carry of long positions. Morgan Securities Ltd.50 Change 16-Mar-12 12 10 0. … …instead. 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. 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. European Derivatives • The EONIA curve bear steepened. 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. buying 3Mx5Y gamma Sell Schatz gamma vs. 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. implement 5s/30s bear flatteners Close longs in 5Y in the 1s/5s/12s level-neutral fly. taking late 2012/early 2013 ECB OIS rates to their highest level since the beginning of the year.European Rates Strategy Global Fixed Income Markets Weekly March 16. sell 3Mx10Y gamma vs. but hold 2s/5s/10s bull-belly richeners Excess liquidity.… …however. the EONIA curve bear steepened. the level of yields. However. the improvement occurred only in • • • • • • 16 . turn mildly bearish on the EONIA curve with a steepening bias. we do not recommend this and instead. the level of 5Y and is expected to remain directional.40 4 2 • 0. % Change since 9 March 2012. taking late 2012/early 2013 ECB OIS rates to their highest level since the beginning of the year ECB OIS rate. with our bearish duration view and ECB members discussing an early exit strategy from emergency liquidity measures (see Euro Cash). investors may be tempted to fade the recent sell-off and implement longs on the EONIA curve to earn carry. buying maturity matched swaption gamma • • • • • Swap Curve Since our last publication.43%. 2012 Pavan WadhwaAC (44-20) 7777-3370 Fabio Bassi (44-20) 7325-8615 Khagendra Gupta (44-20) 7777-1980 J.

80 0.7 0. carry 0.1 -0.7 0.7 0.4 0.6 3. making the Euribor curve positively directional.1 0. the level of yields since the announcement of the 3Y LTRO in December 2011 (Exhibit 3).8 0.1 -0.25.7 0. making the Euribor curve positively directional.20 Exhibit 4: Given that risks have dissipated.1 adjusted carry -0. we therefore recommend weighted reds/blues EONIA curve steepeners.75 0.65 y = 77. bp 25 20 15 10 5 0 0. On RV. Investors wishing to position for a continuation of the positive directionality of the Euribor curve may consider conditional bear steepeners.2 -0.2 2. The reds/blues EONIA curve appears too flat vs.4 R 2 = 92% 16-Mar-12 1. we close Jun12/Jun13 Euribor bear-flatteners.3 2.4 0.7 4. we expect some term premium to remain in the Euribor strip.9x .2 0.20 y = 67. bp 140 130 120 110 100 90 80 1. 2012 Pavan WadhwaAC (44-20) 7777-3370 Fabio Bassi (44-20) 7325-8615 Khagendra Gupta (44-20) 7777-1980 J. therefore.70 0.80 Blues EONIA.2 -0. FRA/OIS is no longer a significant driver of the Euribor curve. Our recommendation is to Exhibit 3: Reds/blues EONIA curve is too flat adjusted for the level of yields.8 4. This clearly challenges our long-standing Euribor bear flatteners.95 17 .9 3.9 4. the implied directionality on the money-market curve is expensive relative to the delivered directionality (Exhibit 5).85 6th Euribor futures y ield. 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 2012.4 0.3 * Risk is defined as 1M standard deviation of daily changes of the underlying EONIA rate. Lev el 6M Carry Risk* Annualized risk.52. we recommend buying Jun12 mid-curve put spreads (on Jun13 Euribor) funded by selling call spreads.5x .5 1.8 0. We favour bearish positions on the Euribor curve. as we see limited upside in Jun13 Euribor. Given that tail risks have dissipated.7 0.6 4. With EONIA likely to stabilise in the 35-40bp range for the first year of the EONIA curve.60 1.1 R 2 = 95% 0.P.2 -0. % 0.European Rates Strategy Global Fixed Income Markets Weekly March 16.90 0.2 -0. for example. fronts and reds EONIA due to the large increase in volatility further out the curve (Exhibit 2). the FRA/OIS is no longer a significant driver of the Euribor curve. since 1 December 2011. we do not expect Jun13 Euribor to rally above 99. However.6 0. past 2W.1.6 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. expressed via option structures. % 2.40 1. steepening in a sell-off and flattening in a rally (Exhibit 4). Morgan Securities Ltd.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) 0.00 2. which we recommended in December 2011 as a hedge for a flare-up in the peripheral crisis. limiting the attractiveness of these conditional structures.1 -0. we recommend weighted steepeners as relative-value trade Reds/blues EONIA curve regressed against blues EONIA. close Jun12/Jun13 Euribor bear flatteners 2nd/6th Euribor curve regressed against 6th Euribor contract.4 4. Thus. which offer about 12bp of upside.

625 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.000 99. 2s/5s steepened about 10bp. the swap curve bear steepened. We still find steepeners attractive and hold weighted greens/10s steepeners.375 98.875 99.00/98. Over the past week.6 R 2 = 55% 18 * Isopremium indicates the breakeven level for entering conditional fly trades at zero cost.500 99. we hold 2s/5s10s bull-belly richeners. However. Going forward.375 99. With options on 30Y tails trading more expensive than option on 5Y tails. which can be initiated at zero cost via 3M payers at a level close to spot (see Trade Recommendations). bp 110 Spot 100 3M Forw ard 90 80 70 60 1.00 5Y EUR sw ap y ield. as implied directionality is rich to delivered directionality. with significant underperformance of the 5Y sector. Morgan Securities Ltd.00/98.20 y = -39.75 put spread funded via selling 99.3M beta of daily changes in front contract regressed against daily changes in 1Y forward Euribor contract. 98.European Rates Strategy Global Fixed Income Markets Weekly March 16.40 1.25/99.75 Jun12 mid-curve put spread funded by selling the 99. we refrain from recommending bear steepeners.P. we have less conviction that relative value will be a driver of curve moves. which remain attractive on RV Weighted greens/10s curve and 2s/10s EUR swap curve. past 6M.875 -10 -20 buy the 99. This is based on COB 15/3/2012. 2012 Pavan WadhwaAC (44-20) 7777-3370 Fabio Bassi (44-20) 7325-8615 Khagendra Gupta (44-20) 7777-1980 J. implement 5s/30s bear flatteners 5s/30s EUR swap curve regressed against 5Y EUR swap yield and isopremium* line.750 99.750 98.60 1. we believe the intermediates will drive the sell-off. 100.250 99.625 98. the level of 5Y yields and has a decent negative directionality. Going forward. Since last Friday.500 98.250 98.25/99. which are likely to expire worthless if the sell-off continues. investors sharing our bearish view should consider option structures on Jun13 Euribor via Jun12 mid-curve options such as buying 99.25/99.… Current implied* and delivered** directionality for various Euribor curve trades. The weighted greens/10s steepeners have underperformed 2s/10s steepeners over the past week (Exhibit 7). compelling us to stop out of 1s/5s/12s level-neutral fly.000 155 150 145 140 135 130 125 . with both 5s/10s and 5s/30s flattening about 2bp.125 98.00/98. % Exhibit 6: …however. 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. % 2. hold weighted greens/10s steepeners. 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. the level of 5Y and is expected to remain directional.125 99.80 2. while the weighted greens/Bunds performed better and benefited from a narrowing of the swap spread. ** Delivered directionality for the swap curve calculated as 1 . exerting flattening pressure on 5s/30s. given the risk of further intermediates under-performance.50 call spread (Exhibit 6). short 99. Exhibit 5: Although the Euribor curve is positively directional in yield. We also hold -30 Exhibit 7: Weighted greens/10s curve has lagged the 2s/10s steepening.50 call spread on Jun12 Euribor mid-curve options. we find it attractive to implement 5s/30s bear flatteners (Exhibit 8). Last week.75 put spread vs. A historical analysis shows that 5s/30s is trading too steep vs.000 98.0x + 155.50 call spread Projected P&L profile at expiry on long 99.

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. past 1Y. Morgan Securities Ltd. 10Y and 30Y German b/m swap spreads narrowed 7bp. €-denominated issuance by financial institutions (including covered bonds) and supras/agencies. 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. bp * Contract rolled 20D before option expiry.European Rates Strategy Global Fixed Income Markets Weekly March 16.8bn/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. €bn/day Swap Spreads The sharp sell-off in fixed income markets left its mark on swap spreads. Subsequent improvement in risk sentiment allowed 2Y swap spreads to narrow almost 100bp over the next 6-9 months. plus one half of corporate bond issuance. and retain our 75bp near-term target on 2Y b/m swap spreads. 2Y swap spreads continue to appear too wide. 21-day MA of NSA excess liquidity. 2Y swap spreads peaked again in mid-2010 at 85bp in response to the Greek crisis. In fact. 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. Morgan estimate of seasonally adjusted swapped issuance*. Exhibit 9: Despite recent narrowing.P. bp €bn 110 90 70 50 y = 1. In past crises when 2Y swap spreads have widened dramatically. bp Exhibit 10: In the past. 2Y. On the week. as an estimate of swapped issuance unprecedented amount of excess liquidity that exists in the banking system. 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). we believe 2Y swap spreads can narrow significantly more.0x + 28. front-end swap spreads appear too wide. We recommend investors hold 2Y swap spread narrowers on both an outright basis and on a hedged-against-FRA/OISwidening basis.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. before narrowing 20bp as liquidity improved. respectively. we retain our near-term target of 75bp for 2Y b/m swap spreads 2Y German b/m swap spreads vs. We use fixed-rate. both on an outright basis and on an adjusted-for-the-FRA/OIS basis. leading to narrowing pressure on front-end spreads (Exhibit 10). past 5Y. which narrowed across the curve. 19 . full-allotment tenders were introduced in October 2008 when 2Y swap spreads peaked at 120bp due to the Lehman crisis. significant widening of front-end swap spreads has been followed by dramatic increase in liquidity provision by the ECB. 2012 Pavan WadhwaAC (44-20) 7777-3370 Fabio Bassi (44-20) 7325-8615 Khagendra Gupta (44-20) 7777-1980 J. For example. the ECB has introduced considerable liquidity into the banking system. Given the 3 2 Av g: €0. which has put narrowing pressure on 2Y swap spreads. 9bp and 7bp. 2Y swap spreads have narrowed around 30bp from their peak of 115bp. This time around.P.

10Y swap spreads appear to be trading a tad wide (Exhibit 13). that swapped issuance is running at high levels even after adjusting for this seasonality. implieds on shortdated options are up between 0. 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.2-0.7bp/day on the back of the jump in yields on Wednesday.0 1. each 10-pt increase in the S&P500 index has resulted in seasonally adjusted swapped issuance increasing by around €0.5bp/day over the week (Exhibit 14). Implieds on govie options also followed a similar pattern. Net.93 R 2 = 89% 16-Mar-12 1150 1250 S&P500 index .0 -0. 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. 3M. Indeed. Additionally. 1M delivered volatility also increased between 0.7*(10Y Yld) + 63. bp 140 y = 8. Morgan estimate of seasonally adjusted swapped issuance* regressed against S&P500 index.2 0. Despite the recent narrowing. 2Y and 5Y expiries. we expect markets to remain in risk-on mode and therefore expect swapped issuance to stay high. We believe they can narrow further in the short term and retain our narrowing bias.P. 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. Exhibit 13: …especially in the belly of the curve where spreads are trading a tad wide and are most susceptible to swapping activity.5 1050 y = 0.2bn (Exhibit 12). 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.European Rates Strategy Global Fixed Income Markets Weekly March 16. thereby putting narrowing pressure on swap spreads. In the intermediate term. 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. .34. We note. Swapped issuance continues to run at very high levels. Exhibit 11 shows the J. they rebounded over the following three days.85bn/day. we continue to expect 10Y spreads to trade in a 2040bp range. After having dropped to the lows since the start of the Greek crisis in May 2010 during the early part of the week.5 2. past 6M.4 0.7*(3Mx 10Y Vol) . past 6M. especially in the belly of the curve. bp/day 0. thereby putting a narrowing pressure on swap spreads… J.12x + 68.P. however.0. 2012 Pavan WadhwaAC (44-20) 7777-3370 Fabio Bassi (44-20) 7325-8615 Khagendra Gupta (44-20) 7777-1980 J. which is exactly twice the 5Y average of €2. Exhibit 12: …and the risk-on sentiment that has prevailed over the past 3 months. Morgan Securities Ltd.2 R 2 = 87% 130 120 16-Mar-12 110 100 4 5 6 7 3Mx 10Y implied v ol. €bn/day 2. the risk-on sentiment that has prevailed over the past 3 months has resulted in increased appetite for spread products.0 0.00001x 2 . points 1350 1450 * See Exhibit 11 for definition of swapped issuance.5 0.5 1.7bn/day. We expect markets to remain in risk-on mode and therefore expect swapped issuance to stay high.P. For example. To smoothen the data series. 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.6 0.2 1Y 2Y 3M 2Y 5Y 20 5Y Tails 10Y 30Y Note: Implieds on 1Y tails are based on the 3s curve.2bp/day and 0. bp/day 8 9 Euro Volatility Implieds had a roller-coaster week. the 20-day MA of swapped issuance is currently at €5.0 -0. Morgan estimate of seasonally adjusted swapped issuance.

However.5 7.5 6.35 2. we continue to favour short gamma positions as delivered volatility in yields is likely to stay below implieds over a long term (say 3M). At current levels. we do not discount the possibility of further jumps in yield. buying 3Mx5Y gamma. Second. we have recommended outright short gamma positions on 3Mx10Y.8. 2012 Pavan WadhwaAC (44-20) 7777-3370 Fabio Bassi (44-20) 7325-8615 Khagendra Gupta (44-20) 7777-1980 J. We estimate that on Wednesday. compared to the level of rates (Exhibit 16). while Bobl and Bund implieds increased 0.7 Exhibit 15 shows the estimated number of days of carry lost to various yield moves if we initiate short gamma positions at current levels. Morgan volatility indices. Options are re-struck at the beginning of each month.002x 2 + 0.P. we reduce our conviction on outright short gamma positions (see below).0 4. which assume daily delta hedging and zero transaction cost. Returns from this switch have exhibited a positively convex relationship to outright short gamma positions Rolling 2W returns* from selling 3Mx10Y straddles vs. the implied volatility spread is currently trading close to its multi-year highs (Exhibit 21 . Instead. when 10Y swap yield increased 10+bp.0.0 6.45 3Mx 10Y EUR sw ap y ield. Therefore.4bp/day. We had argued that implieds were likely to stay low and delivered volatility to tread below implieds.25 y = 5. bp/day 40 20 0 -20 -40 -100 y = 0.35 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. To be sure.78x .50 2. buying a gamma equivalent amount of 3Mx5Y straddles regressed against rolling 2W returns from selling 3Mx10Y straddles outright. past 3M.40 2.0bp/day). 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.5 5. Thus.0 2. Exit short 3Mx10Y gamma as jump risk is high… 3Mx10Y implied volatility regressed against 3Mx10Y swap yield. a 10bp jump in 10Y swap yields would cost 9 days of carry to short gamma positions.0 5. buying a gamma-equivalent amount of 3Mx5Y swaption straddles for several reasons. # days Exhibit 15: Short gamma positions are susceptible to jump risk. Number of days of carry lost from selling 3Mx10Y gamma for various one-day jump in 10Y swap rate. 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. % 2. returns from this gamma-neutral switch have exhibited a convex relationship to that of an outright short gamma position (Exhibit 17). we recommend exiting short 3Mx10Y gamma positions at a small loss (see Trade Recommendations). we are wary of the jump risk.P. First. bp of notional 100 * Returns calculated using J. bp 1 3 5 9 7 15 12 18 21 24 16-Mar-12 2.882 R 2 = 52% -50 0 50 2W return from selling 3Mx 10Y gamma. we recommend low-risk short gamma proxies such as selling 3Mx10Y swaption straddles vs. Additionally. past 2Y.340x . Morgan Securities Ltd. implieds now appear cheap 7 We use current implied volatility and 3M delivered volatility on the underlying swap to calculate carry. Exhibit 17: Instead. a short gamma position in 3Mx10Y would have lost around 9 days of gamma carry. initiate short gamma position via low-risk proxy such as selling 3Mx10Y vs. 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. bp/day Exhibit 16: …and implieds are trading cheap relative to yield levels 7. However.55 14 15 increased 1bp/day.30 2.5 4.European Rates Strategy Global Fixed Income Markets Weekly March 16. Going forward.

low central bank activity and low volatility. the delivered volatility spread has. Schatz yields are likely to continue to under-deliver their swaption counterparts as they remain in a tight range. Thus. buying maturity-matched swaption volatility. 0.0 * See Exhibit 17 for definition of returns.5bp/day.P.8 This implied volatility spread of 0. While we do not expect that level of normalisation to occur over the trade horizon. we do believe that 10Y volatility is likely to decline relative to 5Y volatility as the volatility surface normalises.5 1. lost money if initiated at < 0. we do not expect the implied volatility spread to increase significantly higher even if Schatz yields continue to grind higher.8bp/day). 8 Implieds on Schatz options increased 1bp/day whereas implieds on maturity matched swaptions increased only 0.8bp/day Rolling 3M returns* from selling 3Mx10Y straddles vs.0 1. The recent increase in Schatz implied volatility compared to maturity-matched swaption volatility provides an attractive entry point. 2012 Pavan WadhwaAC (44-20) 7777-3370 Fabio Bassi (44-20) 7325-8615 Khagendra Gupta (44-20) 7777-1980 J. during periods of high excess liquidity. buying 3Mx5Y. this switch offers positive gamma carry… 2 1 0 -1 -2 -3 2002 2004 2006 2008 2010 2012 Current imp spread: 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. in general. ** 1M delivered volatility of Schatz futures – 1M delivered volatility of maturity matched swaps. Implied volatility spread (3Mx10Y – 3Mx5Y) versus 3M delivered volatility spread*. Note: Futures are rolled 10D before option expiry. bp/day Exhibit 19: …and has historically been profitable when initiated at current level of implied volatility spread (0. These tail switches have. we recommend selling 3Mx10Y gamma vs. The one exception to this was during year-end 2008 when technical flows were dominant.3bp/day 150 100 50 0 -50 -100 -0. Indeed. On a relative basis. remained below the current level of implied volatility spread. With excess liquidity at extremely high levels and the ECB temporarily on hold. Furthermore. we recommend selling Schatz volatility vs. 18). past 3M. we like selling Schatz volatility vs.0 0. 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 . Historically. bp/day 2. past 3Y. maturity-matched swaption volatility as this switch offers positive gamma carry Schatz/Swaption implied volatility spread* versus 1M delivered volatility spread**. 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. a trend we expect to continue over the next few weeks. Third. this switch offers positive gamma carry (the 3M delivered volatility spread is 0.European Rates Strategy Global Fixed Income Markets Weekly March 16. 10Y volatility trades at par or below 5Y (see highlighted section in Exhibit 18).5 3M prior imp v ol spread. Morgan Securities Ltd. bp/day Exhibit 18: Additionally. Finally.05 R 2 = 54% * Delivered volatility spread is defined as 3M delivered volatility on 3Mx10Y swaps – 3M delivered volatility on 3Mx5Y swaps.7bp/day above the 1M delivered volatility spread (Exhibit 20). buying a gamma equivalent amount of 3Mx5Y straddles regressed against 3M prior implied volatility spread (3Mx10Y – 3Mx5Y). this switch has generally been profitable when initiated at current levels (Exhibit 19). Additionally. Exhibit 20: At the front end. however.5 y = 55. as Exhibit 21 illustrates.72x + 9.6bp/day is close to the highs of the past 3 months and is about 1.4bp/day below the implied volatility spread). past 10Y.

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

previous bullmarket sell-offs*. bp 140 120 100 80 60 40 2.5 1. 2012 Francis DiamondAC (44-20) 7325-3541 francis. last 12M. which can be entered for zero cost via 3M payers at 70bp.70 level in 4s22. bp unless stated Change Period 16 Mar 11 .5 0.com J.64 -2. 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.42x + 2.70% (currently 2.01x + 1. 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. A similar dynamic is also observed in swap space where the directionality of 10s/30s swaps increases substantially with 10Y swap yields above 2.5 3. Given our curve view. the flattening in 10s/30s seen so far has lagged that seen on average in the previous bull-market corrections (Exhibit 4).0 10Y par y ield.0 1. 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. Over the past few months as the BoE has been conducting QE purchases. as 10Y par yields rise above the 2. However. 10Y and 30Y implied vols trade at the same level and the rate carry and slide is only -1.12 Apr 11 18 Aug 11 .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. However. although is not as rich in ASW 26 .60%.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.45%. 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. Given our bearish duration view we recommend entering 10s/30s gilt curve flattener. In addition. % 3.0 -0.64%).European Rates Strategy Global Fixed Income Markets Weekly March 16. the 10s/30s curve has generally been non-directional with 10Y yields.28 Oct 11 Av erage 9 Mar 12 . target 2. Exhibit 3: …and the beta between gilts and US Treasuries has increased sharply over this past week 2.37%) We take profit on our tactical 5s/10s steepener.04 R 2 = 0% 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. In addition.0 current y = -0. We go short 10Y duration but look to trade this with a tight stop loss (current 4s22 yield @ 2. especially as QE purchases look unlikely to be extended in May. stop loss 2.P. 2) technicals are supportive with our technical analysts targeting the 2. and 3) we expect the risk-on dynamic to continue.5bp per month.diamond@jpmorgan.17 R 2 = 82% y = -0.5 4. we think 10s/30s bear flatteners are attractive. We stay long the belly of the 10s/30s/50s gilt fly. Morgan Securities Ltd.1 Sep 11 5 Oct 11 .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. although there have been with sporadic instances of directionality. the same level as priced by the forwards.0 0.50% level we expect the 10s/30s curve to become much more directional (Exhibit 5).

Exhibit 6: The belly of the 3T19/4T20/4s22 fly is rich 50:50 fly in yield and ASW space. In the 10-13Y sector. 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. -75 -80 -85 Mar 11 Jun 11 Sep 11 Dec 11 Mar 12 * Calculated using risk weights 66%:100%:66%. In swap space. but there is a growing possibility that this scheme could be pre-funded directly via gilt issuance. space (Exhibit 6). 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. 4s60 on a cash-for-cash basis. 7Y swap rates. as the scheme is expected to be operational for only a few years.European Rates Strategy Global Fixed Income Markets Weekly March 16. baseline and high issuance scenario.diamond@jpmorgan. Further out. We had initially expected this scheme to allow participating banks to issue debt underwritten with a government guarantee. at around £150-£190bn. One additional source of uncertainty is the funding for the ‘credit easing’ scheme which is expected to be launched the day before the budget. bp -70 av erage = -78bp More on the FY 12/13 issuance remit. Morgan Securities Ltd. gilt 4s60 has corrected from its very rich levels and we take profit on our recommendation to be long 4Q55 vs. 2012 Francis DiamondAC (44-20) 7325-3541 francis. We think that this remit could contain some surprises. 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. 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. 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.This fly has shown limited directionality with the curve and level of yields. which is close to its richest level over the past 12 months (Exhibit 7). given that there are several uncertain factors that could drive the headline gilt sales number. we think this would result in an increase in the supply short maturity gilts. We recommend paying the belly of the leveladjusted 3s/7s/15 swap fly (risk weights 66%: -100%:66%). This scheme is expected to be up to £20bn in size.** 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 Exhibit 8. £bn unless stated Low Baseline High scenario scenario scenario CGNCR* Redemptions Reserv e Financing Short Term financing Adj. and if it were to be funded via gilts. As we have discussed previously (GFIMs. 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. with participating banks paying a fee to the government to access the funds.P.com J. 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*.

42 3.European Rates Strategy Global Fixed Income Markets Weekly March 16. 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. % Mod. The recent announcement that the Treasury is considering issuing 100Y gilts should be followed by the launch of a consultation process by the DMO.5 21.com J. Despite the tight levels.2bp Jun 11 Sep 11 Dec 11 Mar 12 * 5Y swap spread = -0. y ears PVBP 07-Dec-2042 22-Jan-2060 15/03/2112* 3. Our forecast for the maturity split for gilt issuance remains the same as we presented last week i. 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). a 1% increase in linker issuance and reductions in medium and long nominal issuance by 2% and 1% respectively. We also think this announcement increases the possibility of ultra-long gilt issuance in the 50-60Y area of the curve. This bond trades rich on our par curve model as it is 28 3T19 8s15 2s16 4s16 5s18 . leaving both 5Y and 10Y swap spreads at close to their tightest levels for the past few months. 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. However. 9 – 16 Mar.54. but we think the likelihood of a 100Y gilt actually being issued is low. last 12M.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. 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. 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). given the lack of intermediary bonds between 50Y and 100Y maturity. 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 5.43 3.9 29.12 * 5Y par + 0. and 2) 5Y swap spreads remain too wide based on our high frequency model (Exhibit 10). 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*. Whilst this would represent attractive funding for the government. modified duration and PVBP for a hypothetical 3.38 17. 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.e.5% 100Y gilt compared with existing 30Y and 50Y gilts Maturity Yield.21 * rolling 2nd FRA/OIS + 0. a 3% increase in short nominal issuance (given the low level of spot and forward years and recent strong demand). 5Y par yields and rolling back FRA/OIS spread*.5 years more duration than the existing 2060 bond (Exhibit 9).7 28.5 25.7 22.. Dur. bp 15 10 5 0 -5 -10 -15 Mar 11 current = 4.diamond@jpmorgan. bp Enter tactical 5Y swap spread narrower Swap spreads have narrowed across the curve as gilt yields have risen over the last week.P. which we do not think is generally expected by investors. 2012 Francis DiamondAC (44-20) 7325-3541 francis. Morgan Securities Ltd. 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).

stop loss @ 7bp. P/L since inception is 3bp. stop loss @ 110bp. stop loss @ 2. selling payers on 2Y and 10Y) − Pay £100mn of 5Y swap vs. 1T17 on ASW Long lv l.5bp.0 7.37. stop loss @ 63bp.0 -1. receiving £72.8mn of 15Y @ -82bp.0 3. selling £16mn of gilt 3T21 and selling £25mn of gilt 4s60 @ 46bp. stop loss @ -85bp.diamond@jpmorgan. stop loss @ -9bp (recommended 9 Mar).0 3.4mn of 1Yx1Y GBP swaps @ 32bp. buying £25mn of gilt 4s16s and £19mn of gilt 5s18 @ -4. long 5s18/4s22/5s25 Sell 4s16 v s. P/L since inception is 0bp (recommended 20 Jan).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.European Rates Strategy Global Fixed Income Markets Weekly March 16. • Keep paying 12Mx6M GBP swaps Pay £50mn of 12Mx6M swap @ 1.5bp.P. P/L since inception is 8p (recommended 20 Jan). • Keep reds/greens swap curve steepener Pay £50mn of 2Yx1Y GBP swaps vs.5mn of gilt 4H42 @ 104bp.0 13. 3M carry and slide is -4bp. Target 2. 30Y France BE Short ILG50 v s. • Take profit on 5s/10s gilt curve steepener Close long £50mn of gilt 1T17 vs. • Stay long the belly of the 4Q32/4T38/4H42 fly (50:50) Buy £30mn notional of gilt 4T38 vs.30%.5 4. • Sell the belly of the 3s/7s/15s level-neutral swap fly (66%:100%:66% risk weights) Sell £50mn of 7Y swaps vs. but we would not rule out a further reopening of this bond in the next fiscal year. receiving maturity matched swaps @ 59. • Take profit on short in 4s60 vs.and curv e-adj.0 10.0p. P/L since inception is 4bp (recommended 10 Feb).0 2. And curv e adj 3s/12s/25s sw ap fly Long belly lv l.0 3.3mn of 3Y and £17.5% Mar19 vs. • Take profit on short in belly of 3T21/5s25/4T30 fly (50:50) Close short £30mn of gilt 5s25 vs.25. 3M carry and slide – 9bp. P/L since inception is 6bp (recommended on 2 Mar). buying £21mn of gilt 3T21 and £12mn of gilt 4T30 @ -1.0 5. receiving £50mn of 2Y swaps and £50mn of 10Y swaps via 3M payer options. Target 30bp. • Enter 10s/30s flatteners Sell £50mn of gilt 4s22 vs. 29 .5bp. P/L since inception is 24p (recommended 24 Feb).5bp.75% Sep20 @ -7. • 5Y swap spread narrowers Sell £50mn of gilt 4s16 vs.05%. buying £20mn of gilt 4Q55 @ a relative price ratio of 0. 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. buying £23.0 -10. • Close short belly of the 4s16/1T17/5s18 fly (50:50) − Unwind short £50mn of gilt 1T17 vs.3mn of gilt 3T21 @ 114bp. Target -75bp. receiving £50. selling £29. Target 1. P/L since inception is 0bp (recommended 3 Feb). Target 2bp. Adj. 4Q55 cash-for-cash Close short £20mn of gilt 4s60 vs. larger than the 2017 lines. • Keep paying belly of 2s/5s/10s GBP swap fly via 3M payers (buy payers on 5Y vs. selling £19mn notional of gilt 4Q32 and £14mn notional of gilt 4H42 @ weighted spread of 5. 2012 Francis DiamondAC (44-20) 7325-3541 francis. Target 45bp. buying £17mn notional 5s18 and buying £13mn notional of gilt 3.0 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. stop loss @ 50bp.9612. 3M carry and slide is -2bp. (recommended 24 Feb).45%.60%. 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 50bp. Morgan Securities Ltd.0bp.0 27-Jan-12 10-Feb-12 138c ENTRY EXIT P/L Trade recommendations • Go short 10Y gilts Sell £75mn of gilt 4s22 @ 2. • Sell the belly of the 5s18/4H19/3T20 fly (50:50) Sell £30mn notional of gilt 4. 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.0 4. 04-Nov -11 24-Feb-12 stop loss @ 15bp. We recommend positioning for our narrowing view in gilt 4s16. Target -3. Target 95bp. stop loss @ 1. 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 17.3M carry and slide is -3bp.0 7.com J. • Stay long belly of 10s/30s/50s gilt fly cash-andduration neutral fly Buy £40mn of gilt 4Q40 vs.P/L since inception is 0bp.

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

95 0.7 -12.6 35.9 443. Morgan tradeweighted USD index.049 0.5% -20.6 21. see also Cross Sector Overview.149 0.3 5965.4 3.8 616.3 22.200 0.317 0.0 189.293 2.6 1.8 -244.7 -24.406 -0.6 -3. Morgan Securities LLC.244 -0.1 -11. SunTrust.63 * 3/15/12 level for Europe and US corporate credit spreads.005 -0.9 -3.4 25. fueled a substantial sell-off in government bonds and a rally in risky assets This week’s FOMC meeting contained no surprises.137 0. On the whole.1 -1.7 -21.3 394 1376 353 618 -2 80 -16 0 12 197 -134 -135 -1 -36 13 12 0.2 2608.34 8. As we have noted recently.* change since 3/9/12.114 1.06 -0.9 -38. but we look for only a modest rise in yields and maintain our 2.60 Oil futures ($/bbl) 107.3 -9.3 78.7 215. US Fixed Income Markets Weekly.1 -15.6 16.0 -35.7 12. and credit spreads narrowed sharply (Exhibit 1).9 -32.138 0.50% target for 10-year yields by mid-year Exhibit 1: Back to rally mode Current level. quarter-to-date change.390 2.0 -6. Equities outperformed. Stay overweight risky assets We think the sell-off in Treasuries will continue.6 10129.1 146. Despite the stringent nature of the stress scenario. driven by technicals.9% -2.9 -74.232 -0.0 -107. favorable bank stress test results.1% in 3Q11).84 -0. pending bank downgrades and the potential for a weaker earnings season are risks.3% in 4Q13 (versus 10. 1. government bond yields rose.051 0. Citi. the results confirm that large US banks are well-capitalized.220 0.par gov't spd 2Y USD par swap .8 18.046 -0.6 96% 101% 0.361 0.2 -5.4 31. 3/16/12 level for all others.3 92. These results.6 -83.027 5. known as the Comprehensive Capital Analysis and Review (CCAR).0 -101.3 -104.9 • • • • Markets spring forward as winter fades Markets experienced a significant risk-on rally in a week that brought positive economic data. A key catalyst for this week’s rally was the relatively strong outcome of the Fed’s stress tests for banks. Four of the nineteen bank holding companies did not pass the test (Ally.3 1674.4 -50. and MetLife).419 0. and the J. 3/2/12). coupled with the Fed’s 31 .5 126. the results were surprisingly positive.1 -130.6 291.81 -15.025 -0.76 0.3 -60. US Cross Sector • Despite including a stringent macroeconomic stress scenario.20 118.9 229.0 -17.089 1404.2 136.23 -0.2 -1.017 -0.6 -90. 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.34 -8. Harano (1-212) 834-4956 J.1 200.001 0.014 0. 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 .6 221.23 19. while Fifth Third received limited approval to carry out its capital plans.60 -74.8% -0.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) 1659.6% 88.003 1.262 0. but we believe the positive news from the stress tests and a generally supportive macroeconomic backdrop will keep the risk-on momentum going.191 0.8 321.032 -0.8 393.916 83.50 -39.6% 1.037 0.44 30. and an unsurprising FOMC statement. the stress test involved considerably onerous economic and market scenarios (see Special Topic.3 49.8% 0.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16.7 -24.P.126 0. Despite projected losses of $534bn over nine quarters under the hypothetical stress scenario.3 -27.55 81.080 -0. 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. with most of the nineteen banks meeting minimum capital requirements even in such an adverse scenario.0 -47.4 153.P. along with supportive economic data.8 33. 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.6 7.0 -0.5 -15.0 -9.

TBA = To Be Announced. 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. not disclosed 0 0 3101 Up YoY.05 0.18 Qtrly Dividend 2011 2012 Fed Approved ($/share) 0. approval for dividend increases and stock buybacks for several banks subject to the tests (Exhibit 2). January and December sales were revised up and now suggest that real consumer spending is tracking a decent 1.3 to 74. supply remains a headwind in several sectors. initial jobless claims fell to 351K. manufacturing IP increased 0. On the other hand. Initial claims have now flattened out around a level that is favorable for the recovery (see “US: Initial claims get back down to the cycle low.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. The Fed did not take any balance sheet actions.30 TBA 0.01 0.1%. The Fed seemed marginally less concerned about the growth outlook.P. and commenting that “strains in global financial markets have eased. 3/13/12). 000s 000s 700 650 600 550 500 450 400 Continuing claims 7000 6000 5000 4000 3000 Initial claims 350 2000 Mar 08 Oct 08 Apr 09 Nov 09 May 10 Dec 10 Jul 11 Jan 12 assets overall. Second.3 in the preliminary March reading. In addition. Morgan estimates. set a very positive tone early in the week. at least for monetary policy.01 0. Looking ahead. and bank ratings downgrades are still expected to occur in coming weeks. but more importantly. with core CPI rising 0.05 0.13 0.000 Modest. 2012 Srini RamaswamyAC (1-212) 834-4573 Kimberly L.” Daniel Silver. Both the Empire State and Philadelphia Fed surveys increased in the latest month. sentiment indicators were less upbeat.P. In addition. potentially dampening risk sentiment.12 0.0% annualized growth rate in 1Q12 (see “Turn-of-the-year spending pothole now looks shallower.08 0. marginally above the cycle low of 355K (Exhibit 3).35 0. company data.01 0. Moreover.24 Buyback Approved Growth ($mn) Buyback ($mn) 0% 25% 0% 0% 20% NA 0% 0% 56% 83% 0% 33% 0 0 0 0 8. 3/13/12). 3/15/12). Exhibit 3: Both initial and continuing claims are at or near lows for the recovery Four-week average of initial claims (sa) versus four-week average of continuing claims (sa).3% in February and the growth in January was revised up from 0. while the four-week average of claims was unchanged at 356K. In addition.01 0.01 0.” Michael Feroli. Bloomberg.5-2. economic data were generally supportive of the risky asset rally.08 0.1%. Harano (1-212) 834-4956 J.862 0 0 0 336 2. risks remain.1% in February.13 0.20 0.416 879 NA 0 0 0 Limited to event 15.” On inflation. Finally. One key risk remains elevated energy prices. Third.” Michael Feroli. likely due to rising energy prices.13 0. the University of Michigan confidence measure ticked down from 75. but the changes were minor enough to leave the impression that the Fed would prefer to err on the side of being too slow rather than too quick in embracing improving data (see “A quiet Fed day.20 0.25 0. 14% above their average levels in 4Q11.7% to 1.22 0. but the details were mixed to slightly weaker.01 0. noting that that the unemployment rate has declined “notably” recently. Source: J. but not disclosed 1160 1800 Note: See Special Topic for more details. continuing claims fell to a new low for the cycle. Morgan Securities LLC. February retail sales rose 1. One factor that was not necessarily supportive—but not a surprise either—was the FOMC statement. We continue to see a positive backdrop for risky 32 Exhibit 2: The Fed’s approval for dividend increases and stock buybacks for several banks helped set a positive tone in markets Capital actions announced for select banks in the 2012 CCAR 4Q11 Dividend ($/share) BAC BBT C FITB JPM PNC RF STI USB WFC BK STT 0. Brent oil prices have averaged $124/bbl over the past month. and continue to pose a risk to economic growth. there were enough changes in the statement to show that the Committee is watching and reacting to the data. All in all.16 0. and a few modest changes in the statement language suggested diminished prospects of QE3 at upcoming meetings. our strategy in US markets remains the same. signaling some improvement in general business conditions. inflation data remained tame. To be sure. First. .

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

1/25/07.4 2. US Treasuries • Momentum is likely to cause yields to trend higher for several weeks. While fundamentals were the main catalyst for yields to break out of their narrow trading range. representing a 3 standard deviation move (Exhibit 1). Because markets that are rangebound for a prolonged period usually produce significant exposure in yield curve carry trades.5% by mid-year However.5 2.125% Dec-15s. and effectively wiping out 9 months of carry for investors long this sector of the curve. 2012 Terry BeltonAC (1-212) 834-4650 Meera Chandan (1-212) 834-4924 Kimberly L. which followed a sustained period of improved funding conditions in Europe.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*. stronger US labor market data.0 3.1 2.8 * 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. with yields overshooting value as investors unwind these trades. sell-offs that push yields outside a long-held trading range tend to create momentum. their highest since October and 43 bp above their levels at the start of the year.P. but unwind tactical 10s/30s TIPS breakeven curve steepeners Exhibit 1: On a vol-adjusted basis. 5/29/08. The outsized move reflects both bad positions (as 3. The move. the sell-off in the front end appears overdone. 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. dates include 7/15/03. 10-year yields increasing 26 bp.7 3.0 1. 11/29/04.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.5-year sector of the curve Change in Treasury yields since March 6 divided by 6-month standard deviation of 8-day yield changes 3.0 2.2 2.625% Jun-14s versus a combination of 1.9 3. accelerated this week as rates finally broke out of the very narrow trading range they have held since November. Morgan Securities LLC.8 3. technicals are now supportive of additional follow-through. 5/7/09. Jun 14s are rich and their large foreign ownership makes them vulnerable to increased foreign selling Stay bullish on TIPS breakevens.8 2.9 1.5 3.2 2.5% by mid-year. 5-year yields increasing 22 bp.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16.3 2. 10-year notes are now yielding 2. and 30-year yields increasing 22 bp. This is evident in Exhibit 2 which highlights the average 34 . the move in the 3. and a rally in risky assets. buy 2-year Treasury notes versus OIS Sell 2.and 5-year sector of the curve was even larger when looked at on a volatility-adjusted basis. Harano (1-212) 834-4956 J.30%.4 -40 -30 -20 -10 0 10 20 30 Business days around first move above 200d average 40 Average 14-Mar-2012(Y1) 2.5% Dec-13s and 2. Threeyear Treasuries have sold off 18 bp since March 6. While the sell-off was led by 10-year notes.6 2.2 3.4 2.1 4. With the sell-off. 4.2 4.6 3.6 2. the sell-off this week was most severe in the 3. % Market views Treasury yields gapped higher this week with 2-year yields increasing 4 bp. we remain biased for higher intermediate rates still targeting 10year yields to reach 2. we remain biased for higher intermediate rates still targeting 10-year yields to reach 2. 12/7/10 and 3/14/12 Despite the magnitude of the sell-off.

7 8.3 Prelim.9 28.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. including preliminary data on transactions in long-term securities (released monthly) and final survey-based holdings of long-term US securities (formerly released annually. The model suggests that. but will be released monthly going forward). Thus. Further improvements in the labor market. These country-level inaccuracies are corrected to a large extent by the final survey-based holdings data. in such instances. Exhibit A highlights this by fitting a model of final purchases released in the annual data to the preliminary monthly data. Treasury 1.S. As discussed last month. Model fitted since 2002 Source: J.0 0. 2/24/12).6 32. we note that this is most likely an underestimation of its actual purchases during the month.3 1.9 8. China’s actual purchases of coupon Treasuries in January were likely closer to $29bn.7 5.5% point decline in the expected unemployment rate for 4Q13 (see U.4 1. % 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. not Italy. These data suggest that. 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. Treasuries using a financial intermediary in Switzerland. Fixed Income Markets Weekly. net purchases by UK 0. should push these forward rates higher still. even after this week’s sharp sell-off. 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. Exhibit 3: Even with this week’s sell-off. the preliminary monthly data have a “transactions bias” which results in distortions when trying to attribute purchases to certain countries.7 0. However.5 Nov 11 OIS fair value 8. based on the latest preliminary data.3 8.7 7.4 OIS rate Unemployment rate 8. Finally.9 0. Morgan Securities LLC.S. Beyond technical pressures.5bn coupon Treasuries during the month.2 Prelim.6 8. a deteriorating outlook for foreign sponsorship of Treasuries supports higher rates over the medium term.P. 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). net purchases by China 2. TIC data released this week suggests better buying during January Tstat January -1. moreover. if an Italian resident purchases U.40% (Global FI Technical Strategist. yields continue to trend higher for several weeks by an average of an additional 10-20 bp.5 2.2 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). forward OIS valuations appear rich and provide some fundamental support for the sell-off to continue given the current level of the unemployment rate. and shows that China purchased $7. December 2014 OIS appear too low given the asymmetric risk from downside unemployment surprises December 2014 OIS rate versus unemployment rate. we estimate the fair value of December 2014 OIS will increase roughly 50 bp for a 0. Indeed.5 8.6 0.9 35 . the preliminary data showed that China purchased $53bn coupon Treasuries. Because China likely uses a UK intermediary for some of its Treasury purchases.8 8.2 1. while the final data showed that China purchased $194bn coupon Treasuries over the same period. moreover. For example.8 0. This is broadly consistent with the near-term targets of our technical analysts. Harano (1-212) 834-4956 J. 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. it suffers from certain biases that could result in inaccuracies. given the “transactions bias” discussed above. Exhibit A: A model for estimating final purchases of coupon Treasuries by China Variable Coeff.P. For example. The preliminary data for January was released this week by Treasury. To be sure. This system provides insight into international buying of US securities and has various data releases. who expect momentum to push 10-year yields towards 2. 3/14/12). 2012 Terry BeltonAC (1-212) 834-4650 Meera Chandan (1-212) 834-4924 Kimberly L. Intercept -36. For the year ending June 2011. the sale of Treasuries would be recorded vis-àvis Switzerland.1 1. Morgan.4 Estimated final purchases by China in January R2=92%. While this data provides substantial insight into foreign buying of US securities. we continue to view forward OIS rates as too low given the uncertainty around the Fed’s unemployment rate forecast. 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).

Member. While these factors are supportive of higher rates.S. however. with the aim of seeking stable and sound financial returns. debt and diversify its foreign-currency reserves more quickly. " China should use some of its foreign exchange reserves to purchase energy and metal minerals that are of “strategic importance”...S. however. we will continue our investment in Europe. Official press agency Aug-11 Xia Bin. Concerns over safety. compared to the $118 bn of selling in 4Q11. Monetary Policy Committee.2 trillion "The incremental parts of our of our foreign reserve holdings should be invested in physical assets. while keeping risk control a top priority. Our short-term fair value model of 10-year yields suggests yields have now reached fair value (Exhibit 6). Russia and Taiwan. should instead total 20 percent of GDP. liquidity and potential revenues are three major factors affecting the government's thinking. For now. 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. and will wait for further .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. dollar.. and maybe we should invest in these types of companies in a proactive way. Valuations remain low compared to early last year both because consensus growth forecasts have fallen. dollar as the sole global reserve currency and begin a shift toward a more multipolar reserve system. and reduce investment in U. and Apple. 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.S. In order for 10-year yields to retrace to 3%. This will lessen the world's dependence on the U. China will continue to diversify its investments in foreign bonds.P.S. Brazil. Intel. This buying is small.5 bn and could have been as large as $30 bn (see grey box). 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. China. dollar Treasuries. Chairman of CIC Xia Bin. PBOC adviser in a publication Xu Nuojin. Member. $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. Vice governor of the PBOC's Guangzhou branch Jun-11 Source: China Daily. Japan. significantly higher. Harano (1-212) 834-4956 J. 2012 Terry BeltonAC (1-212) 834-4650 Meera Chandan (1-212) 834-4924 Kimberly L.. Bloomberg including net purchases from China that were reported at $7. China will continue to strengthen its foreign exchange reserves diversification. either sovereign stress in Europe needs to fall further. or market expectations on the timing of Fed tightening needs to move forward.2 trillion. 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). China should buy more non-financial assets with its reserves to diversify risks and should seek to globalize the yuan. PBOC adviser and monetary policy committee member Cheng Siwei. 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. increase investment in euro-denominated assets. vice-governor of the PBOC and head of the State Administration of Foreign Exchange Li Daokui. U.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. Morgan Securities LLC. former vice chairman of the Standing Committee of the 9th and 10th National People's Congress Li Daokui. PBOC Lou Jiwei. now $3. Monetary Policy Committee. we maintain our mid-year target on 10-year yields at 2. 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*. Sep-11 Sep-11 Xinhua News Agency. we would highlight that the near-term magnitude of any selloff from current levels should be relatively modest absent a change in Fed expectations.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. Looking ahead. "China should urgently assess risks from being the main foreign investor in U. and because flight-toquality risks from Europe remain somewhat elevated with semi-peripheral spreads still twice their levels compared to one-year ago. or about $1.We would like to buy stakes in Boeing. Under such principles.S. The nation should also optimize the structure of its foreign exchange reserves by diversifying away from U.5% (Exhibit 7).

Going forward. To position for declining front-end supply.178 * 1-year ahead J.P.003704 * semi-peripheral Europe 5-year CDS spreads (bp) Assets under management under government and prime money market funds. and technically driven de-risking this week as rates broke out of their trading range and investors unwound carry trades.25 2.2 3. with 2year notes reaching June 2011 levels earlier this week.6 2.P.30 1.357 * 5yx5y inflation swap rate (%) + 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 0.09 0.8 1. $bn 100 80 60 40 20 0 -20 -40 -60 37 .60 0. Morgan projections.40 0. A key driver of this move is front-end supply.50 0.10 0. Morgan positions index – 0.0 1.45 0.60 3.30 1.P.10 0.10 0. Quarter end cyclicals are also modestly supportive as GC repo has tended to narrow into quarter end.35 3.29 1.02 0.50 3. as government money fund flows have stabilized and bill supply is poised to turn sharply negative as Treasury tax receipts increase in April.454 * 3mx3m OIS rate (%) + 0. % Exhibit 7: J.10 0.97 + 0.0 2.13 0.47 0.4 3. bp Tbills net issuance.50 3.60 0. a seasonal increase in bill supply causing GC repo rates to spike.15 2. Morgan Securities LLC.2 2.11 2.02 0. Morgan GDP growth forecast (%) – 0. the sell-off in the front end appears overdone to us.4 2. Harano (1-212) 834-4956 J. 2y Tsy/ OIS spread.288 * J.41 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.25 2.45 0.36 1.02 0. While we remain biased for higher intermediate rates.8 2. 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).US Fixed Income Strategy Global Fixed Income Markets Weekly March 16.30 1.30 3. Exhibit 6: 10-year Treasury yields are back to fair value Actual versus fair value* of 10-year Treasury yields.50 0.P.04 0. we recommend buying 2-year Treasury notes versus OIS (see Trade recommendations). 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).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 1.25 2. 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.6 3. $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.50 3.P. 2012 Terry BeltonAC (1-212) 834-4650 Meera Chandan (1-212) 834-4924 Kimberly L.

Thus far in FY2012.4% below the same period in FY 2011.4% Deficit Finally. term Term (yrs) (yrs) 10 3 5 10 5 10 3 3 5 10 7 10 7 10 5 8.6 9.375 1.9 0.0 1. Morgan Securities LLC.2 4.625% Jun-14s versus a combination of 1.4 1.3 -0.625 2.8 -2. Thus.7 0. respectively.7bn during the month. Rem. we recommend underweighting 2. the budget deficit has totaled $581bn. Exhibit 10: Off-the-run 5s and 7s with high foreign ownership have cheapened Top 15 Treasury issues with the highest foreign purchase at auction Orig.625 2. bought by foreigners at auction ($bn) 26 21 21 21 21 20 17 17 17 16 16 16 15 15 15 Yld error (bp) -1. While CUSIP-level data on foreign ownership of notes and bonds is not available. we recommend selling 2. outlays and budget deficit thus far in FY 2012 relative to FY 2011.and level-neutral basis.3 1.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16.8% On the yield curve.9 0.7 Exhibit 11: Foreign ownership of issues maturing in late 2014 and 2016 is particularly high Foreign purchases at auction grouped by maturity date. Treasury 5% 2. foreign ownership of issues maturing in that part of the curve is especially large.625 1.5% Dec13s and 2.8 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.6 0.5% Dec-13s and 2.0 0.375 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. $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. Looking ahead.625% Jun-14s.7 -0. 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.7 -0.125 2. Treasury does release data on the percentage of issue size foreign investors take down in each auction. helped by both higher revenues and lower outlays (Exhibit 12).625% Jun-14 is rich on the curve and is likely to cheapen if foreign investors continue to reduce their Treasury holdings.3 0.125 3. we note that issues maturing in late-2014 and 2016 could stay vulnerable in the near term.1 1. Foreign buying of 1.5 -0.5 Amt.3 1.7 0. % Issues with 3-month yield error z-score of greater than 1. In addition.8 1.8 2.375 2.9 0.3 2.125 2.125% Dec-15s was only $4.3 3m chg in yld error (bp) 0.8bn at auctions.125% Dec-15s (see Trade Recommendations). As shown in Exhibit 11.4 1. if foreign selling persists. 38 0% -2.625 1.3 0.7 1. highlighting that the budget deficit was $231. the CBO also released updated .0 1.P. Source: J.2 0.5 and greater. Harano (1-212) 834-4956 J. Morgan. 2012 Terry BeltonAC (1-212) 834-4650 Meera Chandan (1-212) 834-4924 Kimberly L.3 8.375 2. which have not cheapened despite foreign ownership of $21bn. or 9.4 3. US Budget Outlook Treasury released details of its February budget this week.625% Jun-14s.4 0.0 1.4 1.2 -3.125% Dec-15s on a curve and level neutral basis.7 0.3 9.125 2. and recommend selling this issue versus other issues that are not held in size by foreign investors.6 -0.1 -0.0 2.6 1.6 0. Exhibit 10 shows a list of the 15 issues with the largest foreign purchases at auctions. and currently appear modestly cheap versus the Jun-14s on a curve.7 7.2 -0.4 4. and currently have yield error z-scores of 1.4% -5% -10% Receipts Source: Treasury Outlays -9.75 3. The 2.7 8.25 3.3bn and $4.5 are bolded.4 -0. A notable exception is 2.8 -0.625 2.P.6 1.5 -1.4 0.625% Jun-14s versus a 86:22 risk weighted barbell of 1.5% Dec13s and 2.2 1.4 2.2 2. we think it is likely that foreign selling could extend to the 2.1 -0.4 2.7 2.

we continue to look for wider breakevens.6 TIPS The risk-on rally and sharp sell-off in nominal Treasuries helped push breakevens wider this week.0 Mar 10 5-10 year ahead Oct 10 Apr 11 Nov 11 1 year ahead 3. and 17bp.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. with longs in 5-year and 10-year breakevens carrying positively by 6.2 3.27x + 35. Looking ahead. or 7. purchases were concentrated at the long end.0 5. Third.0 2. One potential reason why the Fed bought an unusually small amount of TIPS is because investors offered them an unusually small amount—only $2. Indeed. 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). showing that headline CPI rose 0. 12bp. below expectations of a 0.5 Amount of TIPS offeredin Fed purchase operation. over the past eight months (post-QE2). and the Fed purchase operation caused the breakeven curve to steepen this week: 5-. Thus.P. The key events for the TIPS market were the Fed purchase operation on Wednesday and Friday’s CPI report. 2012 Terry BeltonAC (1-212) 834-4650 Meera Chandan (1-212) 834-4924 Kimberly L. with the Fed buying $1bn in the 28-30-year sector.0 y = -8. over the very near term. this curve no longer looks mispriced relative to the nominal 10s/30s curve and oil prices. However.9 2. the report still implies that carry will be attractive in April.90 R² = 0. as Exhibit 14 shows.9bn. Their FY 2012 budget forecast (released January) was revised up by $93bn to $1.5% lower than that in the prior year.6bn Feb-42s. 39 . 20.5 3. budget projections for FY 2012-2022 incorporating recent changes in to the legislation. $bn after the operation. respectively.5 4. today’s University of Michigan consumer sentiment report showed that consumers’ inflation expectations have been rising in recent months.5bp they have widened so far. 16bp. including $0.8 2. this increase is likely supportive of wider breakevens.7 2. respectively. In addition. 10-.2bp. Once again.4bp and 2. Second.0 3. 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. The recent data from both sources is broadly consistent with our own FY 2012 budget deficit forecast of $1. All in all.and 30-year breakevens widened by 4bp. If the risk-on rally continues as we expect. versus the 3. breakevens will likely continue to grind wider. we think the results of the Fed’s purchase operation argue for wider breakevens.44% in February.57% gain.1bn TIPS. On the curve. the modest decline in oil prices. we remain bullish on TIPS breakevens. 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 weaker-than-expected CPI report.1 3. the Fed purchased only $1. Separately. Morgan Securities LLC.0 4. % % 5.2tn.5 5. In the purchase operation. We think the low amount of TIPS offered to the Fed reflects strong investor demand for TIPS. a record low.0 2. bp 15 10 5 0 -5 -10 -15 3. The CPI report for February was slightly disappointing. especially their near-term expectations (Exhibit 13). Harano (1-212) 834-4956 J.2tn. the smallest purchase since Operation Twist began. breakevens have tended to widen after Fed purchase operations with small offered amounts. 8/11-2/12.5 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.0 3. To the extent that consumer expectations reflect broader inflation expectations.45 4.5 2.

or $101. valuations are mixed: 10-year real yields are slightly higher than they were before the January auction.8 196.997 0. or $14. • 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. P/L since inception: +4. or $25mn notional of T 4.434%.0 1. Exhibit 15: Ten-year real yields are slightly higher than they were in January. • 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.553 -0.114 Bid/ 2.625% Jun-14s (yield: 0. Quarter-end cyclicals are also modestly supportive as GC repo has tended to narrow into quarter end.4 217. P/L since inception: -25.0 -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.037 -0. .3bp. however.3mn notional of T 2. or $100mn notional matched maturity OIS at a spread of 11bp.8 1.729 -0. or $156.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16.0 205. Looking ahead to next week.5mn notional of T 2. 2012 Terry BeltonAC (1-212) 834-4650 Meera Chandan (1-212) 834-4924 Kimberly L. Not only do Dec-13s and Dec-15s have relatively low foreign ownership. or $6. or $122.75% Feb-42s (yield: 0.5% Dec13s (yield: 0.8 241.117%).788%.0 -4.2mn notional of T 2% Feb-22s (yield: 2.5bp and roll is 0.2bp.4 -3.125% Feb-16s (yield: 0.3bp and roll is 0.88 2.91 2. This trade is weighted to level and curve neutral.4mn notional of T 2% Nov-21s (yield: 2.61 2.7bp of yield.91 2.66 2. Unwind long 100% risk. bpv: $180/mn). − Unwind overweight on 96% risk. while breakevens are considerably wider than their January levels Auction statistics for 10-year TIPS.625% June-14s have relatively high foreign ownership.9 236.62 2.258%).125% Dec15s (yield: 0.8mn notional of T 2. this curve no longer looks mispriced relative to the nominal curve and oil prices. bpv: $234/mn). current cycle statistics as of 3/16/12 Size Auction date 01/11/10 04/05/10 (re) 07/08/10 09/02/10 (re) 11/04/10 (re) 01/20/11 03/24/11 (re) 05/19/11 (re) 07/21/11 09/22/11 (re) 11/17/11 (re) 01/19/12 Average 03/22/12 (re) 13 ($bn) 10 8 12 10 10 13 11 11 13 11 11 15 BE before Yield before 244. bpv: $383/mn).018 0. One-month weighted carry is 0. If this pattern holds.8 238.7mn notional of T 3.P. We stop out of this trade at a loss.681 1.80 2. Unwind long 50% risk.25% Nov-13s (bpv: $169/mn) versus 100% risk.732 EDM3 contracts (price: 99. Buy 22% risk.75% Feb-37s (yield: 3.5 1.1 1. It is interesting to note.931 0.847%).0 4.125% Feb-42s (yield: 3. this curve now looks close to fairly priced relative to the broader curve.65 3.408%).7mn notional of TII 0. 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. and could come under pressure like other off-the-run 5s in this sector with high foreign ownership. Harano (1-212) 834-4956 J.452 0.125% Jan-22s (yield: -0. 1/27/12). or $136.43 2. Morgan Securities LLC. Compared to history.868%).958 0. Sell 100% risk.5 173.1mn notional of T 0. reflecting the negative convexity in the trade. Furthermore.2 232.37 2. Weighted spread is -4. Unwind short 50% risk. (US Fixed Income Markets Weekly. or 2. or $76.7bp of yield. Unwind underweight on 100% risk. or $9.2bp.625% Jun-14s versus 1. 40 Unwind underweight on 78% risk.125% Dec-15s The 2. (US Fixed Income Markets Weekly.770 0.3 auction (bp) auction (% ) cover dealer % bidder % bidder % Trade recommendations • Sell 2. we are likely to see a strong auction and subsequent widening in breakevens. while breakevens are substantially higher than their January levels (Exhibit 15).97 2.298%). so we recommend unwinding this trade.352 1. − Buy 86% risk.7mn notional of T 1.8 -4. the key event for the TIPS market will be Thursday’s 10-year TIPS reopening.352%.6 212. or $16. • Unwind underweight in Apr-14 TIPS versus Jan-14 TIPS After the recent steepening. or $25mn notional of TII 0.242 0.64 2.4 188.205 0.5 6.0 0. One-month weighted carry is 0.26%).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. − Unwind short 100% risk. Unwind overweight on 100% risk. 3/9/12). − Buy 100% risk. they also appear modestly cheap relative to Jun-14s.2 158.1 -3.0 -3.2 226.0 235.33).

Stay overweight 85% risk.565). Stay underweight 100% risk. • Stay overweight 4s and 8s versus 6s − Stay overweight 69% risk.937%).625% Feb-27s (yield: 2. P/L since inception: +5. or $157. or $50mn notional of T 2% Feb-22s (yield: 2. or $50mn notional of T 1. P/L since inception: -0.361%).25% Apr-14s (yield: -1.6bp of yield.9bp of yield.6mn notional of T 0. or $170.408%). Stay underweight 100% risk.875% Mar-18s (yield: 1. Stay overweight 40% risk. reds/greens flatteners 7s/30s flatteners 3s/7s flatteners 4s/25s steepeners hedged with reds/10s flatteners 01/20/12 02/10/12 -11. (US Fixed Income Markets Weekly.354 EDZ4 contracts (price: 98.4mn notional of T 2. or $25mn notional of T 6. Stay overweight 63% risk.361%).33). or $151.2 3.P.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16.834%).25% Feb-14s (yield: 0.875% Jan-17s (yield: 1.375% Feb-19s (yield: 1.125% Feb-42s (yield: 3.0 1/32nds 12/16/11 01/20/12 03/09/12 03/16/12 02/24/12 03/16/12 -12. or 1.664%).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. − Stay underweight 100% risk. Stay overweight 71% risk.682%). P/L since inception: +1.3 4. or $25.8 5.75% Feb-18s (yield: 1. (US Fixed Income Markets Weekly.296%). Unwind short 100% risk. 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. or $168.327 EDM3 contracts (price: 99.8 -14.5 -25. 2/24/12). 3/9/12). • Stay in 2s/7s steepeners hedged with reds/ greens flatteners − Stay overweight 100% risk.25% May-16s (yield: 0.9bp of yield.88).1bp of yield. or $25mn notional of TII 2% Jan-14s (yield: -1. or $191. 3/2/12).25% Jan-19s (yield: 1.25% Jan-15s (yield: 0.555%).0 44.0 3.7mn notional of T 2.936%).41%).3bp of yield. Stay underweight 100% risk. P/L since inception: -2.375% Jun-18s versus 1. Morgan Securities LLC. Stay underweight 98% risk.5 8. or 1. Stay underweight 100% risk.103 %). • Maintain exposure to belly cheapening trades − Stay overweight 94% risk. P/L since inception: +2.25% Feb-15s (yield: 0. − Unwind long 100% risk. or $475. (US Fixed Income Markets Weekly. or $281. or 3. 3/9/12). 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 2.25% Nov-17s (yield: 1. P/L since inception: 0. 3/9/12). or $112. 2/24/12).166 EDZ4 contracts (price: 98. or $148.565). or $307. or $25mn notional of T 6. (US Fixed Income Markets Weekly.7bp of yield. (US Fixed Income Markets Weekly. 41 . Stay overweight 54% risk. Stay overweight 42% risk. 2012 Terry BeltonAC (1-212) 834-4650 Meera Chandan (1-212) 834-4924 Kimberly L.4mn notional of TII 1.4bp of yield.4 Stay overweight 100% risk.375% Nov-19s (yield: 1. or 3.7mn notional of T 3.7 5.535%). Stay underweight 98% risk.1mn notional of T 0.3mn notional of T 0.842%). 2/24/12). or $50mn notional of T 3.8mn notional of T 1. P/L since inception: +4.1mn notional of T 0. 2/3/12).25% Feb-14s (yield: 0. Stay underweight 33% risk.875% Jan-17s (yield: 1.831%).625% Feb-27s (yield: 2.6mn notional of T 0. (US Fixed Income Markets Weekly. (US Fixed Income Markets Weekly.7mn notional of T 0.9 -2. or $50mn notional of T 2.875% Oct-17s 7s/30s flatteners Buy Nov-21 Cs versus Ps 4s/6s steepeners vs.842%). Harano (1-212) 834-4956 J. • Maintain 5s/10s and 5s/30s flatteners − Stay underweight 100% risk.389%). (US Fixed Income Markets Weekly.339%). 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. • Maintain 2s/6s steepeners hedged with 9th/11th Eurodollar flatteners − Stay overweight 100% risk.7 Misc.103%). − Stay overweight 75% risk.2 -0.3bp of yield. P/L since inception: +5. or $50mn notional of T 3.725 EDM4 contracts (price: 99.

Stay underweight 70% risk.825%). (US Fixed Income Markets Weekly.125% Dec-13s (yield: 0.430%).350%).5% May-38s (yield: 3. • Stay overweight 6.   • Stay in weighted 2s/3s steepeners − Stay overweight 100% risk.8bp of yield. or $48.25% Aug-23s (yield: 2.290%). (US Fixed Income Markets Weekly. or $39mn notional of T 6. • Stay underweight on-the-run 10s versus triple olds − Stay underweight 100% risk. or $50. Stay underweight 100% risk.5% Nov-26s (yield: 2.375% Feb-31s (yield: 3. Harano (1-212) 834-4956 J. Stay overweight 100% risk. Stay underweight 38% risk.8mn notional of T 0.9mn notional of T 5% May-37s (yield: 3.535%).5% Nov-26s versus a weighted barbell of Aug-23s/Feb-31s − Stay underweight 62% risk. Morgan Securities LLC.6mn notional of 2% Feb-22s (yield: 2. 1/27/12). 1/20/12). P/L since inception: +0. or $50mn notional of T 3.139%).258%). P/L since inception: +1. • Stay underweight May-38s versus May-37s − Stay overweight 100% risk.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. 2/10/12).051%).25% Jan-15s (yield: 0. (US Fixed Income Markets Weekly. 42 .296%).P.3bp of yield.5mn notional of T 5.125% May-21s (yield: 2. 2/3/12). Stay overweight 100% risk. P/L since inception: -0. or $16.9bp of yield. (US Fixed Income Markets Weekly. or $100mn notional of T 0. P/L since inception: -3. or $50mn notional of T 6. or $50mn notional of T 4. or $219.3bp of yield. 2012 Terry BeltonAC (1-212) 834-4650 Meera Chandan (1-212) 834-4924 Kimberly L.

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. US Interest Rate Derivatives • Turn neutral on intermediate maturity swap spreads. and this week’s spread narrowing—in the face of sharply higher yields—is partly a reflection of issuance-related pressures on swap spreads. Morgan Securities LLC. 2012 Srini RamaswamyAC (1-212) 834-4573 Praveen Korapaty (1-212) 834-3092 Alberto Iglesias (1-212) 834-5116 J.454. 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. Our narrowing -20 -10 0 10 # business days around range-break date* 20 * Dates used are 5/31/2007. 12/14/2010 and 2/4/2011. as we highlighted last week. Notwithstanding the likely continuance of such narrowing pressure. but upsize the short duration hedge Exhibit 1: Yes Virginia. 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. there is still negative convexity to hedge … Estimated dollar duration of the aggregate mortgage servicing rights universe. % • • Y = 89.P.8218 X1 .4 3. and 10-year yields are now near their six-month highs. 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. . we now recommend taking profits on spread narrowing positions. 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.12 • • Exhibit 2: … and mortgage related paying flows could increase if yields break out of their range.8 3. we now recommend turning neutral 43 .0065 period = Mar 15.to 10-year sector. Maturity matched swap spreads in the belly of the curve are narrower by 23bp in the 3. but wider by 0. This factor remains a valid one. 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.2 3. Treasury yields are about 30bp higher in the 7.8 4.4 MBS 30-year current coupon yield. $bn of 10-year equivalents -60 -80 -100 -120 -140 -160 -180 -200 -220 -240 2.to 5-year sector and 2bp in the 10-year sector. the pace of issuance remains well above average. regressed against mortgage current coupon yields.6 3. 3/25/2010. 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.Mar 15. 5/22/2009.01% standard error = 12.2 4.0 3.3bp in the long end of the curve. issuance-related narrowing pressures remain.9358 R² = 93. In the intermediate sector.11 .US Fixed Income Strategy Global Fixed Income Markets Weekly March 16.0 4.6 2. The modest compression in swap spreads belies the more violent nature of the move in yields.

751 Invesco Mortgage Capital Inc.027 MFA Financial. 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. 1.315 84. because of growing (and asymmetric) risk of paying from mortgage hedgers and REITS. Inc. 5. 10. versus a weighted average of the top 5 REITs’ stock prices* 20.056 (627) 4. there is still negative convexity to hedge. Nonetheless. 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.524 363 6.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. In addition.5 19. 10-year Treasury yields have broken out of their 6-month trading range on five occasions. if rates continue to drift higher.5 108. REITs have emerged as important marginal buyers of Agency MBS.0 17.5 107. 2012 Srini RamaswamyAC (1-212) 834-4573 Praveen Korapaty (1-212) 834-3092 Alberto Iglesias (1-212) 834-5116 J. As our mortgage strategists have noted often in recent years.917 Exhibit 4: A composite index of the top 5 REITs’ stock prices has tracked the MBS index price in recent months … The J.5 Mar 12 * We used prices of the top 5 REITs in the previous table.232 Dynex Capital. with relatively sizeable holdings in aggregate (although they remain small in comparison to the two GSEs—see Exhibit 3).762 18 1. 9. 7. they are not necessarily dynamic hedgers. 54. REITs on aggregate seem to hedge a significant portion of duration risk.0 19. Inc. with the Fed owning one quarter of the Agency MBS market. on intermediate swap spreads.512 41.414 201.074. 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.P. leading to sizeable hedging flows on an episodic basis. with weights of 0. Nonetheless. the business model for REITs centers on levered carry and allows for greater ability to run duration risk in comparison to the GSEs. and with prepayments structurally slower due to refi capacity constraints and negative home equity. Some evidence for this is seen in Exhibit 2. evidenced by the relatively small coefficient with respect to rates.019 11. Inc. thus.273 Hatteras Financial Corp.625. the subsequent beta between intermediate swap spreads and Treasury yields has tended to pick up.069 (1. While surprising at first glance. The results are shown in Exhibits 4 and 5. Morgan Securities LLC. To assess the likely hedging flows from REITs. coefficients are not stable over longer periods.840 ARMOUR Residential REIT.5 18. 106. First. 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).252 25 3. Over the past 5 years.463 Two Harbors Investment Corp.05. This risk is likely asymmetric from current yield levels. Inc.417 100. with GSE portfolios shrinking.318 CYS Investments. 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. and is one tactical reason to be cautious regarding spread narrowing trades.Morgan MBS index price. meaning that if REITs hedged duration using 5-year and 10-year instruments (liquid points in the . the hedging flows from mortgage portfolios and servicers in this week’s sell-off have likely been relatively modest. Such an analysis is no doubt imperfect.784 12.5 Sep 11 MBS index price Weighted average REIT index price 108. 0.155 Capstead Mortgage Corporation 12.394 (582) 4.5 20.0 18.to 3-year range in recent months. To be sure. REITS on aggregate benefit from yield curve steepening. Second. hinting at rising mortgage-related paying flows. Inc. 0. Weights based on shares outstanding.420 American Capital Agency Corp. three observations are worth making. Nonetheless. on average.420 10.062 Anworth Mortgage Asset Corporation 8. To be sure.0 107. A second risk to spread narrowing positions has to do with potential hedging flows from mortgage REITs. 17.058 and 0. but this is unsurprising given that REIT holdings of Agency MBS have risen sharply mainly over the past year or so.P.965 (107) 773 Top 10 Total Top 5 Total 240. 6.193. to estimate the current risk exposure of REITs in the aggregate.372 (26) 3.517) 25.444 (75) 1. 0. we created a composite market value index of the top 5 REITs from Exhibit 3.0 Oct 11 Nov 11 Jan 12 Feb 12 106.792 34 8. as numerous other factors could affect traded REIT prices. Assuming that half of this negative convexity is dynamically managed. . 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. it may reflect the fact that MBS index durations have remained in the 2.

646*3Mx2Y) minus (0. Exhibit 6: Stay positioned for a renormalization of the yield curve 115 110 105 100 95 90 85 80 3Mx7Y minus 3Mx3Y plus (0.4 Long options return* -33. Adjusted curve calculated as 2s/10s curve minus 0. and has essentially flat carry and slide. Treasury futures / swap markets). 5-year spot swap rates have risen by over 20bp this week. (For a more detailed discussion of 75 Mar 11 Jun 11 Sep 11 Dec 11 Mar 12 this theme. Aggregate REIT exposure to: Coefficient T-stat 5Y swap yield. we now recommend initiating 3-month forward 3s/7s swap curve steepeners. But perhaps most important. we recommend a receiver swaption spread. . we continue to recommend efficient ways of positioning for a renormalization. One such trade that currently appears attractive is a 3s/7s swap curve steepener. the emerging and asymmetric risk of mortgage–related paying if yields continue to rise is a powerful tactical offset. 2012 Srini RamaswamyAC (1-212) 834-4573 Praveen Korapaty (1-212) 834-3092 Alberto Iglesias (1-212) 834-5116 J. Interpretation of the convexity return coefficient is as follows: REITs stand to lose $33. although issuance remains elevated and threatens to bias intermediate swap spreads narrower. For instance. it also suggests that REITs may be operating under tighter net duration risk limits than generally assumed. REITs could become more active in hedging some part of their spread exposure. the Fed’s communications of its funds rate projections has caused the yield curve to shift to a new regime since August 2011. At the same time. and recommend unwinding spread narrowers in the 10-year sector (see Trade recommendations).0 12.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. closing at 1. In our view.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. $mn/bp 54.58*5Y swap yield. risks to the expectation of a flat-until4Q14 funds rate are growing as the labor market continues to strengthen. see Interest Rate Derivatives. 3/9/2012). Morgan Securities LLC. and exposed to a widening in the MBS basis. they would implicitly be in yield curve steepening positions. 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).1mn in a 3-month period where a $1bn notional long 3Mx10Y straddle position produces $1mn in daily-delta-hedged P/L. bp Weighted spread Prior mean Recent mean Swap yield curve On the swap yield curve.6 -2. however. 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. hedged with a weighted 2s/Blues flattener. convexity and MBS spreads. adjusted 2s/10s swap curve. Third. but should have experienced a discrete shift in their mean levels as part of the change in yield curve regime. However.2 -1.1 -2. In sum. given their considerable mortgage spread exposure. This will likely mean paying in swap spreads.0 2s/10s curve (adjusted for yield). meaning that they could become active in hedging any material increase in MBS durations. Exhibit 5: REITs on aggregate appear to hedge duration risk. the curve.347% versus a 1-month average (as of a week ago) of 1. but instead drift back lower to recent averages. The first two observations suggest that REITs are relatively well hedged currently. Therefore. As we highlighted last week. this trade exhibits all the above characteristics. US Fixed Income Markets Weekly. we now turn tactically neutral on swap spreads. In addition. but remain exposed to a widening in MBS spreads Estimated aggregate exposure* of the top 5 REITs to rates. given the correlation between mortgage OAS levels and swap spreads. $mn/bp -3.P. hedged with a weighted 3Mx2Y/Blues flattener (see Trade recommendations). REITs are (unsurprisingly) short convexity. To position for the possibility that rates do not continue their upward renormalization. 45 . Therefore.4 MBS OAS. $mn/bp -27.13%. trades designed to position for such a renormalization should have several characteristics – they should be relatively non-directional and meanreverting. As seen in Exhibit 6. such trades should ideally have flat or positive carry & slide.334*3Yx1Y) swap yield spread. long convexity returns and MBS index OAs. in conjunction with currently tight OAS levels and diminished prospects for QE3-related MBS purchases. 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.

. the recent average level (see Trade recommendations).P. ** Replication strategy constructed using a cash investment in 3M Agency discount notes.13%—i.42 0.e. For instance.Morgan US Government Bond Index versus the 15s/30s Treasury par curve. Looking ahead. we recommend buying 3Mx5Y receiver swaptions struck at the 5-year spot swap yield. we recommend a 10th / 15th ED flattener hedged with a 13th / 18th ED steepener (1:1 weighted). Bond Index replication With March Treasury note and bond futures close to expiry. Morgan Securities LLC. and is likely to be a better proxy for the long-end maturity bucket of the bond index. as seen in Exhibit 9. and selling an equal-notional amount of receiver swaptions struck at 1. leaving exposure to the 15s/30s curve as an implicit consequence. Thus.38 Jan 12 Feb 12 Mar 12 * See previous exhibit.40 0.46 0. Risk on this trade (measured as the 2year standard deviation of rolling 3-month change in the weighted spread) is 8. The total return of the synthetic asset in 1Q12 was 113bp or about 19bp more than the returns in the index.P. we now recommend initiating EDM4/EDU5 flatteners hedged with EDH5/EDM6 steepeners (see Trade recommendations). and with most investors having rolled into June.8bp. the performance of the synthetic asset has closely followed the movements of the 15s/30s Treasury curve during 1Q12. as we did in December. bp of total return bp 30 25 20 15 10 5 0 -5 Dec 11 Cumulative excess return 15s/30s Treasury par curve 0. 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. offers about 6bp of slide over 3 months.Morgan US Government Bond Index. We also recommend adding exposure to well-hedged carry trades. 2Q11 refers to the period from 3/1/2011 – 5/31/2011. Therefore. 5-. 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. and mimicking index risk with TU. Maximum loss on the position is 7bp of yield. TY and US Treasury futures. which would occur under a return to recent yield levels.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. quarterly returns on a synthetic replication strategy** and excess returns on the synthetic strategy. we review the performance of synthetic assets created with Treasury futures during 1Q12. In particular. 10-year note futures and bond futures (weighted to match the partial-bpvs of the J. As was the case last quarter. synthetic Treasury assets created by combining cash investments in 3-month Agency discos and long positions in 2-. As shown in Exhibit 7. and is well hedged (it moved by barely 1bp during this week’s sell-off).44 0. This would have been true in 1Q12 as well. 2012 Srini RamaswamyAC (1-212) 834-4573 Praveen Korapaty (1-212) 834-3092 Alberto Iglesias (1-212) 834-5116 J.Morgan US Government Bond Index) have outperformed the index for the first time in the past eight quarters.P.52 0. Futures positions rebalanced monthly. 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.. Exhibit 7: Synthetic strategies that combine cash investments with Treasury futures positions outperformed the bond index returns in 1Q12 Quarterly returns* on the J. The former extends out to 30-year maturities while the latter has a CTD in the 15-year sector. 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.7bp of yield. specifically. The maximum profit in this position.P. bond contract as a way to mitigate this long-end Treasury curve exposure in synthetic assets.50 0. outperforming as the curve steepened (Exhibit 8). FV. The ultra-long bond contract’s CTD is in the 25-year sector. . is 21.48 0. The weighted spread corresponding to this trade is attractive from an entry-level perspective (near its YTD highs).

1 6M30Y -74 -32 -15.2 Front FV -24 -63 0. The reason is two-fold.7 6.8 4. our short-duration hedge. Thus. including short volatility positions.P. Rangebound markets tend to produce increased exposure to carry trades.1 5. What is more notable is that even with these sharp increases week-on-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. Rising implied volatility. coupled with elevated delivered volatility. evaluated as twice the difference between the implied volatility at a strike equal to the ATMF rate plus the yield change over the week. to the exercise in Exhibit 11. given exante skews.Morgan US Government Bond Index. we had viewed skews as rich. on 1. which was empirically estimated over the past 18 months when skews were generally flatter than now.to 30-year underlying swap rates. meaning that any increases in normal implied volatility (unless otherwise hedged out) results in vega P/L.0 5.7 5. supporting our a priori decision to not explicitly hedge the skew.7 -23. and unlikely to be realized—an analysis analogous * Derived from the swaption skew as of 3/9/12. but for the 3-month period ending as of a week ago. our delta-hedging assumes the use of normal deltas.7 4. 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. abp 20 15 10 3m10y 5 3m2y 0 2y tails -5 0 1y tails 5 10 15 Expected change in swaption implied volatility*. our short 3Mx10Y volatility positions lost money this week. versus expected change*. Options are re-struck at the start of each month. particularly ones delta-hedged using normal deltas as seen in Exhibit 10. This appears true of the current 47 . .7 2. as seen in Exhibit 11. in fact).US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. Morgan Volatility Index.3 -5. implied volatility largely rose by less than what might have been expected.5 Front TY -33 -38 5. 2012 Srini RamaswamyAC (1-212) 834-4573 Praveen Korapaty (1-212) 834-3092 Alberto Iglesias (1-212) 834-5116 J.P.7 6M5Y -30 -78 -6. The second strategy replaces positions in the classic bond futures contract with bpv-equivalent positions in the ultra-long bond futures contract. ** Adjusted to a theta-neutral amount of 6Mx10Y swaptions.3 -31.4 Front US -56 -30 -33. Although this must be deemed an underperformance of implied volatility.9 4.2 5.1 -58. would show close to a zero beta (slightly negative. as investors seek to take advantage of stable markets to earn excess returns.8 4.6438 R² = 0. which assumes daily delta rebalancing and zero transaction costs. Second.704 Options Implied volatility rose sharply into the middle of the week.7 6. first. proved quite damaging to short volatility positions. proved largely inadequate this week. 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. The rise in implieds came as yields rose to recent highs and threatened a further breakout from their recent range.6 * Returns calculated using the J.2 -23.4 2. 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). abp 20 y = 0.. but retraced later in the week.2 -22. implied volatility across the vol surface generally rose by about 75% of the amount priced into skews as of a week ago.1.8 6.6 6.7457x . Actual change in swaption implied volatility levels since 3/9/2012 for options expiring between 1 month and 5 years.P.6 6M10Y -41 -41 -9.0 -37. Morgan Securities LLC. and the implied volatility at a strike equal to the ATMF rate. 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. 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.

We have often noted that the reactive nature of implieds to a sharp rise in delivered volatility. 2012 Srini RamaswamyAC (1-212) 834-4573 Praveen Korapaty (1-212) 834-3092 Alberto Iglesias (1-212) 834-5116 J. our Treasury 48 strategists are bearish but expect 10-year yields to stabilize near 2. This is likely to be the case in the current context.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. averaged over (i) the past 5 years. but recommend upsizing the short duration hedge from $10.4 Jun 11 Sep 11 Dec 11 Mar 12 0. * Partial beta calculated from rolling 1-month regressions of return of daily returns versus daily delta hedged return from selling 3Mx10Y straddles.1 0. this growth in short volatility exposure can also mean that when yields break through ranges. we recommend maintaining short gamma positions. and our model projects that maintaining short gamma positions going forward should prove considerably profitable.6 0. thus.1 0.4bp/day. 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). means that short gamma positions tend to outperform following a spike in implied volatility.5 0. Morgan Securities LLC. investors might seek to cover short vol exposure.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. the “excess” weekly increase in implied volatility was positive. for instance. This weighted spread exhibits little directionality with front-end . producing greater sensitivity of implied volatility to yield levels (assuming yields break out of the range towards the upside). the major US bond funds.3 0. Hedging the directionality of implied volatility for the fixed-strike option that we are short requires an additional swap notional of $10mn. Where does this leave us? Going forward. we would expect implied volatility levels to exhibit greater sensitivity to yield levels at least tactically. 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. However. environment—as seen in Exhibit 12.7mn to $20mn notional of a pay-fixed 10-year swap position (see Trade recommendations). with yields poised to break further out of recent ranges. our model framework also requires the directionality of short straddle returns to be properly hedged.0 -0. This is illustrated in Exhibit 13.1 -0. as well as (ii) conditionally averaged in episodes where yields have broken out of a range to the upside*.4 0. we recommend maintaining a short gamma bias.3 -0. For reference. However. making skews more likely to be realized.2 0. This average has been essentially close to zero over the past five years. 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*. but with an upsized rate hedge.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). the corresponding average conditional change in rates was about 26bp. However. as also seen in Exhibit 13.P. The average change in 10-year swap yields (%) in those episodes is also presented for reference 0. coupled with the fact that sharp increases in realized volatility tend not to persist unless supported by fundamentals. have likely maintained a short gamma bias for all of the first quarter.3 0. . averaging nearly 0.2 -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. daily change in red ED and 10-year yields. and daily change in MBS and credit spreads. In this regard.0 -0.4 0.5%.

7mn notional) of a 3Mx10Y forward starting swap (swap start date 6/13/2012.485 weights) (US Fixed Income Markets 49 . 2/24/12).25% June 16 spreads versus receiving in 3. P/L since inception: loss of 5. − Stay short $100mn notional of 3Mx10Y swaption straddles (notification date 6/11/2012.25% 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.464%) @ a premium of 34bp of notional. swap end date 04/24/2017) and stop paying fixed in $21. but upsize duration short We continue to recommend selling 3Mx10Y vol hedged for rates. buy the 5Y spot 1. . − Unwind longs in $100mn notional of 3-1/4% June 16 and stop paying fixed in $105.9mn notional of a 3Mx30Y forward starting swap (swap start date 04/24/2012. we recommend positioning for a reversal towards lower yields via options. However. Therefore. and stop receiving fixed in $96.13%. • 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). − Buy 1000 EDU5 futures versus selling 1000 EDM4 futures and also buy 1000 EDH5 futures versus selling EDM6 futures @ a yield spread of 2bp.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. we recommend unwinding this trade. maturity date 6/13/2022.646/0.13% strike. Carry and slide on this trade is approximately flat over 3 months. Morgan Securities LLC. rates. but instead drift back to recent averages. 1/20/12).5bp of yield (US Fixed Income Markets Weekly. • Maintain Reds / 10Y steepeners hedged with weighted 2Y / Blues flatteners − Maintain 1Yx1Y/3Mx10Y swap curve steepeners hedged with weighted 3Mx2Y/3Yx1Y curve flatteners (1.3 notional of a 06/30/2016 swap. • Buy 3Mx5Y receiver spreads Considering the possibility that rates do not continue their upward renormalization.11/0. and sell an equal-notional amount of receiver swaptions struck at the 1-month average of 1.347% strike and sell the 1. notification 06/18/2012. stop paying fixed in $133mn notional of a 3Mx5Y forward starting swap (swap start date 04/24/2012. cover shorts in $98mn notional of 31/4% of July 16 and stop receiving fixed in $103.8abp.7bp of yield (US Fixed Income Markets Weekly.2mn notional of a 2/15/2022 swap). given the greater likelihood of skews being realized as yields rise. − Buy $100mn notional of a 1.P. • 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.5bp. maturity 06/20/2017.4bp. Thus. swap end date 04/25/2022). ATMF and strike 2. swap end date 04/24/2042) @ a profit of 2. ATMF at 1. − Initiate 3Mx3Y/3Mx7Y swap curve steepeners hedged with weighted 3Mx2Y/3Yx1Y curve flatteners (0. − Stop receiving in $100mn notional of 2% Feb 22 maturity matched swap spreads (cover shorts in $100mn notional of 2% Feb 22s.5mn notional of a 7/31/2016 swap @ a profit of 0. defined as EDM4 yield minus EDU5 yield + EDM6 yield minus EDH5 yield.646*3Mx2Y minus 0. • 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. which has considerably corrected. 2012 Srini RamaswamyAC (1-212) 834-4573 Praveen Korapaty (1-212) 834-3092 Alberto Iglesias (1-212) 834-5116 J.347%/1. we recommend unwinding this trade. flat carry. 03/02/12). 03/02/12).189%) versus paying fixed in $20mn notional (upsizing our previous recommendation of $10. we recommend unwinding it.9bp of yield (US Fixed Income Markets Weekly. • Stop paying in 3. Three month carry on this trade is 6. and is likely to continue to trend higher as the yield curve eventually normalizes.334 weights) at a weighted yield spread (defined as 3Mx7Y minus 3Mx3Y + 0. − Stop receiving fixed in $100mn notional of a 3Mx10Y forward starting swap (swap start date 04/24/2012. we recommend upsizing the short-duration swap hedge.13% 3Mx5Y receiver swaption spread (1:1 weighted. • Stay short delta-hedged 3Mx10Y swaption straddles.334*3Yx1Y) of 87. buy 3Mx5Y receiver swaptions struck at the current 5Y spot swap yield. This trade is also attractive from an entry level perspective. and stop paying 20% of the risk (or $18035/bp) in September 2012 3M FRA-OIS spreads @ a profit of 2. swap end date 6/13/2022) (US Fixed Income Markets Weekly.

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. ATMF CMS 10s/30s yield spread and strike at 239. and continue to pay fixed in $110. P/L since inception: profit of 1.375). strike 1. ATMF and strike 0. Morgan Securities LLC. • Maintain synthetic conditional trade by selling 10s/30s YCSO caps versus 10Y receiver swaptions − Sell $500mn notional (i. maturity 8/31/16. stay long $95mn notional of 0. and in annualized bp of volatility for option trades.756% 3Mx1Y payer swaption spread (1:1 weighted. P/L since inception: loss of 0. continue to receive fixed in $138. ATMF and strike 2.75% of Feb 2041 spreads (stay long $100mn notional of the 4.845%). P/L since inception: profit of 2. P/L since inception: profit of 10.5275%). $50K/bp forward DV01) of single-look 6-month caps on the 10s/30s swap curve 50 . notification 5/10/2012.1bp of yield.25 calls (FVM2 @ 12304.. also.5mn notional of 3-month expiry 1-look caps on the 2s/30s CMS curve (end date 5/8/2012.2 (0. swap maturity date 5/8/2014.6) Income Markets Weekly.073%. maturity 09/18/37. 2/24/12). swap start date 5/8/2012. also stay short $998. 2/3/12).75% of Feb 2041. • 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 02/14/2013.4mn notional of a 01/31/2017 swap (US Fixed Income Markets Weekly.25 Jun16 vs rec 3. stay short 1598 0EU2 99. 03/09/12).P.9 P/L (3. swap start date 07/05/12.3mn notional of 6Mx25Y receiver swaptions (notification 09/14/12. expiry 5/25/2012) and stay short $129mn notional of a 05/25/12x8/31/16 receiver swaption (notification 05/25/12.5 0. maturity 09/18/19.506%/0. hedged with 5-year swap spread wideners and the 5s/30s Treasury yield curve − Stay long $50mn notional of 3.8bp of yield.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. yield 1. P/L since inception: loss of 3. versus selling 3-month expiry caps on the 2s/30s CMS curve − Stay long $50mn notional 3Mx30Y payer swaptions (notification 5/3/2012. ATMF 0. P/L since inception: loss of 2.3mn notional of a 02/15/2041 swap).1bp of yield. and stay short $22. swap maturity date 5/8/2042. 2/24/12). strike 2.000 FVM2 123. 2/10/12).098%) (US Fixed Income Markets Weekly. buy the ATMF strike and sell the A+.8) (4. swap end date 02/14/2023.25. yield 2. yield curve and miscellaneous trades.883%) versus staying short $500mn notional 3Mx2Y payer swaptions (notification 5/3/2012. 2012 Srini RamaswamyAC (1-212) 834-4573 Praveen Korapaty (1-212) 834-3092 Alberto Iglesias (1-212) 834-5116 J.506%.513%). Weekly.7 2. 1/27/12).e. strike 1.9) 1. swap start date 5/8/2012.6mn notional of a 1Yx10Y forward starting swap (swap start date 02/14/2013.4) 1.2bp of yield. 2/10/12). swap end date 02/17/2015.375 puts (midcurve option expiry 09/14/12. (US Fixed Income Markets Weekly.25 strike) (US Fixed Income Markets Weekly. ATMF 1.7 P/L 18.6bp of yield.354%) (US Fixed Closed trades in 2012 P/L reported in bp of yield for swap spread.7bp of yield. EDU3 strike 99.1) (9.125% of Nov 2041s and pay fixed in $51. • 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 conditional 2s/30s steepeners via 3-month expiry options.734%) and continue to receive fixed in $29.3mn notional of a 1Yx2Y forward starting swap (swap start date 02/14/2013. . • Stay long 3Mx1Y payer spreads − Stay long $100mn notional of a 0. maturity 5/14/2013.9 2. (US Fixed Income Markets Weekly.797%).4bp of yield. swap end date 02/14/2018. 03/02/12). P/L since inception: loss of 0.6mn notional of a 11/15/2041 swap. • Maintain 5-year swap spread wideners in a rally − Stay long 1. • Maintain 30-year matched maturity swap spread wideners.875% of Jan 2017s and continue to pay fixed in $67.5) (16.5bp of yield. yield 0. strike 123.25 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. P/L since inception: profit of 0. • Maintain 30-year swap spreads wideners − Continue to pay in 4.7bp) (US Fixed Income Markets Weekly.

2/24/12). (end date 6/11/12.7mn notional of 6Mx30Y swaption straddles (notification date 8/24/2012. P/L since inception: loss of 5. swap end date 6/13/2014) (US Fixed Income Markets Weekly. maturity date 8/30/2022. maturity date 06/13/22.64%) (US Fixed Income Markets Weekly. • 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 09/06/2012.8abp.1bp) versus buying $21.P.620%) and continue to receive fixed in $28. ATMF and strike 2.6mn notional of a 3Mx2Y forward starting swap (swap start date 6/13/2012. • 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. P/L since inception: loss of 0. strike and ATMF 10s/30s CMS yield spread at 60. 12/09/11).4bp of yield. maturity date 08/29/2042. 03/09/12). Morgan Securities LLC. • Stay long 6Mx30Y versus 6Mx10Y swaption straddles − Stay long $43.US Fixed Income Strategy Global Fixed Income Markets Weekly March 16. 51 .3mn notional of 6Mx10Y receiver swaptions (notification date 06/11/12. 03/02/12). 2012 Srini RamaswamyAC (1-212) 834-4573 Praveen Korapaty (1-212) 834-3092 Alberto Iglesias (1-212) 834-5116 J.849%) and stay short $100mn notional of 6Mx10Y swaption straddles (notification date 8/24/2012.7abp. ATMF and strike 0. ATMF CMS 2s/10s yield spread and strike at 1.3abp. maturity date 6/13/2014. P/L since inception: profit of 0. ATMF and strike 2. .335) (US Fixed Income Markets Weekly. P/L since inception: loss of 3.220%) (US Fixed Income Markets Weekly. ATMF and strike 2.

as was widely expected.55 0. it appears that there was no such hint. the BoJ did not surprise the market. The futures price drove the selling came on the following day and the futures price . The picture dramatically changed after the sell-off in US Treasuries following the FOMC statement on 13 March. as was widely expected. The bank left the policy unchanged. % 0. 2) the significant rally in equities and depreciation of the JPY since the beginning of this year. After all.50 0. The futures were sold off by 139 cents in two days The concept of relative values was lost and that of momentum gained grounds. such as 1) Greece completing the debt exchange.28 0. 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.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. CFA (81-3) 6736-1493 JPMorgan Securities Japan Co. we do not expect a large sell-off or a consistent rise in yields from here. The sell-off in the US equivalent triggered the sell-off in JGBs. 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. Some investors might have expected further monetary easing in the BoJ’s Monetary Policy Meeting on 12 and 13 March.35 0. The futures were sold off by 46 cents on the next day. 2012 Takafumi Yamawaki (81-3) 6736-1748 Yuya Yamashita. Ltd Japan • The bank left the policy unchanged. Most had expected to see usual rangebound moves this week. The futures price broke lower than the 200-day moving average. Although no change in the policy was the consensus view.40 0. Morgan • Exhibit 2: The 5Y yield broke the range higher and closed at 0.3bp in 7Y yields. 2) trend-following speculative investors must cover the shorts at some point in the future. but… …the sell-off in US Treasuries following the FOMC statement triggered a sell-off in JGB futures.60 0. The move was impressive. 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.. most had expected to see usual rangebound moves this week. With no apparently strong 52 market drivers.37% on 15 March. J. The implied volatilities in the gamma sectors exploded There had existed some backgrounds that could accelerate sell-offs. some had expected an indication of further easing in the bank’s statement or at Governor Shirakawa’s press conference after the meeting. because 1) there are still another 3 months until Operation Twist ends.20 Apr '11 0.30 0.25 0. which probably switched on selling by trend-following speculative investors (Exhibit 1). 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 2011.45 0. probably switching on selling by trend-following speculative investors Front JGB futures price and 200-day moving average. which translates to 4.Japan Rates Research Global Fixed Income Markets Weekly March 16.P. 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). Another wave of selling came on the following day and the futures price declined by another 85 cents. and 3) the long-lasting range-bound JGB market and skewed positioning Going forward.

1bp/day rise in implied volatility per every 10bp increase in the ATMF.00 2. it broke the range higher and closed at 0. 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.28-0. 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.00 3. Although the 5Y yield managed to stay within the recent range of 0. The super-long end swap curve moved higher in a relatively parallel fashion (Exhibit 4).37% on 15 March (Exhibit 2). The super-long sectors remained firm amid the considerable sell-off in the shorter sectors (Exhibit 3). The super-long sectors remained firm amid the considerable sell-off in the shorter sectors JGB yield change over this week.50 2. the 30Y and 40Y sectors remained strong in the super-long sectors as well as on the entire curve. However. the skew of the 3Mx10Y payers swaption a week ago had predicted an approximately 0. The super-long sectors remained relatively strong on the curve. The swap curve was also shifted upwards but the striking difference from the JGB curve is in the super-long sectors. The gamma volatilities spiked and the rise was more than what had been implied by the skew. Then. bp/day 5. 2012 Takafumi Yamawaki (81-3) 6736-1748 Yuya Yamashita. but the 20Y sector was choppy before and after the 20Y auction. and the new 20Y JGB were sold off by about 4bp.35% on 14 March. Meanwhile. the auction result turned out to be extremely strong.94bp/day rise in the implieds. the curve massively bear flattened. However. while the rise in the vega sector volatilities was relatively limited 3Mx10Y and 2Yx10Y ATMF implied volatilities since 2011. The futures sector (7Y-8Y) was sold off by more than 10bps and the shape of the yield curve around 7Y now appears extreme. The implied volatilities exploded.Japan Rates Research Global Fixed Income Markets Weekly March 16.00 1. The move was impressive. The futures price drove the cash market. 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. but the extent was a lot smaller than in the gamma sectors (Exhibit 5). causing a richening in the super-long end ASWs. Ltd declined by another 85 cents. causing a richening in the super-long end ASWs Swap rate change over this week. especially in the gamma sectors.50 4. Although the earlier expectation was negative.50 Jan '11 May '11 Sep '11 Jan '12 2Y x 10Y 3M x 10Y 53 . CFA (81-3) 6736-1493 JPMorgan Securities Japan Co. considering the fact that the medium-term sector had remained very firm after the BoJ announced the expansion of the APP in February. the actual 10bp rise in the ATMF this week resulted in a 0. For example. 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 rise in the vega sector volatilities also outperformed the same skew prediction. with the average yield coming 1bp through the offer side of the morning close.00 4.50 3. the market once again followed the recent pattern of heavy upside after strong auction results.

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

as we explained previously. 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.35 0.90 1. bps 1. We recommend the trade for the following reasons.30 0. Though there could be still some sell-offs. In addition. Ltd loss has been limited due to the reduced weight in the belly.10 0.30 0. The rise in gamma volatilities appears to provide a good opportunity for selling short expiry options.2 1.25 0.38%.P.0 Spot 10Y swap rate Break-even Weighted 5s/7s/10s butterfly -30 -35 -40 -45 -50 -55 0. and therefore. Second.5 1.20 0.05 0.38% was reached only under extreme environments since mid-2010. As we explained above. we expect a rebound in the futures price with short covering some time in the future. CFA (81-3) 6736-1493 JPMorgan Securities Japan Co. 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 2010.35% and the breakeven swap rate after the premium paid upfront is considered is 1.Japan Rates Research Global Fixed Income Markets Weekly March 16. the current ATMF 20bp is about 1. 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. Third. 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).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 2012.6 1. we expect the trade to finally perform.9 Jan '10 Jun '10 Nov '10 Apr '11 Sep '11 Feb '12 Source: J. bp/day 0..1 1.10 0. 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). We recommend selling 3Mx10Y payers swaption with the strike of ATMF + 20bp.70 7Y JGB Yield (%) 0.4 1. First. The premium paid upfront is currently about 37 cents (mid). Morgan *the weighted buttefly = -100% x 5Y + 168% x 7Y -100% x 10Y 55 . 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. 2012 Takafumi Yamawaki (81-3) 6736-1748 Yuya Yamashita.3 1.50 0. bps -25 Exhibit 10: The breakeven swap rate level of 1.15 0. the payer skew has been widening since September 2011 and is at around the widest level since 2011 (Exhibit 9).

. 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 . 2012 Takafumi Yamawaki (81-3) 6736-1748 Yuya Yamashita.Japan Rates Research Global Fixed Income Markets Weekly March 16. CFA (81-3) 6736-1493 JPMorgan Securities Japan Co.

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

Our technical strategists also have a bearish view.00 5. with the unemployment rate having been in the 5 to 5¼ per cent range over the past year.5 0. it probably does not look so low if the currency is taken into account.auld@jpmorgan. If this were to turn out to be the case.m. 14 March 2012).European Rates Strategy Global Fixed Income Markets Weekly March 16.5 Uses Feb reading for Q1 data Feb-00 Jan-05 Dec-09 2. while the current level of the real cash rate looks low by historical standards.com J. it is possible for exchange rates to overshoot … An important indicator here is the labour market. It will be interesting to see whether the March data on job ads (due on 10 April) will validate the latest data print. 2012 Sally AuldAC (61-2) 9220-7816 sally.00 -2. Further. the unemployment rate. pushed fw d.0 -0.7-ppts in 72mths 3.5 1.00 0. In this context. Our US rates strategy team retain a bearish bias and target US 10Y yields to reach 2.00 Mar-93 2.50%. inv erted -2.00 -1.” (Our emphasis) This suggests that the best guide to policy will be leading indicators of the labour market – in particular. Global FI Technical Strategist. the tightening cycle of the past couple of years was quite aggressive. the recent read on ANZ newspaper job ads was telling (Exhibit 4).8-ppts in 12mths 1. Krauss. 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. then risks to the policy and economic outlook would be heavily biased towards a significantly higher unemployment rate at some point in 2012. we have decided to take profits at current 58 50 30 10 -10 -30 -50 -70 Mar-95 ANZ new spaper job ads. If so.0 .0 -1.5 -1. Morgan Securities Australia Limited When thinking about the broader stance of policy.00 1. considering one measure at least.00 3. So. given risks to the economic and policy outlook. monetary policy would have the flexibility to respond provided the inflation outlook remained benign. Despite this. 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.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.P. Ultimately. lhs. 6 mths Annual change in the u-rate. If the unemployment rate were to rise persistently. 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.0 1.0 0. a longterm chart of the real cash rate is telling. 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). 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. given that the market has moved from a ‘trading range market’ to a ‘trending market’ (see M. rhs.00 2. Exhibit 2: Aggressive fiscal consolidation One-year change in budget balance as a % of GDP. We are taking a small profit on our OIS curve steepener and have now reduced conviction in this trade.00 4.6-ppts in 18mths 2.

a. as we noted above) or if the RBA ultimately delivers more easings.European Rates Strategy Global Fixed Income Markets Weekly March 16.0 5.0 0. if we think about relative inflation-term risk premia.4bp.0 Jun-99 10y AUS-US real y ield spread. is a forward-starting steepener in AUD swaps. a spot spread of +69bp). and place a stop at +63bp.0 -2. target a move to +95bp. 2s9s sw ap curv e.0 Oct-03 May -07 Dec-10 59 . Exhibit 7 illustrates scope for ongoing real-yield compression in 10Y spreads. these positions do not have too much negative roll-up to spot. these trades will perform well if the US curve continues to bear-steepen (the near-term risk.0 3. lhs. Our preferred trade.0 1. Morgan Securities Australia Limited levels on our short in 3Y bonds. pushed fw d. US out-performance Jan-12 AUS out-performance Exhibit 6: AUS-US 10Y real yield spread ppts ppts 2.0 0. Indeed.0 -1.0 7.0 1. the theme of growth rotation (away from EM Asia/Australia towards the US) may continue.0 4. 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.0 -3.5 0. US Index 150 100 50 0 -50 -100 -150 Jan-10 Sep-10 May -11 20 day m. largely because we are no longer so confident about the broader policy backdrop being strongly in favour of a neutral rates environment. First. RBA cash rate ppts % 1. 1Y fw d.5 1. We hold our 10Y spread narrowing trade (Entry: 203bp.4bn in the fourth quarter of 2011 (Exhibit 9). Foreign investors now own a record 76.auld@jpmorgan. pushed fw d 5q 7.0 Aug-02 Oct-05 Dec-08 Feb-12 Exhibit 7: 2s/9s curve.0 6. Exhibit 7 illustrates that the curve tends to be well correlated with moves in the RBA cash rate. We continue to believe that AUS-US 10Y spread compression trades are one of the better strategic trades for the Australian market.0 -0.5 2. the relative central bank stance (and credibility) should once again favour the AUS 10Y nominal bond over and above the US 10Y nominal bond. The trade offers 3-month carry and slide of 1. As we noted above.5 -1. AUS vs. Exhibit 5: Relative economic surprise indices. Net inflows into the market from offshore recorded their fourteenth consecutive quarterly increase – net inflows were $21. lhs RBA cash rate. In terms of forward-starting curve spreads.0 -0. 1Y fwd vs.0 4. 3m.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. In a broad sense.0 2. rhs. Further. lhs Real GDP spread. Second. Target: 180bp). Current: 197bp.0 6.0 0.5 1. We think this trade should perform well when implemented in either real or nominal space.m.0 5. seeing as yields have reached the top of the recent trading range. currently. 2012 Sally AuldAC (61-2) 9220-7816 sally.5 0. given the flatness of the forward curve structure.5 -1.0 8. There are a number of reasons for this. inv erted 3. we have also taken profits on our AUD OIS curve steepener.P.com J. especially if highfrequency data momentum is any indicator (Exhibit 5).3% of the Australian government’s bond market (Exhibit 8).

Domestic bank holdings of ACGBs have remained largely stable over the past couple of years (at around $20bn).7 0. In our view. as such. for many investors. all other things being equal. ACGBs outstanding have increased by $125bn over the past two years. and 3) the 3s/10s spread will be structurally flatter. demand from offshore has largely absorbed most of the net supply in ACGBs over the past two years. Our analysis suggests that a 1ppt increase in offshore holdings of ACGBs lowers the fair value estimate of 10Y bonds by around 4. The recent sell-off in NZD rates means that carry and slide in received positions is starting to look attractive again (for example. while offshore holdings have increased by $110bn over the same period. 2012 Sally AuldAC (61-2) 9220-7816 sally.6% (current: 3. We continue to expect offshore demand for ACGBs to keep term yields suppressed in Australia (financial repression does not necessarily respect borders).8 0. has generated tighter financial conditions. Curve spreads should trade directionally and strategically – we would favour being better receivers of NZD rates. with the RBNZ citing sustained strength in the currency as reducing the need for future increases in the OCR. are neutral duration and curve spreads at these levels. 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.P.2 0.4 0. We would look to enter received positions in 1Y1Y swap at 3.auld@jpmorgan. increasingly.m. Australia still retains one of the highest term structures of yields of any AAA-rated sovereign issuer.European Rates Strategy Global Fixed Income Markets Weekly March 16. all other things being equal. ppts 0.5bp. 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. we think the currency and fiscal adjustments imply a ‘low for longer’ environment for New Zealand term rates. this alone appears to be a compelling justification for investment in ACGBs. Taken together. 1Y1Y swap offers 3M carry and slide of 14. 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) .42%). In addition. the coming fiscal adjustment in New Zealand is significant (Exhibit 10).5 0. We think NZ outrights and curve spreads are largely fairly priced.com J. The RBNZ appears to have finally accepted that the higher NZD is a structural phenomenon. Morgan Securities Australia Limited Generally speaking. 2) swap spreads will be structurally wider. given the macroeconomic and policy backdrop and.6 0.3 0. foreign demand for ACGBs continues to be driven by central bank reserve diversification and. which.4bp).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. Exhibit 8: Foreigners hold 76% of ACGBs in issue – a new high Proportion of ACGBs held offshore. and we like receiving on dips The RBNZ’s Monetary Policy Statement was more dovish than most expected. interest from private retail and institutional investors.

0bp 63.6bp +0. 1-Mar -17. Source: J. Morgan Securities Australia Limited Trade Updates Current Trades Date 7-Feb Trade AUS-US 10Y spread contraction trade Entry 203.P.0bp -21.0bp Current 197.10 9-Feb 44.4bp 50.m.0bp Target 180.P.0bp -12.0bp 16-Mar 73. 12month) Buy KfW Jan-16s vs.com J. P/L takes into account the futures roll 61 .European Rates Strategy Global Fixed Income Markets Weekly March 16. Take Profits.0bp 95.2bp +4.0bp Take Profits. Nov14s) AUD OIS steepener (3-month vs. *Price is YMM2. Hold Trade.1bp -7.47 96.5bp 34. Morgan. Take Profits. Outrights have reached the bottom of the recent trading range.8bp -25.5bp 29.0bp 73. 1Y forward 96.0bp 0.auld@jpmorgan. 2012 Sally AuldAC (61-2) 9220-7816 sally. 8 Feb Sell YM1 QTC ASW flattener (Jul-22s vs.5bp -13. We like the spread narrowing trade as a strategic position to reflect AUS outperformance. We now have less conviction that this position adequately reflects risks to the policy and macro backdrop.0bp Comment Hold Trade. EIB Apr-15s on ASW AUS 2s/9s swap curve steepener.3bp Stop 213.60 94.0bp flat 1-Mar -13.0bp 96.7 P/L +5.1 +15.0bp New Trade. The trade has reached our target level.20* +23.

20 4. Bloomberg (current values) 62 .33 4.m.P.20 2.30 4.25 4. Morgan Securities Australia Limited Forecast Table Current Australia RBA cash rate 10-year yield New Zealand RBNZ OCR 10-year bond 2.25 4.75 4.30 Jun-12 Sep-12 Dec-12 Mar-13 Source: J.25 4.com J.25 4.25 4.50 4.auld@jpmorgan.P.50 4. 2012 Sally AuldAC (61-2) 9220-7816 sally.20 3.30 3.40 4.25 4.European Rates Strategy Global Fixed Income Markets Weekly March 16.00 4.25 4.40 2. Morgan (forecast values).

60 3.50 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 4.04 1.00 2.95 2.05 92 100 192 0. Interest rate forecasts Euro area Refi rate Euribor 16-Mar-12 Jun-12 1.x.85 0.13 0.10 10Y 2.50 Libor 3M 1.40 Govt curve 0.25 4.30 New Zealand Cash rate Govt curve 10Y 2.80 2.95 2.49 3.20 2.13 0.33 4.0.45 2.97 94 92 186 0.60 3.00 103 85 188 0.00 0.30 1.85 2.50 1.05 0.30 3.25 4.00 0.75 4.20 3.40 3.40 3.45 0.0.50 1.50 2.25 4.00 0.25 1.chordia@jpmorgan.20 2.50 1.30 4.00 4.37 0.25 1.05 0.81 1.30 5Y 1.20 4.30 0.40 2.00 2.25 0 .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 0.25 10Y 2.80 180 70 250 75 55 35 5 Sep-12 0.50 1.75 0.30 5Y 1.13 1.05 1.37 1.com J.05 0.50 0.13 0.75 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 0.65 0.0.25 4.50 4.00 92 95 187 0.43 3.48 0.35 1.50 2.05 1.30 0.06 2.50 205 95 300 80 40 20 -15 Dec-12 0.34 0.European Rates Strategy Global Fixed Income Markets Weekly March 16.40 1.70 0.40 190 100 290 80 40 20 -15 United States 16-Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Fed funds 0 .05 0.55 3.32 2.25 0 .50 4.25 4.P.15 102 100 202 63 .50 0.40 1.50 Govt curve 30Y 3.30 10Y 2.75 3M 0.0.50 5Y 1.50 0.25 Libor 3M 0.25 30Y 2.30 1.60 3.30 2.75 0.71 2.10 2.25 1.65 2Y 0.0.50 2Y 0.25 0 .75 0. 2012 Aditya ChordiaAC (44-20) 7777-9841 aditya.25 4.55 30Y 3.00 2.05 1.15 1.50 1.47 0.70 170 70 240 85 65 45 10 Mar-13 0.50 2.15 1.30 0.05 0.12 0.50 1.30 0.00 0.25 0 .35 1.80 2.40 190 100 290 80 40 20 -15 Mar-13 0.05 2.07 1.20 2.25 4.05 2Y 0.23 1.75 175 70 245 80 60 40 10 Dec-12 0. Morgan Securities Ltd.11 0.

30 1.37 0.52 0.79 1.58 0.30 1.chordia@jpmorgan.43 3.36 1.73 2.01 0.25 2.86 0.28 0.07 2.99 1.58 1.17 3.05 2.96 0.07 1.34 0.34 0.11 2.37 3.59 0.39 0.49 2.96 1.23 0.23 1.82 2.30 1.07 2.47 0.59 1. 2012 Aditya ChordiaAC (44-20) 7777-9841 aditya.76 1.38 1.15 2.64 2.81 2.44 2.34 1.40 0.94 0.30 0.46 2.23 0.47 2.x.16 0.96 0.13 1.93 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 0.16 1.97 1.39 2.00 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.80 1.49 3.43 0.87 2.62 0.35 2.14 1.39 2.22 3.90 1.35 0.72 0.30 0.98 3.32 2.85 1.90 0. Morgan Securities Ltd Recent curve movements EUR Govt.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 1.12 3.23 0.50 1.18 1.03 1.European Rates Strategy Global Fixed Income Markets Weekly March 16.04 1.52 1.34 0.80 1.78 1.11 0.05 0.42 2.89 1.11 0.98 3.44 0.21 0.22 2.86 0.53 0.99 0.12 2.54 2.01 1.46 0.07 0.89 2.77 0.19 3.15 0.98 1.96 1.48 0.55 2.06 1.82 1.59 1.29 0.78 0.42 2.07 2.11 3.10 1.38 3.86 2.99 0.02 0.52 1.23 1.71 2.17 1.59 1.45 2.12 3.13 0.11 0.33 2.22 3.04 1.11 0.77 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 .92 1.86 1.11 1.37 0.com J.48 2.P. 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 0.32 0.17 1.99 0.37 2.31 3.06 2.29 1.74 1.53 2.85 0.30 2.50 3. 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 0.94 1.34 0.42 2.11 2.81 0.86 1.30 0.

peri. Italy and Spain (weighted by the size of their outstanding bond market).0 69 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. 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 0.6 11 0.8 327 0.1 13 0.0 *Weighted peripheral spread computed against Germany for Ireland.5 47 -0.P.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.6 98 -0. peri. 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 0.3 156 -0.4 60 0.0 73 -0.com J.4 124 -0.4 282 1.0 32 -0. peri.3 141 1. Morgan Securities Ltd Recent sovereign cash spread movements Cash spread to Germany.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. 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 0.9 133 -1. 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 0.2 227 -1.European Rates Strategy Global Fixed Income Markets Weekly March 16.chordia@jpmorgan.2 310 -1.3 180 1.8 133 -0.0 87 -0. Portugal.0 39 0.6 93 -0.2 17 0.3 8 0.6 2 2. 2012 Aditya ChordiaAC (44-20) 7777-9841 aditya. 30Y does not contain Ireland and Finland.5 10 0.x.9 21 0.0 61 -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.4 37 0. peri.5 39 0. 65 .3 120 -0.4 148 -0.0 73 -0.1 101 -0.3 89 0.

weighted by the size of their outstanding bond market.7 12 -1. Netherlands and US.9 141 0. 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. Italy and Spain. peri.1 395 1.2 16 -0. Greece.P.9 25 -0. Austria.5 70 -0. 66 .4 34 0. Germany.5 110 -0.6 185 -1. Italy.com J.x. 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 -0.7 70 0. Ireland.3 9 0. **Weighted peripheral spread computed as CDS spread of Ireland.2 19 0.1 15 -0. 100bp running coupon used for UK. peri.3 49 0.5 83 -0. 2012 Aditya ChordiaAC (44-20) 7777-9841 aditya.1 219 1.4 56 0.4 20 0. France. Portugal and Spain. Portugal.chordia@jpmorgan. 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. Belgium.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.5 170 -0.4 48 0. Spreads for all the countries except US are in $ CDS and for US it is in € CDS.1 55 0.6 85 0.8 118 0. Morgan Securities Ltd Recent sovereign CDS spread movements CDS spread*.4 150 0.European Rates Strategy Global Fixed Income Markets Weekly March 16.3 * 25bp running coupon used for Finland.

Italy. 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. Dealogic 67 . Source: J. **** Greece. 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. P. 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. 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. 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). 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. ** Maturities in all currencies and jurisdictions and include secured. France. unsecured and securitised issuance.chordia@jpmorgan. Portugal. 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. 2012 Aditya ChordiaAC (44-20) 7777-9841 aditya. The data also include any government guaranteed issuance by the banks but no direct issuance by government or government sponsored institutions. linkers. Morgan Securities Ltd Euro area conventional bond* and bank debt** redemptions €bn Austria Sov. Belgium. floaters zero coupons and international bonds. 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.European Rates Strategy Global Fixed Income Markets Weekly March 16. Finland. 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. Spain.com J. Euro-area**** Sov. Ireland. Morgan. 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.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. Banks 1 0 0 1 1 1 2 1 1 0 1 1 0 9 Ireland Sov. Germany and Netherlands. 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. 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.P. ***** For the remaining part of the month.

European Rates Strategy Global Fixed Income Markets Weekly March 16.x.com J.chordia@jpmorgan. 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 . 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. 2012 Aditya ChordiaAC (44-20) 7777-9841 aditya.P.

com J.3 8. %) 2012 2.623 212 159 1.617 623 169 1. Source: ECB 69 .8 19.5 -7.0 0.0 -3.1 -1.7 -5.0 -3.0 -8.2 -5.0 -4. The ECB started buying Italian and Spanish bonds on Monday.0 0.3 2.4 0.0 5. Autumn 2011.European Rates Strategy Global Fixed Income Markets Weekly March 16.9 -3.0 0. rate (%) Latest 4.5 10.6 -4. Morgan's EMU IG index requires any 1 of 3 credit ratings (S&P's. bal.9 Amount matured (€bn) 1. acc.0 0.8 2.3 -0.3 -1.0 -0.0 6.5 -1.1 -0.1 224.9 GDPpc (EU=100) 2012 124 116 123 104 108 63 119 90 126 54 80 101 Unempl.negative outlook. Moody’s. Moody’s and Fitch) for a country's exclusion.1 0.P.4 2.3 0.0 0.094 9.chordia@jpmorgan.1 0.566** GDP growth Inflation* Budget balance^ Prim. IMF.0 7.9 14.P.3 3.6 -2.8 23.495** 1.2 0.9 14.5 -0.5 1. 3) Citigroup requires both S&P and Moody’s rating to be below IG.0 219.8 Amount offered for sterilization (€bn) 218.3 -1.7 -0.3 4.6 2.5 0.2 4.5 -3.0 -7.3 8.9 (% of GDP) 2012 -3.0 -3.7 3. POS – positive outlook. %) 2012 0.4 -4.4 -7.028 2.0 8. 2012 Aditya ChordiaAC (44-20) 7777-9841 Aditya.5 0.9 1.415 15.9 -0.8 0.0 2.5 219.9 2.4 0.5 1.8 -3.9 -3.3 * HICP. grey highlight: below IG.3 1.0 0.1 -4. 8 August 2011.5 219.0 -5. National index if not available **Local currency *** IMF Estimate ^ Net lending (+) or net borrowing (-) Source: EC European Economic Interim Forecast Feb-12.1 1.0 0. Outlook:NEG .0 3. (oya.2 1.1 -4.5 -2.5 219.developing outlook and blank represents stable outlook Notes: 1 – Rules for a country to be excluded from its index: 1) J. Balance Gross debt Curr. 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).4 -8.5 219.4 7.5 -5.3 1. This is equivalent to SMP purchases which settle on Monday (first settlement date) to Friday of the previous week (last settlement date). Fitch) to be below IG. EC European Economic Forecast.3 -3. 2) Barclays Capital requires 2 of the above 3 credit ratings to be below IG.8 9. 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 2.6 (oya.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. DEV .6 (% of GDP) 2012 73 99 52 89 81 198 118 121 65 111 74 91 105*** 89 (% of GDP) 2012 2.3 1.x.6 -0.9 2. 2 – Markit iBoxx uses an average rating methodology (S&P.0 0. 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) 0.8 (% of GDP) 2012 -0.3 -1.0 7.

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Mar Euro area 1000 PMI flash Mar Mfg 49. conf.5 Index. sa France 0900 PMI flash Mar Mfg 50. Telephone your J.P.000 1245 Chairman Bernanke speaks in Washington.8 £bn. Forecasts are m/m. conf.0 Index.com J. Times shown are local.chordia@jpmorgan. unless stated & times are local. sa Auction 3-month bill United Kingdom 0930 UK Spring Budget MPC minutes Mar A 9-0 vote for unchanged policy is expected.5 Index.C. sa 1100 Industrial new orders Jan 1600 EC cons.C. Highlighted data are scheduled for release on or after the date shown. Mar Netherlands 1030 CBS bus. conf. Mar Spain Trade balance Jan United Kingdom 0930 CPI Feb 3.P.000 Permits 685. Conf. 23 March France 0845 INSEE bus. sa Services 50. 1730 Minneapolis Fed President Kocherlakota speaks in St. sa Composite 49. 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. conf.2 Index. sa Japan 0830 Reuters Tankan Mar 0850 Trade balance Feb -185 billion yen.2 %oya 1100 CBI industrial trends Mar United States 0830 Housing starts Feb 685. conf. sa Composite 53. 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. conf.2 Index. sa Services 53. 26 March Germany 1100 IFO business survey Italy 1000 ISAE cons.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. 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. conf.0 Index.2 Index.3% (-1. 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 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 320.2 Index. D.0%m/m. Feb United States 0830 Personal income Feb 0945 Chicago PMI Mar 0955 Consumer sentiment Mar final Selective list as of 16 March. 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. nsa. Louis 21 March Germany Auction Schatz Mar14 & IL Apr23 Japan 1330 All sector activity index Jan -1. 2012 Aditya ChordiaAC (44-20) 7777-9841 aditya. conf. D. 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. Mar 1100 EC cons.x.5 Index. conf.C. sa Germany 0930 PMI flash Mar Mfg 50. sa Services 49. Morgan representative for an update/more details. 0930 Public sector finances Feb 7. D.000 1000 FHFA HPI Jan 0. 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.9%bal. D.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.European Rates Strategy Global Fixed Income Markets Weekly March 16.C.65 mn 22 March Belgium 1500 BNB bus. 72 . prelim Mar -19. conf. nsa United States 1000 Existing home sales Feb 4. sa Composite 50.C. 2000 St. 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. D.000 1430 Atlanta Fed President Lockhart speaks in Washington.

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