Download Global Fixed Income Weekly

Deutsche Bank
Markets Research
Global
Rates
Credit
Date
17 January 2014
Francis Yared
Global Fixed Income Weekly
Strategist
(+44) 020 754-54017
[email protected]
Dominic Konstam
„
Strategically, there is still upside potential to UST 5Y yields, and scope for
(more limited) tightening in peripheral spreads.
„
The market may remain in a range for now as a material repricing of
monetary policy will require first some signs of normalization of inflation
and positioning is more balanced.
„
An analysis of the shape of the money market curve suggests that a Dec16 – Dec-18 flattener represents an asymmetric risk reward.
„
The declining excess liquidity in the Eurozone is mechanically putting
upward pressure on spot money market rates. However, the market
remains reasonably confident that the ECB is willing and able to control
the front-end.
„
In Europe, we adapt our trade recommendations to the risk of a more
aggressive ECB. We maintain Bund ASW wideners and switch periphery
spread tighteners vs. swaps rather than vs. Bunds. We also recommend a
5Y-30Y steepener and a 5Y5Y-5Y30Y conditional steepener with payers.
„
Leading indicators point to a pick-up in wage growth in the US and UK this
year, which would be a positive for B/Es, but may be a slow process; we
see medium-term upside for B/Es. In RV, across markets, we prefer 30y UK
RPI over 30y USD CPI and 1y1y EUR HICP v 1y1y FRF CPI. In USD, 5y CPI
looks relatively low v 2y and 10y wings. In GBP and EUR, we find 10y
RPI/CPI rich compared to 5y and 30y.
„
„
„
„
Our ongoing theme remains that though economic healing warrants rates
well above the cyclical lows - and higher than current spot levels - the
forwards are aggressively priced and we expect that rates will not beat the
forwards at a 1y horizon. Though the historical data from recent decades
encompass a secular bull market, we observe that bearish trades very
rarely beat the forwards, particularly at one year horizons and expressed
through 10y rates.
Research Analyst
(+1) 212 250-9753
[email protected]
Table of contents
Bond Market Strategy
Page 02
US Overview
Page 07
Treasuries
Page 14
Derivatives
Page 20
Agencies
Page 24
Mortgages
Page 25
US Credit Strategy
Page 34
Euroland Strategy
Page 38
European ABS Update
Page 44
With spot and 1y forward 10y USD - EUR lingering near multi-year highs,
we like spread tighteners as a moderately bearish trade, either outright or
conditionally via payers.
Covered Bond Update
Page 45
Historically, shorting the market outright has not been a good trade
because of the associated negative carry. Bearish investors with a high
conviction that rates can move above forwards should look for ideal entry
and holding periods. We analyze a combination of swap tenors and trade
horizons to determine the shorts that could stand the highest chance of
being profitable. Conditioned on the Fed hiking rates in the next 12 months,
outright shorts in the 2y rate have historically been more successful than in
10s.
Japan Strategy
Page 56
Global Relative Value
Page 60
Dollar Bloc Strategy
Page 68
Inflation-Linked
Page 79
Global Inflation Update
Page 83
UK Strategy
Page 48
Nordic Strategy
Page 51
As an alternative to bearish trades in rates, investors should look for a
good entry level to be short mortgages later this year based on the
expected supply and demand imbalance amid taper and the seasonal
issuance trend in MBS.
________________________________________________________________________________________________________________
Deutsche Bank AG/London
DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 054/04/2013.
17 January 2014
Global Fixed Income Weekly
Global
Rates
Gov. Bonds & Swaps
Rates Volatility
Bond Market Strategy
„
Strategically, there is still upside potential to UST 5Y yields, and scope for
(more limited) tightening in peripheral spreads
„
The market may remain in a range for now as a material repricing of
monetary policy will require first some signs of normalization of inflation
and positioning is more balanced
„
An analysis of the shape of the money market curve suggests that a Dec16 – Dec-18 flattener represents an asymmetric risk reward
„
In Europe, we adapt our trade recommendations to the risk of a more
aggressive ECB. We maintain Bund ASW wideners and switch periphery
spread tighteners vs. swaps rather than vs. Bunds. We also recommend a
5Y-30Y steepener and a 5Y5Y-5Y30Y conditional steepener with payers.
Francis Yared
Strategist
(+44) 020 754-54017
[email protected]
Soniya Sadeesh
Strategist
(+44) 0 207 547 3091
[email protected]
Abhishek Singhania
Strategist
(+44) 207 547-4458
[email protected]
Jerome Saragoussi
Strategist
(+33) 1 4495-6408
[email protected]
Stuck
The view: Strategically, there is still upside potential to UST 5Y yields, and
scope for (more limited) tightening in peripheral spreads. However, a material
repricing of monetary policy will require first some signs of normalization of
inflation. In Europe, we tweak our trade recommendations to account for the
risk of a more aggressive ECB than we expect.
The rationale: In the US, the data remains broadly in line with our macro view
(retail sales, regional surveys, jobless claims). As long as the data remains
consistent with the FOMC’s projections, the December FOMC rate forecast
should constitute a lower bound for front-end rates. The market should add
some risk premium to the December “dots”, as the risk will remain tilted
towards upward rather than downward revisions of the forecasts. However,
such risk premium will likely remain modest without further hard evidence (so
far lacking) that inflation is normalizing. Our analysis suggests that inflation
should (slowly) normalize over the course of the year as wages and core
inflation tend to be lagging indicators of unemployment and the ISMs. In the
meantime, the front-end may remain stuck in a relatively narrow range,
especially as positioning is now more balanced. Given our strategic view and
current pricing (close to the dots), we nonetheless maintain our short 5Y
recommendation.
Also, we find standard carry considerations in the front-end of the curve
misleading. As long as the data supports rate hikes in H2 2015, a calendar
based analysis (i.e. pricing vs. the FOMC forecasts on specific dates), will
probably be a better reflection of the risk premium embedded in the front-end
of the curve. Indeed, running a scenario analysis using the December
distribution of rates forecasts by FOMC members, we find that a Dec-16 – Dec18 flattener offers a particularly asymmetric risk/reward. It should perform
under a scenario consistent with the more hawkish FOMC forecasts and even
have limited upside under a scenario consistent with the more dovish FOMC
forecasts.
In Europe, we continue to have a positive bias for peripheral spreads, but the
upside prospects remain limited. Our base case remains that the data will be
good enough for the ECB not to embark on any material additional easing.
However, as pointed out by our economists, the threshold for more decisive
Page 2
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
action has been lowered. Thus, we adapt our portfolio of recommendations to
account for the risk of an ECB QE. More specifically, if the ECB moves to
implement QE, it is likely to do so on a pro-rata basis along its capital keys, and
avoid extending to the long-end of the curve. This should benefit the lower
(marketable) debt-to-GDP countries and have limited impact beyond the 10Y
point. At the margin, Italy, Belgium and France should benefit less than Spain,
Germany and other semi-core names. Also, the long-end of the curve should
remain steep.
The trades: We maintain the short 5Y UST, and receiving 10s in 5s10s30s. We
also recommend a Dec-16 – Dec-18 ED flattener. In Europe, we rotate our long
BTP-Bund into a BTP ASW tightener (in line with our Bund ASW bias). We also
rotate our short Austria-Bund into a short France-Bund. We maintain our long
Bund-ASW and long 5Y Breakevens. We also recommend a 5s30s steepener
and a 5Y5Y-5Y30Y conditional bear steepener, attractive from a carry and vol
perspective.
Waiting for the next trigger
Since the December FOMC meeting, the pricing of future Fed Funds rates by
the market has hovered around the scenario implied by the median of FOMC
dots. At the time of writing, the market is pricing the FOMC’s median forecast
with a small risk premium of 5-10bp. We expect the FOMC dots to correspond
to a lower bound for the market given:
„
Our constructive macro scenario based on an improving fiscal impulse and
a robust credit impulse
„
The change in composition of the FOMC. Seven of the twelve voting
members on the FOMC will have been replaced by the time of the March
FOMC meeting. Bernanke, Duke and Raskin are leaving on the board, and
rotating positions will be replaced by regional presidents that are on
average more hawkish (for instance Evans and Rosengren replaced by
Plosser and Fisher).
„
The limited impact of tapering on long-term forward rates such as 5y5y (as
tapering was mostly priced in), but also on volatility and risky assets. In
particular, the positive reaction of US equities gives the Fed little incentive
to further strengthen its forward guidance. Indeed, the Fed strengthened
its forward guidance most likely as a risk management tool ahead of
tapering (as opposed to being fully consistent with the FOMC’s growth
forecasts). Thus, if the data comes in line with the FOMC’s expectations,
the Fed is more likely to revise upward than downward its rate forecast.
On this basis, the market should stabilize slightly above the median FOMC
projections to embed a small risk premium, for instance 25bp above the
median FOMC dots. For the market to price a sharper normalization of
monetary policy, further evidence of a normalization of inflation is likely to be
necessary. As we discuss below, our base case remains that core inflation will
accelerate slowly by the end of the year and that wage inflation will increase.
However in the short-run, inflation momentum remains mild, and there are no
“smoking guns” to lead to a sharper repricing of the 5y sector.
On the wage front, the latest job report indicated some moderation in wage
inflation relative to the previous month. Despite this decline, the upward trend
in wage inflation is likely to resume, reflecting the reduction of the slack in the
labour market, as summarized by the level of the unemployment rate excluding
long-term unemployed (see graph below).
Deutsche Bank AG/London
Page 3
17 January 2014
Global Fixed Income Weekly
Wage inflation is a lagging indicator of the
unemployment rate and has room to accelerate further
Core CPI YoY should drop to 1.6% before recovering
towards 1.9% by the end of the year
3.5%
Core CPI YoY
DB Forecasts
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
Source: Deutsche Bank
Source: Deutsche Bank
As for core inflation, the pipeline inflation picture is neutral (lower energy
prices but recovering industrial metal prices) implying some stabilization of PPI
inflation at a time when inflation from imported core goods seems to be
bottoming. This suggests that inflation for core goods and services is likely to
stabilize first and then recover slowly over the course of the year, pushing core
CPI YoY towards 1.9% from 1.7% currently. However, core CPI could well drop
towards 1.6% in the next couple of months on the back of significantly
negative base effects on core CPI ex shelter in January and February.
Moreover, the December CPI release revealed that medical care inflation was
particularly soft, while shelter inflation remained strong. The combination of
soft medical care inflation and resilient shelter inflation suggests that the
wedge between core PCE and core CPI will remain wide in the short run (given
the larger weighting of medical inflation in Core PCE basket and lower
weighting of rent inflation in core PCE basket).
Market positioning (as per the CFTC data) does not send any short-term signal
either. Speculative positioning in Treasury futures at a global level (i.e. from the
2Y futures to the long Bund futures) is close to neutral. Moreover models
looking at the market reaction of the 10Y UST yield relative to theoretical
market reactions implied by economic surprises indicate that recent market
reactions are currently well aligned with theoretical moves implied by historical
betas. This is consistent with a fairly neutral positioning and no substantial
trading signal in the near term.
Page 4
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
Speculative position across the spectrum Treasury
futures is neutral on average
Global Net speculative positions in Treasury
futures (average % of open interest in 2Y, 5Y, 10Y,
30Y futures)
18
15
Positioning implied by market reaction to data surprises
shows market is mostly neutral
5.00
-1.5
4.00
-1
3.00
12
2.00
9
-0.5
1.00
6
0.00
3
0
-1.00
0
-2.00
-3
-3.00
-6
-4.00
-9
-12
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
Source: Deutsche Bank
-5.00
Sep-11
0.5
Positioning index implied by
UST10Y reaction to surprises
1
Subsequent 2M change in UST
10Y yield (rhs, inverted)
Mar-12
Sep-12
Mar-13
1.5
Sep-13
Source: Deutsche Bank
In the Global Relative Value section, we analyse more closely the shape of the
money market curve between Dec-15 and Dec-18. We run scenario analyses
based on the distribution of the FOMC rate forecasts using December “dots”.
On this basis, we find that the Dec-16 –Dec-18 slope is probably too steep. For
instance, in a scenario consistent with the 3rd most hawkish FOMC forecast, it
should flatten by 80bp, helped by a particularly strong sell-off in Dec-16.
However, even in a scenario consistent with the 3rd most dovish FOMC
forecast, it should flatten by 4b as there is more room for a Dec-18 rally from
current levels.
Adapting the portfolio to a more aggressive ECB
Given our macro outlook, we do not expect the ECB to embark on a material
new easing. However, as pointed out by our economists, the threshold for
more aggressive new measures, including QE has probably been lowered. In
this context, we adapt our trade recommendations (which in any event would
generally benefit from a more aggressive ECB) to such a scenario (see also
Euroland Strategy for more details).
In a broad based QE, the ECB is likely to determine the proportion of buying of
government bonds of Eurozone countries along its capital keys (i.e. close to
GDP weighted). As a result, countries with lower (marketable) debt/GDP ratio
will stand to benefit compared to countries with higher (marketable) debt/GDP
ratios. Thus, Italy should benefit less than Spain, and Belgium and France
should benefit less than other semi-core names, while Bunds could be one of
the biggest beneficiaries. With this in mind, we maintain ASW widener on
Bunds and recommend switching periphery spread tighteners vs. swaps rather
than vs. Bunds. Also, we recommend switching our semi-core spread widener
in Austria to France (vs. Bund).
Deutsche Bank AG/London
Page 5
17 January 2014
Global Fixed Income Weekly
(1)
(2)
[(1)-(2)]/(2)
ECB capital
key weight
General go vt.
debt share
Winners/
Lo sers
25.7%
20.3%
17.6%
12.6%
5.7%
3.5%
2.9%
2.8%
2.5%
1.8%
1.7%
2.9%
23.6%
21.0%
22.8%
10.4%
4.9%
4.4%
3.5%
2.6%
2.4%
1.2%
2.2%
1.2%
9.1%
-3.5%
-22.9%
21.9%
17.8%
-19.0%
-16.5%
9.7%
5.6%
48.4%
-26.2%
145.8%
Germany
France
Italy
Spain
Netherlands
B elgium
Greece
A ustria
P o rtugal
Finland
Ireland
Others
Share of Eurozone general govt. debt
Countries with general govt. debt share lower than the ECB capital key
weights would stand to gain in a broad based ECB QE
30%
25%
IT
DE
Losers
20%
15%
10%
ES
Winners
5%
0%
0%
5%
10%
15%
20%
25%
30%
ECB capital key share (only Eurozone countries)
Source: Deutsche Bank
In a broad based QE, the ECB will probably refrain from buying at the long-end
of the curve to avoid increasing the pressure on the pension and insurance
funds. This would suggest that the impact of an eventual QE would be limited
beyond the 10Y point, and therefore be supportive for long-end steepeners
(which should in general benefit from a more aggressive monetary policy).
We update our model for the 5Y-30Y slope, including Dutch pension fund
solvency ratio as an explanatory variable (see Euroland Strategy for more
details). The model shows that the EUR curve is close to fair value. Steepeners
are nonetheless attractive given: (i) the positive carry on the trade, (ii) the fact
that almost any form of ECB policy easing should support a higher riskpremium in the long-end of the curve (iii) the low level of long-dated forwards
in EUR. In the Global Relative Value Section we recommend in particular a
premium neutral 5Y fwd 5Y-30Y bear flattener which should benefit from the
above-mentioned points with the additional benefit of an attractive vol picture.
Page 6
Adding Dutch pension fund solvency
ratio to EUR 5Y-30Y slope model
EUR 5Y-30Y slope, sample daily data since Apr-2007
Beta
T-stat
EUR 2Y swap (%)
-39.61
-79.4
EUR 5Y5Y inflation swap (%)
31.34
18.3
Italy-Germany spread (bp)
-0.08
-21.0
EUR 1Y30Y implied vol (bp)
-0.36
-14.9
Budget balance (% of GDP)
-0.94
-4.0
Dutch solvency ratio (%)
0.46
8.6
R-sq
94.7%
Source: Deutsche Bank
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
United States
Rates
Gov. Bonds & Swaps
Rates Volatility
US Overview
„
Our ongoing theme remains that though economic healing warrants rates
well above the cyclical lows - and higher than current spot levels - the
forwards are aggressively priced and we expect that rates will not beat the
forwards at a 1y horizon. Though the historical data from recent decades
encompass a secular bull market, we observe that bearish trades very
rarely beat the forwards, particularly at one year horizons and expressed
through 10y rates
„
With spot and 1y forward 10y USD - EUR lingering near multi-year highs,
we like spread tighteners as a moderately bearish trade, either outright or
conditionally via payers.
„
If recent economic forecasts, which reveal a high degree of consensus
regarding the equity-bullish and bonds-bearish views, are in any way
indicative of direction of the future market moves or positioning, the
market could end up being exposed to adverse scenarios.
„
With current vol differentials, financing positions at the wings with 10Y vol
allows for additional cushion for hedges against risk scenarios. We
consider two different trades: 1) Vol flies: Sell $100mn 20bp wide 1Y10Y
strangles vs. buy $200mn 1Y2Y and $25mn 1Y30Y straddles at zero net
cost; 2) Financed payers in the wings by strangles in 10s: Sell $100mn
100bp wide 1Y10Y strangles vs. buy $200mn 1Y2Y and $25mn 1Y30Y
ATMF payers at zero net cost
„
Historically, shorting the market outright has not been a good trade
because of the associated negative carry. Bearish investors with a high
conviction that rates can move above forwards should look for ideal entry
and holding periods. We analyze a combination of swap tenors and trade
horizons to determine the shorts that could stand the highest chance of
being profitable. Conditioned on the Fed hiking rates in the next 12 months,
outright shorts in the 2y rate have historically been more successful than in
10s.
„
The currently steep yield curve implies high forward rates relative to spot.
The negative carry in many outright bearish trades and yield curve
flatteners in rates is punitive; the hurdles to beat the forwards are high. As
an alternative to bearish trades in rates, investors should look for a good
entry level to be short mortgages later this year based on the expected
supply and demand imbalance amid taper and the seasonal issuance trend
in MBS.
„
Japanese investors are expected to fill some of the demand left by the
Fed’s QE exit if Treasury yields remain attractive enough to JGBs. A stable
US inflation rate, the expectations of further yen weakness, a potential for
the BoJ to deliver more QE later this year, and the possibility of pent-up
demand all argue for an increased buying of Treasuries from Japan in 2014.
Dominic Konstam
Research Analyst
(+1) 212 250-9753
[email protected]
Aleksandar Kocic
Research Analyst
(+1) 212 250-0376
[email protected]
Alex Li
Research Analyst
(+1) 212 250-5483
[email protected]
Stuart Sparks
Research Analyst
(+1) 212 250-0332
[email protected]
Daniel Sorid
Research Analyst
(+1) 212 250-1407
[email protected]
Steven Zeng, CFA
Research Analyst
(+1) 212 250-9373
[email protected]
Good shorts (are there any?)
Our ongoing theme remains that though economic healing warrants rates well
above the cyclical lows - and higher than current spot levels - the forwards are
aggressively priced and we expect that rates will not beat the forwards at a 1y
horizon. Though the historical data from recent decades encompass a secular
bull market, we observe that bearish trades very rarely beat the forwards,
particularly at one year horizons and expressed through 10y rates.
Deutsche Bank AG/London
Page 7
17 January 2014
Global Fixed Income Weekly
In the end of course the strength of the data and the Fed's reaction function
will drive the market. As we discussed in our outlook pieces for 2014, we see
three main scenarios for the forthcoming year. Steadfast Fed guidance in the
face of ongoing economic healing, coupled with ongoing reductions in asset
purchases could make the curve stubbornly steep, though we expect that the
potential for bearish steepening is limited by risky assets' reactions to high
long forward rates and potentially the asset allocation behavior of defined
liability investors. Alternatively the curve could flatten bullishly - if data roll
over - or bearishly if growth accelerates.
If it is right that potential growth is low, then a prolonged period of growth at
Q3 levels would threaten inflation as a matter of time, with the operative
question being simply when. Alternatively inflation is little threat if faster H2
2013 growth turns out to be a third post crisis "mini-cycle".
Alternatively it is plausible that potential could even have begun to creep back
to or above pre-crisis levels, which would suggest that inflation remains low
because of a widening output gap. Here accelerating growth would pose little
problem for the Fed as real growth would bolster real rates but the Fed could
have the luxury of allowing remaining slack to be absorbed.
Of these, the greatest threat to the scenario reflected in the forwards is
perhaps the rapid growth/low potential combination. We have our doubts.
At this stage in the cycle, however, we favor looking at cross market
opportunities. For example, spot and 1y10y USD-EUR remain near multi-year
highs. A durable upturn in the US could restart the global growth engine, with
a significant effect on Europe via global demand for Europe's capital goods
exports. We would expect European rates to underperform the US in such a
scenario. We note that - even if a small possibility - unsterilized ECB asset
purchases could bolster longer traded inflation with a bearish effect on longer
nominal rates.
In a more bearish economic outturn, weaker data could produce US
outperformance as the market rallies back into the old range.
The forwards are nearly flat, with the 1y 10y USD- EUR spread only 3 bp wider
than spot. USD vol, however, is significantly high. 1y10y USD vol is roughly
85bp, while it is 70 bp in EUR. This implies investors can enter (USD) BPV
neutral cross market spread trades at zero premium outlay at levels better than
the forwards.
Last week, we wrote that elevated forwards pose a major hurdle to bearish
investors as outright short positions need to overcome a steep (negative) carry
profile to become profitable. We calculated that since 1995 only 27 percent of
outright shorts in the 10y rate were profitable over a one-year horizon, so an
investor needs to have a high level of conviction, or a carefully executed
strategy, or both, in order to profit from bearish trades.
The acute reader will ask “what about a short position in the 30y rate, or
holding the trade for only three months instead of one year?” Our analysis
attempts to answer that question. The tables below show the percentage of
bearish trades that had beaten the forwards given various holding horizons and
positions on different parts of the curve. The conclusion is that you can do
better than the 27% success rate by executing a strategy different than paying
10s for 12 months. You can even get close to 2:1 odds at beating the forwards,
but you must time your trade right.
Page 8
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
Percent of outright shorts that had beaten the forwards
over the trade horizon, 1995 – 2013
Percent of outright shorts that had beaten the forwards
over the trade horizon, 2009H2 – 2013
1995 - 2013
2y
1m
39%
3m
35%
Trade
31%
Horizon 6m
9m
26%
1y
24%
July 2009 - 2013
2y
1m
35%
3m
21%
Trade
12%
Horizon 6m
9m
6%
1y
2%
5y
40%
35%
34%
28%
23%
Tenor
7y
40%
36%
36%
30%
24%
10y
41%
40%
39%
32%
27%
15y
43%
42%
40%
33%
27%
30y
45%
43%
42%
35%
30%
Source: Bloomberg and Deutsche Bank
5y
33%
28%
27%
20%
16%
Tenor
7y
36%
31%
35%
28%
22%
10y
40%
36%
42%
37%
24%
15y
44%
41%
49%
43%
27%
30y
48%
47%
52%
48%
33%
Source: Bloomberg and Deutsche Bank
First, a couple of observations from the full-sample period study. Since 1996,
no outright short strategy had been able to beat the forwards more than 50%
of the time. Also, profitable bearish strategies have tended to have shorter
horizons. Once a position is held for more than six months, the odds of being
profitable dropped off considerably. Finally, an outright short in the 15y or the
30y rate has historically stood a better chance of beating the forwards than an
outright short in 10s.
Looking at the post-crisis sample period which we define as 2009h2 and after,
the percentage distribution of profitable shorts looks roughly the same with the
exception of shorter tenor positions have had a much worse performance
record than longer tenor positions. This makes sense, since short rates were
held down by an ultra-dovish Fed over this entire period. However, if one
thinks that the next 12 to 18 months will be an unwind of the Fed’s
sponsorship of the front end, then the ideal location to put on an outright short
should be in 2y rates.
To confirm this, we analyzed the profitability percentage distribution
conditioned on the most recent tightening cycle, starting 12 months before the
first hike and ending on the last hike date. Note that the distribution appears
almost a mirror image of that of the last three years. Outright short positions in
the 2y have had the most success, and the best holding horizon is six months
to a year, which had been profitable two-thirds of the time. In contrast,
shorting the 10y rate had only 50/50 odds of beating the forwards.
Percent of outright shorts that had beaten the forwards
over the trade horizon, 3/2003 – 6/2006 (last hiking cycle)
6/2003 - 6/2006
2y
1m
59%
3m
60%
Trade
67%
Horizon 6m
9m
69%
1y
66%
5y
50%
42%
46%
52%
39%
Tenor
7y
49%
39%
44%
47%
33%
10y
48%
54%
52%
41%
47%
15y
47%
49%
50%
39%
39%
30y
46%
46%
49%
40%
37%
Source: Bloomberg and Deutsche Bank
An alternative to being short rates
The currently steep yield curve implies high forward rates relative to spot rates.
The negative carry in many outright bearish trades and yield curve flatteners in
rates is punitive. The hurdles to beat the forwards are high, especially in the
intermediate sector of the yield curve. The one-year drop on the three- and
five-year swap rates is more than 70bp.
Deutsche Bank AG/London
Page 9
17 January 2014
Global Fixed Income Weekly
Being short the intermediate sector in US rates has punitive negative carry
0.9
0.8
1yr
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0.0
2yr
3yr
5yr
7yr
10yr
15yr
20yr
25yr
30yr
Source: Bloomberg and Deutsche Bank
As an alternative to bearish trades in rates, investors should look for a good
entry level to be short mortgages later this year based on the expected supply
and demand imbalance amid taper and the seasonal issuance trend in MBS.
The Fed has been a major buyer of MBS in QE3, in the order of 250% of the
supply according to Flow of Funds data. Other investors, such as households,
foreigners, mutual funds, and brokers/dealers have been net sellers. Once the
Fed exits, those investors will have to step in to replace the Fed.
Supply and demand for Agency & GSE-backed Securities when there was no
QE
No QE: 3Q2011
2Q2011
3Q2011
Household sector
$
393 $
325 $
Foreign investors
$
1,074 $
1,092 $
Fed
$
1,026 $
979 $
Change % supply
(67)
-938%
18
244%
(46)
-646%
236%
Banks
$
1,560 $
1,577 $
17
Insurance
$
493 $
494 $
1
18%
Pension
$
354 $
359 $
4
60%
Money market funds
$
360 $
383 $
23
326%
Mutual funds
$
685 $
757 $
72
1002%
-111%
Brokers and dealers
$
175 $
167 $
(8)
GSEs
$
368 $
368 $
(0)
-1%
Other
$
1,091 $
1,085 $
(7)
-91%
Agency & GSE-backed Securities supply
$
7,578 $
7,585 $
7
100%
The Fed continued the reinvestments of principal payments from its securities holdings. Source: Federal Reserve and Deutsche Bank
Page 10
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
Supply and demand for Agency & GSE-backed Securities during QE3
QE3
4Q2012
3Q2013
Change % supply
Household sector
$
184 $
133 $
(52)
-33%
Foreign investors
$
1,004 $
883 $
(121)
-76%
Fed
$
1,003 $
1,403 $
399
251%
Banks
$
1,670 $
1,700 $
31
19%
Insurance
$
474 $
480 $
5
3%
Pension
$
418 $
444 $
26
16%
Money market funds
$
344 $
354 $
11
7%
Mutual funds
$
879 $
866 $
(13)
-8%
Brokers and dealers
$
170 $
106 $
(64)
-40%
GSEs
$
311 $
295 $
(16)
-10%
Other
$
1,098 $
1,051 $
(47)
-30%
Agency & GSE-backed Securities supply
$
7,555 $
7,714 $
159
100%
Source: Federal Reserve and Deutsche Bank
At the end of the day, supply is always equal to demand; the question is at
what price levels. In 3Q2011, when there were no Fed purchases in Treasuries
and MBS, foreigners, banks, mutual funds took down the lion share of the
MBS supply. Our mortgage strategists have pointed out the supply and
demand imbalance in MBS post QE, and have highlighted the seasonal
issuance patterns in MBS. Assuming the Fed tapers $10 billion per FOMC
meeting, the “cross-over point” between issuance and Fed purchases will
probably happen around in Q2. That is the point when Fed purchases will drop
below net MBS supply. The net supply of MBS is projected to be around $200
billion this year. MBS spreads will likely have to widen enough to attract
domestic real money investors. Therefore, although it’s not an imminent trade,
investors should look for a good entry level to be short mortgages, especially
when the other options to be short rates are so unappealing from a carry
standpoint.
Net supply of MBS
700
600
ARMs
500
GN fixed
Conv fixed
400
300
200
100
0
-100
-200
-300
-400
2005
2006
2007
2008
2009
2010
2011
2012
2013 2014E
Source: Deutsche Bank
Can Japan fill the Fed’s void?
The Japanese are yield buyers. In the late 1990s, when the yield on US 10yr
notes were 4 percentage points higher than the equivalent JGBs, Japanese
banks, pensions and insurance companies owned a sum of foreign securities
Deutsche Bank AG/London
Page 11
17 January 2014
Global Fixed Income Weekly
(mostly in US government and agency bonds) equal to half of their total JGB
investments. During the 2000s, as global bond yields converged and the yield
advantage of Treasuries over JGBs waned, Japanese demand for foreign
bonds relative to domestic paper also declined. By 2011, the ratio of Japanese
investments in foreign securities to JGBs fell to a decade-low of 1:4. Over the
past two years, the UST-JGB spread reversed direction and pushed wider,
once again making Treasuries attractive compared to the perennial lowyielding JGBs. The ratio of Japan’s foreign-domestic investments has since
recovered to about 1:3.
10Y UST-JGB spread and Japanese investments in Treasuries relative to JGBs
500
bp
450
400
10Y TSY-JGB spread
0.55x
Japanese Banks, Insur & Pension: foreign
securities to JGBs (RHS)
0.50x
0.45x
350
300
0.40x
250
0.35x
200
150
0.30x
100
0.25x
50
0.20x
0
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Source: Bank of Japan, Haver Analytics and Deutsche Bank
A rebound in Japanese diversifying abroad is good news for Treasury investors.
As the Fed prepares to wind down its QE operations, the question on many
investors’ minds today is who will be the marginal buyers once the Fed is
gone? The answer could be Japanese investors if the UST-JGB spread stays
attractive enough. At the end of Q3 2013, Japanese banks, insurance and
pensions held nearly $1.7 trillion of foreign securities to $5.2 trillion of JGBs on
their balance sheets. So even just a 5 percent reallocation into Treasuries from
JGBs could create demand for $260 billion of USD products, or the equivalent
of three full months of QE purchases.
There are several good reasons for why we could see increased UST buying
from Japan in 2014. The first is the difference in inflation trends in the US and
Japan, where the prevailing low US inflation contrasts starkly with the rapidlyrising inflation in Japan. The latest Japanese CPI printed at a five-year high of
1.5%, a sign that the massive BoJ stimulus package launched last spring is
working. Second, expectations are now for further yen weakness behind the
BoJ’s pledge to lift inflation to 2% by 2015 and potentially delivering additional
stimulus later this year to achieve that goal. The BoJ’s easy policy and
resulting FX expectations should compel investors into moving out of yen
assets and into USD assets. Third, more Japanese QE means more money will
be moving offshore, and they will likely find a home in Treasuries. Finally, the
flurry of Japanese buying many people expected to see following last April’s
BoJ QE announcement never materialized. The US TIC report showed net
selling of $12 billion Treasuries by Japan in Q2, and it wasn’t until Treasury
yields rose substantially over JGB yields in Q3 when buyers from Japan turned
up. As a result, it is possible that remaining pent-up demand from Japan will
work its way into a bid for Treasuries in the coming months.
Page 12
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
U.S. vs. Japan inflation trend
3.5
3.0
2.5
Japan net Treasury bonds and notes purchases
US CPI yoy %
Japan CPI yoy %
US forecast
Japan Target
80,000
70,000
60,000
50,000
2.0
40,000
1.5
30,000
1.0
20,000
0.5
10,000
0.0
0
-0.5
-10,000
-1.0
-20,000
-1.5
Jan-12
Jul-12
Jan-13
Jul-13
Jan-14
Source: Bureau of Labor Statistics, Bank of Japan and Deutsche Bank
Deutsche Bank AG/London
Jul-14
Jan-15
Source: Treasury and Deutsche Bank
Page 13
17 January 2014
Global Fixed Income Weekly
United States
Rates
Gov. Bonds & Swaps
Alex Li
Steven Zeng, CFA
Research Analyst Research Analyst
(+1) 212 250-5483 (+1) 212 250-9373
[email protected] [email protected]
Treasuries
„
The currently steep yield curve implies high forward rates relative to spot.
The negative carry in many outright bearish trades and yield curve
flatteners in rates is punitive; the hurdles to beat the forwards are high.
There is a chance that forwards is not fully net. Historically on average the
market didn’t have a significant sell-off and curve flattening until a few
months before the first Fed rate hike.
„
In the TIC data, Asia remained a good buyer of Treasuries in November, as
China and Japan added, respectively, $10.7bn and $6.7bn.
Timing the Fed is a difficult task
The currently steep yield curve implies high forward rates relative to spot rates.
The negative carry in many outright bearish trades and yield curve flatteners in
rates is punitive. The hurdles to beat the forwards are high, especially in the
intermediate sector of the yield curve. The one-year drop on the three- and
five-year swap rates is more than 70bp.
Historically on average the market didn’t have a significant sell-off and curve
flattening until a few months before the first Fed rate hike. The most extreme
event was the 1999 Fed tightening cycle, when Treasury yields troughed in
October 1998 during the LTCM crisis, about nine months before the first rate
hike. 5s/30s started flattening also in October 1998 and continued into the first
rate hike.
Change in 5yr yield in prior Fed tightening cycles
3.00
2.50
2.00
1.50
5Y yield
2/4/1994
6/30/1999
6/30/2004
Average
1.00
0.50
0.00
-0.50
-1.00
-1.50
-2.00
-500 -450 -400 -350 -300 -250 -200 -150 -100 -50 0
50 100 150 200 250
Trading Days Relative to to tightening start date
Source: Bloomberg Finance LP and Deutsche Bank
Page 14
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
Change in 2s/10s curve in prior Fed tightening cycles
2s/10s
1.50
1.00
0.50
0.00
-0.50
-1.00
2/4/1994
6/30/1999
6/30/2004
Average
-1.50
-2.00
-500 -450 -400 -350 -300 -250 -200 -150 -100 -50 0
50 100 150 200 250
Trading Days Relative to tightening start date
Source: Bloomberg Finance LP and Deutsche Bank
Change in 5s/30s curve in prior Fed tightening cycles
Source: Bloomberg Finance LP and Deutsche Bank
Deutsche Bank AG/London
Page 15
17 January 2014
Global Fixed Income Weekly
Being short the intermediate sector in US rates has punitive negative carry
0.9
0.8
1yr
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0.0
2yr
3yr
5yr
7yr
10yr
15yr
20yr
25yr
30yr
Source: Bloomberg Finance LP and Deutsche Bank
TIC Update: Asia remained a good buyer of Treasuries in
November
As the incoming economic data appeared to underpin economic recovery,
Caribbean banking centers offloaded a record amount—$39.4bn—of
Treasuries in November. France, Ireland and Luxembourg divested a net
$8.3bn but Asia remained net buyer of $24.7bn of paper for the second
straight month as China and Japan added, respectively, $10.7bn and $6.7bn.
UK was a net buyer of Treasuries for the fifth month in a row but its net
purchases fell sharply from $26bn in October to $12.4bn. Foreign official
institutions accounted for $10.2bn of investments.
Net foreign Treasury purchases totaled -$3.4bn in November but foreigners’ Tbill holdings rose by $21.5bn during the month.
Net foreign purchases of US Treasuries in November
Net foreign purchases of US Treasuries
US Tsy Bills
20
US Tsy Bonds
$b n
60
0
-10
-30
0
Source: Deutsche Bank
„
May-12
Nov-12
May-13
Nov-13
Caribbean
Brazil
Other Asia
HK
Other Countries
Nov-11
China
-60
Japan
-50
Other Europe
-40
-30
-90
May-11
US Tsy Bonds
-20
30
$bn
US Tsy Bills
10
90
UK
120
Source: Deutsche Bank
Agency: Net foreign investments in Agency and mortgage backed
securities were -$0.5bn. China and UK were net buyers of $4.1bn and
$3.1bn, respectively, but the Caribbean and European (ex-UK) nations
divested $1.8bn and $2.8bn, respectively. Japan was a net seller of $1.2bn.
Page 16
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
„
Corporate: Foreign investors turned net sellers of $0.5bn in US corporate
bonds in November. Combined Asia and the Caribbean net investments of
$3.9bn were almost entirely offset by net sales of European investors. UK
offloaded $1.6bn while Japan was a net buyer of $1.2bn of securities.
„
US Bonds: Foreign investors were net sellers of $4.4bn of long-term U.S.
Treasury, agency and corporate bonds in November. Caribbean banking
centers shed $39.3bn of securities, the largest amount since March 2008,
but Asia remained a net buyer of $29.9bn. UK added $14bn of securities
for the fifth straight month but France and Ireland were net sellers of
$5.4bn and $4.4bn, respectively.
Foreign purchases of US bonds by month, vs. 10Y yield level
Net Purchase of US Bonds
Tsy 10Y (rhs)
90
3.0
60
$bn
3.5
2.5
30
2.0
0
1.5
-30
-60
May-11
Tsy 10Y
120
1.0
Nov-11
May-12
Nov-12
May-13
Nov-13
Source: US Treasury; Deutsche Bank
Auction preview: 3s, 10s, Bonds
Market supply includes $64bn of notional worth $57.4bn in ten-year
equivalents through three- and ten-year notes and thirty-year bond auctions
next week. These auctions will settle on the following Monday against $32.5bn
of coupon securities maturing on December 15.
Customer participation the recent four auctions has been strong averaging
58.4% vs. 51.4% in the previous four as indirect bidders beat their average
35.1% takedown in each of the last six auctions. 3s and 10s were solidly bid in
the last auction the demand for 30-year paper was weak.
The recent volley of economic data has forced the market to price-in a higher
taper probability in next FOMC meeting resulting in elevated yield levels. Any
disappointment should however result in sharp correction across the curve.
We therefore expect decent customer participation in these auctions next
week.
3-year note
Indirect bidders beat their average 29.1% participation in each of the last seven
auctions. Direct bidders too were solid in the recent three auctions versus their
one-year average of 18.9%. Combined customer participation averaged 53.8%
in the last four auctions and compares with its average level of 48%. Allotment
shares to both fund and foreign investors were above the respective averages
in November and the combined 41.7% share of the two investor classes was
the largest since January. Last auction recorded an eight-month high bid-tocover ratio of 3.46 (avg. 3.33) and stopped through fifth in a row.
Deutsche Bank AG/London
Page 17
17 January 2014
Global Fixed Income Weekly
3-year note auction statistics
Size
($bn)
1yr Avg
$31.6
Primary
Dealers
Direct
Bidders
Indirect
Bidders
Cover
Ratio
52.0%
18.9%
29.1%
3.33
Stop-out 1PM WI
Yield
Bid
BP Tail
-0.1
Nov-13
$ 30.0
47.3%
19.4%
33.3%
3.46
0.644
0.645
-0.1
Oct-13
$ 30.0
45.8%
19.7%
34.4%
3.05
0.710
0.7175
-0.8
Sep-13
$ 31.0
46.8%
20.0%
33.1%
3.29
0.913
0.918
-0.5
Aug-13
$ 32.0
44.7%
14.0%
41.4%
3.21
0.631
0.636
-0.5
Jul-13
$ 32.0
51.5%
13.0%
35.6%
3.35
0.719
0.721
-0.2
Jun-13
$ 32.0
58.4%
8.4%
33.1%
2.95
0.581
0.577
0.4
May-13 $ 32.0
54.7%
14.6%
30.7%
3.38
0.354
0.354
0.0
Apr-13
$ 32.0
64.9%
16.2%
19.0%
3.24
0.342
0.338
0.4
Mar-13
$ 32.0
56.0%
23.4%
20.6%
3.51
0.411
0.414
-0.3
Feb-13
$ 32.0
55.1%
26.9%
18.0%
3.59
0.411
0.412
-0.1
Jan-13
$ 32.0
45.2%
26.4%
28.4%
3.62
0.385
0.383
0.2
Dec-12
$ 32.0
53.3%
24.8%
21.9%
3.36
0.327
0.323
0.4
Source: US Treasury and Deutsche Bank
10-year note
Customer participation has been solid in every first re-opening auction since
November last year averaging 68.6%, which compares with its twelve-month
average level of 60.8%. Indirect bidders beat their average takedown of 38.3%
in each of the last six auctions offsetting weak directs. Combined 59.7%
allotment share of fund and foreign investors in November was above its oneyear average of 54.3% four in a row. However five of the last six auctions
recorded below average (2.74) bid-to-cover ratio even as the last three stopped
through heftily.
10-year note auction statistics
Size
($bn)
1yr Avg $ 22.0
Primary
Dealers
Direct
Bidders
Indirect
Bidders
Cover
Ratio
39.2%
22.5%
38.3%
2.74
Stop-out 1PM WI
Yield
Bid
BP Tail
-0.4
Nov-13 $
24.0
33.8%
18.6%
47.7%
2.70
2.750
2.754
-0.4
Oct-13 $
21.0
40.2%
21.2%
38.6%
2.58
2.657
2.667
-1.0
Sep-13 $
21.0
33.8%
29.6%
36.6%
2.86
2.946
2.966
-2.0
Aug-13 $
24.0
38.5%
15.2%
46.3%
2.45
2.620
2.62
0.0
Jul-13
$
21.0
45.2%
16.3%
38.6%
2.57
2.670
2.668
0.2
Jun-13 $
21.0
36.6%
11.7%
51.7%
2.53
2.209
2.208
0.1
May-13 $
24.0
49.2%
16.9%
33.9%
2.70
1.810
1.799
1.1
Apr-13 $
21.0
33.6%
29.1%
37.3%
2.79
1.795
1.791
0.4
Mar-13 $
21.0
22.3%
30.0%
47.7%
3.19
2.029
2.052
-2.3
Feb-13 $
24.0
47.7%
24.2%
28.0%
2.68
2.046
2.041
0.5
Jan-13 $
21.0
56.7%
14.8%
28.5%
2.83
1.863
1.855
0.8
Dec-12 $
21.0
33.1%
42.7%
24.2%
2.95
1.652
1.672
-2.0
Source: US Treasury and Deutsche Bank
30-year bonds
November auction recorded below-average (53.5% vs. 54.2%) customer
participation for the first time since June as indirect bidder participation fell to
seven-month low level at 35.3%. However, direct bidders remained solid for
the fifth straight month averaging at 19% versus their one-year average of
16.2%. Combined 45.6% allotment share to fund and foreign investors was the
lowest in as many months and compares with its average level of 46.9%. BidPage 18
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
to-cover ratio of 2.16 was weak as compared to the average 2.46 and auction
generated a hefty tail of 1.5 basis points.
30-year bond auction statistics
Size
($bn)
1yr Avg
Primary
Dealers
Direct
Bidders
Indirect
Bidders
Cover
Ratio
$14.0
Stop-out 1PM WI
Yield
Bid
BP Tail
45.8%
16.2%
38.0%
2.46
Nov-13
$ 16.0
46.5%
18.3%
35.3%
2.16
3.810
3.795
0.4
1.5
Oct-13
$ 13.0
35.5%
22.6%
41.9%
2.64
3.758
3.779
-2.1
Sep-13
$ 13.0
41.7%
20.6%
37.7%
2.40
3.820
3.827
-0.7
Aug-13
$ 16.0
42.7%
17.1%
40.2%
2.11
3.652
3.644
0.8
Jul-13
$ 13.0
43.4%
16.3%
40.2%
2.26
3.660
3.674
-1.4
Jun-13
$ 13.0
51.3%
8.5%
40.2%
2.47
3.355
3.324
3.1
May-13
$ 16.0
45.7%
15.5%
38.8%
2.53
2.980
2.990
-1.0
Apr-13
$ 13.0
49.3%
19.2%
31.4%
2.49
2.998
2.990
0.8
Mar-13
$ 13.0
53.1%
4.9%
42.0%
2.43
3.248
3.230
1.8
Feb-13
$ 16.0
49.1%
14.5%
36.4%
2.74
3.180
3.183
-0.2
Jan-13
$ 13.0
45.5%
16.7%
37.8%
2.77
3.070
3.083
-1.3
Dec-12
$ 13.0
46.1%
20.3%
33.7%
2.50
2.917
2.885
3.2
Source: US Treasury and Deutsche Bank
Fed buyback
Fed plans to remove about $12.4bn of notional worth $15.9bn in ten-year
equivalents from the market through six purchase operations next week.
Regular purchases on Monday, Wednesday and Friday will target the long-end
of the curve while 5.75-7 year sector will be in focus on Thursday. Monday’s
second buyback operation (at 1:15 pm) is targeted at 7.25-10 year sector of the
curve whereas the TIPS purchases of the month will be carried out on Tuesday,
December 10.
Fed buyback schedule: December 9-13
Date
9-Dec
9-Dec
10-Dec
11-Dec
12-Dec
13-Dec
Operation
Type
Treasury
Treasury*
TIPS
Treasury
Treasury
Treasury
Total
Maturity Range
2/15/36 11/15/43
2/15/21 11/15/23
1/15/18
2/15/43
2/15/36 11/15/43
9/30/19 11/30/20
2/15/36 11/15/43
Avg Par
($bn)
1.500
3.125
1.250
1.500
3.500
1.500
12.375
Avg
10yr Equiv Sub/cover
DV01
($bn)
(Last 4 avg)
3.37x
16.61
2.91
3.36x
8.12
2.97
2.92x
11.62
1.70
3.37x
16.61
2.91
3.97x
6.15
2.52
3.37x
16.61
2.91
15.93
Source: NY Fed, Deutsche Bank * This operation will be conducted at 1:15 pm
Deutsche Bank AG/London
Page 19
17 January 2014
Global Fixed Income Weekly
United States
Rates
Inflation
Rates Volatility
Aleksandar Kocic
Research Analyst
(+1) 212 250-0376
[email protected]
Derivatives
„
If recent economic forecasts, which reveal a high degree of consensus
regarding the equity-bullish and bonds-bearish views, is in any way
indicative of the direction of future market moves or positioning, the
market could end up being exposed to adverse scenarios.
„
With current vol differentials, financing positions at the wings with 10Y vol
allows for additional cushion for hedges against risk scenarios. We
consider two different trades:
„
Vol flies: Sell $100mn 20bp wide 1Y10Y strangles vs. buy $200mn 1Y2Y
and $25mn 1Y30Y straddles at zero net cost
„
Financed payers in the wings by strangles in 10s: Sell $100mn 100bp wide
1Y10Y strangles vs. buy $200mn 1Y2Y and $25mn 1Y30Y ATMF payers at
zero net cost
The poverty of expectations: Again for the first time
Recent economic forecasts reveal a high degree of consensus across the board
with dominant theme centered on bullish equities and bearish bonds views.
While this seems to be consistent with the recent market moves and the base
case scenario of gradual rebound in growth, the year-end forecasts for the
term structure, summarized in Table 1, seem to be at odds with the current
constellation of risks and with market pricing. This is not the first time we’ve
encountered this sort of situation. For the last three years, formation of
consensus around an optimistic outlook has been a regular occurrence in the
first quarter of the year. In that context, this is no exception. However, there
are notable differences as market conditions and risks have shifted
significantly, with a different Fed and the first steps towards changes in
monetary policy already underway.
Figure 1: Summary statistics for the year-end economic forecast of the term
structure
2Y
10Y
30Y
median
0.80
3.45
4.27
fwd
1.11
3.23
3.99
stdev
33
26
28
Source: Bloomberg Finance LP
From the table above, the following patterns emerge. The highest confidence
appears to be in the 10y sector with growing dispersion towards the wings.
Except for a few outliers (one at 2.5% and one at 4%), most of the forecasts for
the 10s reside in a tight range, 3.00-3.75%, with median about 20bp above the
forward. The dispersion is slightly higher at the long end with similar spread of
30bp between the median forecast and the forward. In contrast, distribution
for the short end is skewed to the left and reflects much less of consensus (std
25% higher than for 10s) with about 85% of probability being below the
forward.
Page 20
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
If taken at face value, the forecast summary is consistent with a view of long
end steepener with constrained short end corresponding to forward guidance
in an environment with continued growth with rising inflation expectations. If
this is in any way indicative of the direction of future market moves or general
sentiment likely to be reflected through positioning, the market could end up
being exposed to adverse scenarios.
In terms of dispersion across the term structure, the forecasts are in conflict
with the options market. Figure 2 shows the ratio of volatilites relative to 10Y
points, both as reflected by the forecasts and as implied by the options market.
While forecasts exhibit high dispersion in the wings, the options market prices
1Y10Y vol about 5-15% higher than the wings.
Figure 2: Comparing the relative confidence of the forecast with the vol
term structure
1.30
1.26
1.20
1.08
1.10
Foreacst
1.00
Implied
0.90
0.96
0.80
0.70
0.74
0.60
1y2y/1y10y
1y30y/1y10y
Source: Deutsche Bank
In our view, this type of term structure of vol is consistent with gradual growth
without inflation and does not capture the risks of deviation from it. In reality,
the departures from either this or forecast-based scenarios can take place
along several paths. Guidance in place implies further repricing of forwards at
the short end. Its success would mean further sell-off at the long end with
either a parallel shift or possibly 10s/30s steepener due to higher inflation
expectations. Guidance challenged is a bear flattener led by the short end. In
this case, short-tenor vol outperforms both 10Y and 30Y sector. An interesting
situation could occur if we see a rise in inflation without changes in wage
inflation (which has been residing near its all-time lows for the last 5 years).
Such a development could reinforce bear flatteners due to expectations of
preventive rate hikes as it would reduce purchasing power and adversely affect
growth. In this case, the growth sensitive sector (10s) would remain stagnant
while both wings could reprice higher. Growth with inflation is bearish across
the curve with the short end leading the way due to repricing of Fed
expectations while details at the long end would be a function of exact
blending between the two macro drivers.
With current vol differentials, financing positions at the wings with 1Y10Y
allows for additional cushion. We consider two different trades: vol flies and
payers in the wings financed by strangles in 10s.
„
Sell $100mn 20bp wide 1Y10Y strangles vs. buy $200mn 1Y2Y and $25mn
1Y30Y straddles at zero net cost
Deutsche Bank AG/London
Page 21
17 January 2014
Global Fixed Income Weekly
This is a vol RV trade with macro overtones. It has a positive carry of about
$300K in the first 6M. Given the risks associated with probable rates paths,
both 2Y and 30Y vol are seen as attractive insurance relative to 10Y vol,
especially given their relationship across different macro environments. We are
likely to see an additional rise in vol fly, Figure 3, as both rates and vol
normalize with its value approaching zero corresponding to pre-crisis levels.
Figure 3: 2s/10s/5s vol fly in terms of 1Y expiries
20
15
vol fly
10
5
0
-5
-10
-15
-20
-25
-30
-35
06
07
08
09
10
11
12
13
14
Source: Deutsche Bank
In terms of delta, a unilateral sell-off in 10s is also seen as an extreme
dislocation, in the context of the curve fly, Figure 4. A sell-off in 10s of 25bp
relative to the wings corresponds to extreme historical wides seen only as
transient spikes in 2004 and 2009.
Figure 4: 2s/10s/30s curve fly: a 25bp unilateral sell off in 10s corresponds to
historical lows
20
2s/10s/30s fly
0
-20
-40
-60
-80
-100
10s up by 25bp
-120
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
Source: Deutsche Bank
A similar-looking trade with a completely different spirit consists of using
1Y10Y strangles to finance payers in the wings:
„
Sell $100mn 100bp wide 1Y10Y strangles vs. buy $200mn 1Y2Y and
$25mn 1Y30Y ATMF payers at zero net cost
Page 22
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
This is not a vol RV, but an insurance trade. It has a negative carry around
-$300K in the first 6M due to aggressive roll down at the front end of the curve
and different decay rate in the wings vs. the financing leg. The “mismatch”
between the instruments (payers vs. strangles) allows us to use wide strangles
as a financing leg and provides a comfortable cushion of 50bp on each side.
Both trades are vulnerable to a unilateral move in 10s beyond the strikes on
either side, with potentially unlimited downside. A unilateral 50bp sell-off in
10s, corresponding to the upper strike of the strangle, takes us way out of
bounds defined by past movements, with fly around -130bp.
Aleksandar Kocic +1 212 250 0376
Deutsche Bank AG/London
Page 23
17 January 2014
Global Fixed Income Weekly
United States
Rates
Gov. Bonds & Swaps
Credit
Securitization
Steven Zeng, CFA
Research Analyst
(+1) 212 250-9373
[email protected]
Agencies
Here are two charts showing just how quickly dealers are leaving the agency
debt space, which could translate into further headwind for agency investors in
the form of wider spreads.
The Federal Reserve reported last Thursday that primary dealer positions in
federal agency securities dropped to just $20 billion as of Jan 1, the lowest
level in 16 years. However, the reported figure was skewed by two factors. The
first is seasonality; securities dealers are known to reduce their balance sheet
usage toward quarter- and year-ends. Second, the size of the agency market
has also been declining at a rapid rate, driven by the wind-down of Fannie and
Freddie. To see the true implication of the reported dealer positions, we will
need to adjust for seasonality and by the outstanding GSE debt.
This article originally
appeared in the Global
Strategy Flash on January 14,
2014.
The first chart shows dealer positions as a percentage of market size. The end
of December figure was just 1.1%, which is indeed a record low. We can also
see that for much of the post-crisis period, dealer’s market share was quite
stable, fluctuating between 2% and 5%. In June, the sell-off in rates widened
agency spreads, and dealer’s share tumbled below 2% for the first time and it
has remained sub-2% ever since. It is possible that June sell-off spooked the
dealer community, and with the eventual normalization of rates suggesting the
potential for further spread widening, dealers have decidedly cut back on risk.
We also need to adjust for quarter-end effects. The chart on the right shows
the average weekly changes to the dealers’ market share since beginning of
the year from 2009 to 2012, and then for 2013 as a standalone series. The grey
circles mark a clear pattern of contraction in dealer balance sheet going into
the end of each quarter. Yet, in the four years prior to 2013, dealers ended the
final quarter devoting the same balance sheet usage proportional to the market
size as when the year started. In 2013, dealers’ share of the total market was
1.3% lower by year-end, a clear departure compared to the previous years.
By normalizing the dealer positions data, we can confidently conclude that
dealers have reduced participation in the agency market; the timing of their
withdrawal coinciding with the June 2013 sell-off suggests that higher yields
and wider spreads could limit their future involvement in this space. For
investors, less competition among dealers could mean a drop in liquidity and
thus wider bid-offer spreads for agency securities in the foreseeable future.
Dealer positions as a share of the
market fell to a record low in 2H
2013
Dealer positions as % of total GSE debt
Sep-08:
Fannie/Freddie
placed into
conservatorship
7%
6%
Dealers reduced balance sheet
allocation to agencies proportional to
the market in 2013
Change in dealers market share since 1-Jan
1.5%
Aug-12: PSPA
amended with fulll
sweep provision
5%
1.0%
0.5%
4%
0.0%
3%
-0.5%
2%
quarter-end
2009-12 average
-1.0%
Jun-13:
rates selloff
1%
0%
2013
-1.5%
0
2007
2008
2009
2010
2011
2012
2013
4
8
12
16
20
24 28
Week
32
36
40
44
48
52
Source: Federal Reserve ,FNMA, FHLMC, FHLB and Deutsche Bank
Page 24
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
United States
Credit
Securitization
Steve Abrahams
Research Analyst
(+1) 212 250-3125
[email protected]
Mortgages
Originally published on 15 January 2014 in The Outlook in MBS and Securitized
Products.
REIT valuations, MBS implications
When the equity market’s passion for mortgage REITs drove share prices
above book value for long stretches in 2011 and 2012, it made sense for REITs
to issue equity and become one of the biggest marginal buyers of agency MBS.
But oh, how those passions have cooled. The average mortgage REITs now
trades well below book value and has substantial incentive to repurchase stock.
Repurchases would likely deleverage REITs, putting pressure on15-year passthroughs and hybrid ARMs, where REITs own a significant portion of the
outstanding float.
Mortgage REITs trading below book value
A quick look across the largest agency mortgage REITs reveals at least one
consistent observation—that as of the end of the third quarter of 2013, their
equity traded below book value (Figure 1). On average, the group traded at a
discount to book value of 80%. That picture likely hasn’t changed much since
then.
Figure 1: Mortgage REIT equity trading at significant discount to book value
95%
85%
85%
81%
81%
80%
79%
79%
78%
78%
CYS
NLY
HTS
Price to book
88%
WMC TWO MTGE
IVR
MITT AMTG Wtd. AGNC
Avg.
Note: All levels based on 9/30/2013 third quarter company disclosures.
Source: Deutsche Bank, the companies
REIT valuations remain depressed due to market concern about their ability to
weather some of the risks ahead in fixed income. For instance, potential
spread widening in MBS would leave REITs exposed on the asset side of the
balance sheet. The impact of Basel III could increase the cost of repo financing
and hurt net interest margin. Pressure on margin and an inability to harvest
gains could lead to lower dividends. All of this challenges mortgage REITs’
ability to deliver the stream of dividends built into their share prices during the
Deutsche Bank AG/London
Page 25
17 January 2014
Global Fixed Income Weekly
REIT heyday. But by driving share price so far below book, the equity market
may have jumped ahead of fixed income and created a new opportunity for
REIT shareholders: equity buybacks.
Assuming that REIT portfolio managers have marked their assets and liabilities
at true liquidation values, then buying back shares at current marks should
deliver returns equal to the difference between book and equity value. For
instance, if a REIT’s shares trade at 80% of book value, then every dollar of
equity repurchased should yield a 20% return. It’s hard to find that many fixed
income trades, if any, that show that kind of potential.
Of course, to avoid simply leveraging up their balance sheets in the aftermath
of a buyback, every dollar of equity repurchased will also need to be matched
by the liquidation of assets and unwinding of hedges in proportion to the
current leverage ratio. So if a mortgage REIT is currently seven times levered
and repurchases $1 of equity, it would need to sell roughly $7 of MBS and
possibly unwind some of the associated hedges.
Lately REIT leverage has decreased. In the second quarter of 2013, the average
REIT examined here was levered 6.92 times. By the end of the third quarter,
average leverage decreased by 32 bp (Figure 2).
Figure 2: Current REIT leverage
9
8
7
6
5
4
3
2
1
0
Note: All levels based on 9/30/2013 third quarter company disclosures.
Source: Deutsche Bank, the companies
There’s also some question about how a REIT might deleverage if it choose to
buy back stock. REITs can choose to deleverage actively through the sale of
assets or passively through prepayments and amortization. However, passive
deleveraging is inherently limited by the pace of prepayments. As rates rise
and prepayments slow, the potential impact of passive deleveraging would
decrease, limiting the ability to buy back stock by using this strategy. If a REIT
were inclined to repurchase meaningful amounts of equity, they would likely
have to sell assets to keep their leverage ratios constant.
Current mortgage REIT holdings
Holdings among the REITs reviewed here are dominated by 15- and 30-year
fixed-rated agency MBS. At the end of the third quarter, 30-year pass-throughs
comprised nearly 50% of their mortgage holdings while 15-year pass-throughs
made up nearly 25% (Figure 3). Combined residential MBS holdings for the
group totaled $251 billion.
Page 26
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
Figure 3: Weighted average mortgage REIT MBS holdings
49.8%
24.5%
11.6%
4.2%
4.0%
3.9%
1.0%
WA holding % total resi assets
Note: All levels based on 9/30/2013 third quarter company disclosures.
Source: Deutsche Bank, the companies
Determining the exact coupons held within each product becomes a bit more
art than science. However, most REITs report a weighted average coupon
within each product (Figure 4). Based on disclosures, it appears the majority of
holdings are in 30-year 3.50% and 4.00% pass-throughs and centered around
3.50%s in 15-year.
Market implications
While 30-year MBS make up a large share of the REIT portfolios analyzed,
REITs’ 30-year holdings look small relative to the outstanding balances net of
pools included in CMOs and Fed holdings. Their holdings of 15-year MBS and
hybrid ARMs, however, make up a much bigger share of outstanding market
float despite being a smaller portion of their overall asset allocation. It is
unclear what, if any, path REITs might take to deleverage. However, given their
outsized holdings in relation to total outstanding float, hybrid ARMs and
15-year fixed-rate MBS appear to be particularly susceptible if mortgage REITs
were to sell those assets (Figure 5).
Figure 4: Weighted average coupon by product for REIT universe
3.72%
3.63%
3.51%
2.28%
30Y Fixed
20Y Fixed
15Y Fixed
Non-Agency
WA Cpn.
Note: All levels based on 9/30/2013 third quarter company disclosures.
Source: Deutsche Bank, the companies.
Deutsche Bank AG/London
Page 27
17 January 2014
Global Fixed Income Weekly
Figure 5: Nominal REIT holdings as a percentage of total free float
17.8%
16.6%
9.7%
8.6%
3.4%
Hybrid ARM
15Y Fixed
20Y Fixed
30Y Fixed
CMO + IO
REIT holding % free float
Note: Percentages show total disclosed REIT holdings as of Q3 2013 as a percentage of free float net of Fed
holdings and CMO in coupons 4.5% and below for each fixed-rate sector, and as a percentage of free float net of
CMO for 5/1, 7/1 and 10/1 hybrid ARMs.
Source: Deutsche Bank, CPRCDR
Conclusion
So, for now, the agency REIT cycle has turned. Given the fairly substantial
discount to book value where many REIT stocks trade, it appears that
managers have significant incentives to repurchase stock. Buying back stock
at a discount to book may provide managers with a reasonable alternative to
reinvesting pay downs back in MBS that may offer limited upside given recent
tightening. If managers were to buy back stock in excess of pay downs they
would have to actively deleverage through asset sales. Based on their
disproportionate share of outstanding float in 15-year pass-throughs and
hybrid ARMs, the turn of the REIT cycle has added new risk to those sectors.
***
The view in rates
Friday’s weak payrolls likely have given the market only temporary reprieve
from slowly rising rates. The broader economic data—the ADP survey, weekly
jobless claims, auto sales and trade numbers—still look encouraging. And the
Fed still looks set to head down its announced path. That should eventually
move the market back toward where it stood before last week’s number. Most
importantly, that keeps most of the yield curve steep and the likely returns
from rolling down the yield curve strong, especially in 5- to 10-year bullet debt.
The view in spread markets
MBS have had a good run for most of the last month from a combination of
low net supply and proportionally high Fed demand despite the beginning of
the end for QE. As detailed here last week, the Fed in January is likely to take
down 260% of January’s net fixed-rate MBS supply. The Fed bid should
continue outstripping net supply through March before roughly matching and
then falling below. As the Fed bid goes, arguably so goes spreads. With a
crossover between Fed demand and supply almost bound to come within a
handful of months, it’s risky to passively over-allocate to MBS. It looks better
to go up in coupon where spread risk is thinner. The 15-year sector also has
looked like a reasonable place to avoid basis risk, but the sector’s exposure to
REIT holdings tempers that. We had recommended going overweight 15-year
paper, but we trim that back to neutral.
Page 28
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
The view in mortgage credit
The housing data have come in a little mixed lately. CoreLogic reported that
the average US home price rose 0.1% in November and 11.8% over the prior
year, a bit slower than the pace earlier in the year. The company expects a
0.1% price drop in December. Housing is on the cusp of the slowest months of
the year. Stronger numbers should return in March and beyond.
Steven Abrahams (+1) 212 250-3125
Christopher Helwig (+1) 212 250-3033
Ian Carow (+1) 212 250-9370
Jeff Ryu (+1) 212 250-3984
A REIT reaches for the FHLBanks
The Two Harbors REIT announced recently that a newly formed insurance
subsidiary has become a member of the FHLBank system, becoming the first
public REIT and possibly the only REIT so far to get access to system financing.
That should give Two Harbors a broader menu of funding and, in some cases,
lower interest rates than offered either by competing repo markets or other
sources of funds. The announcement highlights a growing trend of FHLBank
lending to insurance companies and could encourage other REITs and
mortgage investors to explore this novel approach.
FHLB membership process for insurance companies
The legislation that created the FHLBank system in 1932 authorized it to lend
to insurance companies from the outset, but insurance membership and
lending has only really taken off in the last decade (Figure 6). Each FHLBank
maintains unique standards for qualifying insurance companies for
membership. Given the significant latitude the FHLBanks maintain in qualifying
insurance members, it opens the door to other mortgage investors like REITs
to gain access to FHLBank funding.
In the case of Two Harbors, neither the REIT nor FHLBank-Des Moines has
disclosed any details on how this membership was structured. The only
publicly available information is the 8K filed by Two Harbors, which merely
states that the insurance subsidiary was approved for membership. As such,
the nuances of this particular case are entirely unclear at this time. However,
this is not the first time that banks and other entities have established an
insurance subsidiary to access FHLB funding. Based on conversations with
banks that have done this before, it involves a couple of steps.
Deutsche Bank AG/London
Page 29
17 January 2014
Global Fixed Income Weekly
At par value ($bn)
Figure 6: Insurance company advances on the rise post-crisis
60
14%
50
12%
10%
40
8%
30
6%
20
4%
10
2%
0
0%
2000
2002
2004
2006
Ins co advance amt
2008
2010
2012
As % tot advances (RHS)
Source: Deutsche Bank, FHLBank annual reports
Location, location, location
The investor first has to establish the insurance entity that could be eligible for
FHLBank membership. The parent company can either choose to form its
insurer internally, or can go out and purchase a shell charter—effectively a
dormant charter resulting from the merger of two insurance companies.
Depending on the state where the insurance or reinsurance company is legally
located, the insurance activities that the company engages in can be fairly
minimal.
The process also involves finding the right state and the right FHLBank.
Insurance company regulation varies from state to state, with some states
being significantly more amenable to establishing these entities. The art of the
deal is aligning a favorable state regulatory framework in a district with a
FHLBank that would accept the new entity. FHLBank-Des Moines and
FHLBank-Indianapolis have been notably active with insurers and maintain the
greatest percentages of advances to insurance companies (Figure 7).
100
60%
80
50%
40%
60
30%
40
20%
20
10%
0
0%
Advances to insurers
Ins co advances as % total
Nominal advance amt ($bn)
Figure 7: FHLB Des Moines and Indianapolis most active insurance lenders
Total advances
Ins co % of total advances (RHS)
Source: Deutsche Bank, Federal Reserve Bank of Chicago, “Understanding the relationship between life insurers and the Federal Home Loan
Banks,” January 2014 Chicago Fed Letter
Page 30
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
The fine print
Other details of each FHLBank matter, too. In much the same way that the
various FHLBanks differ in their willingness to lend to insurance companies,
they also differ on terms around membership, activity-based capital
requirements, collateral pledge requirements, eligible collateral, collateral
haircuts, advance rates, advance limits, and numerous other smaller factors.
These can amount to a material difference. For example, all FHLBanks have
some up-front membership capital requirement, but the required stock
purchase amount may be assessed differently between different FHLBanks. In
the past, the up-front capital requirement for an insurance company to gain
membership has occasionally been quite large.
Setting up shop
Upon gaining membership, transactions between the insurance company and
the FHLBank can be fairly fluid. The parent entity can assign eligible mortgage
assets to the insurance subsidiary, which the insurance company then pledges
to the FHLBank as collateral in exchange for an advance, which then flows
back to the parent entity. However, depending on the arrangement, assigning
assets to the insurance subsidiary may even be unnecessary—the parent entity
could simply transact directly with the FHLBank. While banks generally are not
required to deliver collateral to the FHLBank, it appears that insurance
companies would likely be required to deliver collateral versus advances.
Implications
While the Two Harbors/Des Moines relationship is the first transaction of its
kind, there are potential implications for the broader REIT community and
other mortgage investors. Broad-based implementation of this structure would
likely improve the manner in which the current market is funded. Funding
would likely become stickier. Additionally, MBS investors would have access
to longer-term funding and funding with embedded optionality, decreasing the
duration of leverage currently funding MBS.
Nevertheless, it is unlikely that we see a structural change tomorrow in how
agency MBS is funded. Ultimately, any spike in demand for advances would
have to meet with equal demand from debt investors, who would need to buy
the FHLBank debentures issued to offset the risk of the advance.
Steven Abrahams (+1) 212 250-3125
Christopher Helwig (+1) 212 250-3033
Ian Carow (+1) 212 250-9370
Larger issuers turn down the HARP volume
Some dramatic changes in the composition of the potential HARP-eligible
universe imply that prepayment speeds for HARP-eligible collateral will
continue to grind slower in 2014. Three of the largest lenders—Chase, Citi and
Wells—comprise small proportions of the total potentially HARP-eligible
universe. The vast bulk of what remains to be refinanced is serviced by Bank of
America and smaller servicers (Figure 8). These volumes mean that changes in
speeds for these three servicers/issuers just can’t move the needle very much
on overall cohort speeds. Slower speeds for “other issuers” means that
aggregate speeds for entire cohorts will approach those of these servicer
cohorts, which are from 3 CPR to 8 CPR slower than speeds of the larger
issuers.
Deutsche Bank AG/London
Page 31
17 January 2014
Global Fixed Income Weekly
Figure 9: Issuer composition among MHA and high LTV
Figure 8: Big drops in outstanding pre-June, 2009
collateral during 2013
pools varies considerably by cohort
300
100%
Dec. 2012
$ billions
250
Dec. 2013
80%
200
60%
150
40%
100
20%
50
0%
4.0000 2,009
4.5000 2,009
4.5000 2,008
4.5000 2,003
5.0000 2,009
5.0000 2,008
5.0000 2,007
5.0000 2,006
5.0000 2,005
5.0000 2,004
5.0000 2,003
5.5000 2,009
5.5000 2,008
5.5000 2,007
5.5000 2,006
5.5000 2,005
5.5000 2,004
5.5000 2,003
5.5000 2,002
6.0000 2,009
6.0000 2,008
6.0000 2,007
6.0000 2,006
6.0000 2,005
6.0000 2,004
6.0000 2,003
6.0000 2,002
6.0000 2,001
6.5000 2,008
6.5000 2,007
6.5000 2,006
0
Other
Source: Deutsche Bank, Fannie Mae via 1010data, Inc.
Bank of America
Citi
Chase
Wells
Source: Deutsche Bank, Fannie Mae via 1010data, Inc.
The 2009 cohorts had the best credit profiles since they were originated to the
tougher post-crisis underwriting standards. But they also had lower coupons,
chiefly 4.0% and 4.5%. The biggest lenders focused on these “easier” cohorts
to refinance first, leaving them with almost no remaining volume.
The flip side of HARP prepayments is issuance of MHA and high LTV pools.
Market shares among this collateral for the large issuers fell during 2013. Even
Quicken, which had aggressively refinanced others servicers’ HARP portfolios,
saw its market share decline from more than 11% to 1%. As the share of the
large lenders was decreasing, the share of “others” has increased to nearly
80% from just over 60% a year ago (Figure 10).
Figure 10: Market share among MHA and high LTV pools
Figure 11: Slower aggregate prepayment speeds for
“other” servicers not in the “big 4”
18%
80%
50
15%
40
12%
9%
40%
6%
20%
3%
CPR
60%
30
20
10
0
0%
0%
1/01/13
4/01/13
7/01/13
Bank of America
Chase
Wells
10/1/2013
Citi
Quicken
Other (RHS)
Note: CR, CQ and 100% refi minimum 80% LTV pools.
Note: coupons 4.0%–6.5% issued from 2001–May 2009.
Source: Deutsche Bank, Fannie Mae via 1010data, Inc.
Source: Deutsche Bank, Fannie Mae via 1010data, Inc.
The final key to HARP-eligible prepayments grinding slower are slower speeds
for “other’ lenders. Aggregate speeds for HARP-eligible cohorts among the
“big 4” servicers were 3 CPR to 8 CPR faster than speeds for “other” servicers
Page 32
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
during 2013 (Figure 11). So even without any further increases in interest rates
or behavior changes by either borrowers or lenders, aggregate speeds will
likely fall by 2-3 CPR. Declines will likely be larger for the peak 2006–2008
cohorts and smaller for the earlier cohorts.
Doug Bendt (+1) 212 250-5442
Deutsche Bank AG/London
Page 33
17 January 2014
Global Fixed Income Weekly
United States
Credit
HY Strategy
IG Strategy
US Credit Strategy
The Staircase of HY Sector Valuations
Oleg Melentyev, CFA
Strategist
(+1) 212 250-6779
[email protected]
Daniel Sorid
Research Analyst
(+1) 212 250-1407
[email protected]
Fundamentally-driven relative value analysis in HY
In this report we focus on the question of relative valuations within HY credit,
both in terms of credit qualities as well sectors. In doing so, we are taking a
further step from our earlier analysis of spread differentials between rating
categories, and look into spread per turn of leverage metrics across various
market segments. Additionally, we put current levels of these metrics against
their own historical ranges, and calculate percentile rankings to help us
formulate opinions on relative value in credit qualities and industry sectors.
Rules & definitions
We start with a sample of roughly 250 US HY nonfinancial issuers, both
publicly traded and privately held. We exclude deeply distressed names from
our analysis, where spread per turn becomes less of a useful measure of
fundamentally adjusted valuations, as such names trade mostly on expecteddollar-recovery basis. We define such names as those levered over 10x or
trading at 2,000bps spreads and wider. Finally, we are excluding names where
one leg of the calculation is missing, i.e. both leverage and spread level have to
be available on the date of calculation for a name to make it into our sample. In
doing so, we are addressing the issue where a name is contributing a spread
observation to our analysis, but not leverage, or the other way around, thus
unnecessarily distorting whatever final picture we are looking at.
Race to the bottom
Figure 1 presents results for alpha-numeric credit quality categories. Here, the
blue bar represents historical range of spread per turn of leverage in each
segment, and the red slider highlights the current level on that range. Figure 2
goes on to show percentile rankings of current observations against their
respective historical ranges. In calculating percentile ranks we are looking at
monthly observations for spread per turn of leverage in each category going
back to Jan 2006; we exclude Oct 2008-Mar 2009 observations for all
segments to prevent extreme levels from distorting our analysis. The scale in
Figure 2 is 0 to 100, zero being historical minimum spread/turn, and 100 being
the maximum. Of course, at current levels, the chart is not even showing the
scale beyond 25%, implying the whole market and all of its segments trading
within the tightest quartile measured against the last eight years of history.
Figure 1: Spread/turn of leverage
BB1
BB2
BB3
B1
B2
B3
CCC1
CCC2/CCC3
0
50
100
Spread/Turn, Current Level
150
200
250
300
350
Historical Range (2006 - Present)
Source: Deutsche Bank
Figure 2: Percentile rank of current
spread/turn vs historical range
BB1
BB2
BB3
B1
B2
B3
CCC1
Overweight low single-Bs, high CCCs
In relative value terms, and the keyword here is relative, there appears to be
some value left in the low-single-B to high-CCC segment of the market, where
percentile ranks are still coming in at high teens. The rest of the market is
trading around 10th percentile, with the tightest levels seen in lower-CCC
ranges, although here readers should exercise caution in reading too much into
results due to lower sample size (12-13 issuers, on average, vs 20-40 in other
segments) and susceptibility to a breakdown in spread/turn usefulness as
names approach distress (we relax conditions slightly for CCC2/CCC3 credits
to <15x leverage, under 3,000bps spread). Broadly speaking, these results
corroborate our existing overweight of single-Bs, and with this new datapoint
we are adjusting it to B3/CCC1 overweight against the rest of the market.
Page 34
CCC2/CCC3
0
5
10
15
20
25
Percentile Rank (Current Spread/Turn vs Historical Range) 0..100
Source: Deutsche Bank
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
Mapping out HY sectors
In the next step, we extend the analysis described above to HY industry
sectors. All selection criteria described above remain the same here, and some
of the largest and most distressed names in the market, such as CZR and TXU,
are excluded subject to leverage/spread thresholds applied. Results are
presented in Figures 3 and 4 below, with the former showing historical ranges
of spread per turn metrics in each sector, including current observations, and
the latter going on to show percentile rankings. Sectors on both charts are
ranked in the same way, according to their percentile scores, starting with
widest at the top and running down to tightest at the bottom.
Once again, the broad takeaway here is that all sectors are trading somewhat
tight, with even the widest ranking at sub-25th percentile ranges. Note,
however, that even as all eight quality segments printed sub-20th percentile
scores, certain industries are still averaging readings above that level, implying
pure sectoral contribution to valuations. Similarly, while no quality group
measured sub-5th percentile readings, there are three sectors producing low
single-digit scores in Figure 4.
Figure 3: Spread/turn in HY sectors
Figure 4: Pct rank of current spread/turn vs history
Packaging
Retail
Commercial Services
Energy
Consumer Products
Gaming, Hotels &…
Media
Technology
Chemicals
Telecommunications
Health Care
Automotive
Real Estate
Food
Capital Goods
Utilities
Metals
Packaging
Retail
Commercial Services
Energy
Consumer Products
Gaming, Hotels &…
Media
Technology
Chemicals
Telecommunications
Health Care
Automotive
Real Estate
Food
Capital Goods
Utilities
Metals
0
50
100
150
Spread/Turn, Current Level
Source: Deutsche Bank
200
250
300
350
400
0
Historical Range (2006 - Present)
5
10
15
20
Percentile Rank (Current Spread/Turn vs Historical Range) 0..100
25
Source: Deutsche Bank
Another important attribute that we can learn from examining these charts is
historical range, a proxy for volatility or cyclicality of each industry group. On
this scale, Figure 3 highlights the widest ranges in metals, retail, tech, and
automotive, while the tightest ranges have been observed in food, utilities,
consumer products, and healthcare. So far, so good – all of the above
conclusions come comfortably within what an educated guess would have
helped us to expect.
What stands out the most: metals
The most important part of this analysis comes, of course, from closer
examination of specific sector positions in Figure 4, coupled with analytical
judgment of where those sectors should be trading, given our understanding
of their underlying fundamental trends. Lines that jump out the most, in our
opinion, are metals on the tight end of distribution, and energy on the wide
end. In metals, the current reading of spread/turn, at just under 100bp, is only
3rd percentile on historical scale, the tightest of any other sector, and
obviously close to the tights against its own range. This comes at a surprising
time when commodities in general, and metals specifically, are trading at weak
levels and are not showing promising signs going forward, given a bleak
Deutsche Bank AG/London
Page 35
17 January 2014
Global Fixed Income Weekly
growth outlook in EM. Even if one was to make an assumption that growth is
just around the corner in EM and commodities should rebound from here, it
appears to be the case that this sector is pricing in such an outcome to a large
extent. We, for one, remain doubtful this is the most likely scenario to begin
with. All in all, we believe this is the sector to be underweight at these levels.
One note of caution on this is that the sector itself is relatively small (only five
names in our sample) and could therefore be subject to greater distortions than
others in our study.
Energy
On the other end of the spectrum, or close to it, we were somewhat surprised
to find energy among some of the widest sectors in HY, adjusted for their
leverage. Aside from the obvious excitement around the energy story in the US
that by now has gone mainstream, we believe a deeper question here is
whether the market starts to question viability of some of those drilling
projects, which continue to require significant capex investments to achieve
desired production goals. We estimate that as a whole, HY energy companies
in the US have been spending roughly 1.5x of their annual EBITDA on capex in
recent years, a development that is both welcome from macro standpoint but
also worrisome in terms of its longer-term sustainability. Our take is that for
the time being the industry still has time to prove viability of its optimistic
production goals at reduced capex rates in the future, but that time is not
indefinite. We would imagine it is probably measured by 2-3 years, where if
continued at present levels of required investments, we would see meaningful
deterioration in investor patience. All in all, we think energy is still a good place
to pickup extra spread and stay overweight, with an eye towards reducing
such overweight if current investment trends do not begin to show signs of
leveling off in the next few quarters.
Chemicals
The final point we would like make here is related to chemicals, a sector that
stands to be perhaps the biggest beneficiary of energy story in the US due to
lower prices on feedstocks for plastics. At the moment, chemicals are trading
at 80bps/turn, or 16th percentile against their historical range. While not high
in absolute terms, this score puts them right in the middle of the stack of HY
sectors. With positive tailwind coming from lower feedstock prices, this sector
is poised to show improving fundamental trends for years to come. One
offsetting factor to consider is that chemical companies are would also have to
make heavy capex investments to fully leverage opportunities presented by the
declining oil and nat gas prices in the US. Having said that, we believe
potential benefits from such investments comfortably outweigh temporary
headwinds that could emerge as a result of their borrowing needs as well as
capex. The sector is also poised for meaningful pickup in consolidation, where
larger players would try to capitalize on this emerging trend by snapping
smaller issuers, usually a positive outcome for HY bond/loan investors. All in all,
we believe a middle-of-the-stack placement of chemicals in our ranking makes
them for a good longer-term overweight position in HY.
Broad-market implications
Aside from helping to make specific sector-levels calls in HY, this framework
also assists us in drawing some macro levels conclusions on the market. With
all credit qualities and most industry sectors trading at sub 20th percentile
ranges, these results provide further evidence of tightness in credit valuations
at current levels. To be clear, sub-20th percentile, by definition, implies that
there is more room left to go to reach historical minimums. And yet it also
makes it evident that any distance left to reach the bottom is a lot shorter
today than what separates us from the top. As the Fed continues to deliberate
its path of deceleration in asset purchases, this picture should provide
additional evidence for the FOMC to consider wider implications of their
Page 36
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
policies. With economy poised to show stronger performance in 2014, and
with present-day monetary conditions in place, we believe it is more likely than
not that we will see spreads being pushed to the tights before they engage on
a sustained path wider in anticipation of the next credit cycle. A bump on this
road to tighter spreads could still materialize from a reversal in flows we have
discussed in detail in our year-ahead outlook. The probability of encountering
such a bump appears to have been reduced by the recent market reaction to
the initiation in tapering, although it remains to be seen whether the rest of of
trip to zero-level purchases by the Fed continues to be as smooth as the ride so
far.
Achieving such an outcome remains one of the priorities of FOMC. Judging
from recent market performance since mid-December, their messaging
strategy appears to have earned them an A on this score. We wonder however
if any messaging strategy, no matter how perfect, could substitute for $85
billion being injected into the market every month. At the current stage, the
risk of negative reaction in credit has transformed from initial tapering
announcement to realization that the tapering may have to proceed at a faster
pace than currently envisioned. Such a realization would come, most likely,
along with stronger macro data, which in turn, would support credit spreads.
All in all, we believe this still implies a potential for some widening as
expectations get recalibrated, with stronger confidence than before that such a
widening would be limited both in terms of extent and duration. If materialized,
it would represent a good opportunity to step in, and increase portfolio risk
further.
Deutsche Bank AG/London
Page 37
17 January 2014
Global Fixed Income Weekly
Eurozone
Rates
Gov. Bonds & Swaps
Rates Volatility
Abhishek Singhania
Strategist
(+44) 207 547-4458
[email protected]
Euroland Strategy
„
The declining excess liquidity in the Eurozone is mechanically putting
upward pressure on spot money market rates. However, the market
remains reasonably confident that the ECB is willing and able to control
the front-end
„
The more aggressive course of action by the ECB including a broad based
QE would require a significant decline in medium-term inflation
expectations.
„
A broad based QE by the ECB is likely to be weighed by GDP or ECB
capital keys, focused on government bonds and unlikely to extend to
longer maturities as was the case in Fed, BoE or BoJ programmes.
„
Countries with lower debt/GDP ratios and where marketable debt accounts
for a smaller proportion of outstanding govt. debt are likely to see a greater
impact on the bond market
„
In such a scenario, all govt. bonds including periphery, should outperform
swaps. We maintain our Bund ASW widener vs. Eonia and would
recommend switching periphery spread tighteners vs. swaps rather than
vs. Bunds
„
Although the EUR 5Y-30Y curve remains close to fair value at current
levels, the positive carry and the potential for the curve to steepen in case
of conventional or unconventional policy action from the ECB leads us to
recommend a steepener
Moderate pressure on money market rates not enough to
elicit ECB response as yet
Heightened dovishness at the January ECB meeting on Thursday combined
with the weaker than expected payrolls (albeit weather affected) on Friday
resulted in a moderate rally in core yields and a moderate sell-off in periphery
at the end of last week. However, the on-going improvement in the outlook for
the US was confirmed by retail sales and regional surveys released this week.
Together with the on-going improvement in Eurozone data concerns regarding
peripheral bond yields in particular have proven to be short lived; Italy and
Spain 10Y bond yields are at or below the lows reached last week. Core bond
yields meanwhile have been far less quick to reprice and remain reasonably
lower than the levels of last week on account of the increased expectation of a
potential broad based ECB QE.
Page 38
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
In addition to the above, money market yields have felt some upward pressure
over the past week due to the evolution of liquidity conditions. The new MRO
conducted this week saw a decline in take up of EUR 17.7bn while the 1M
LTRO saw a decline in take up of EUR 3bn. Combined with the EUR 2.6bn
decline in liquidity due to LTRO repayments announced last Friday excess
liquidity declined to EUR 130bn on Wednesday. We have seen the amount of
excess liquidity decline from about EUR 280bn to EUR 130bn in a matter of 15
days (Figure 1). This has resulted in an increase in Euribor and Eonia fixings
and a moderate widening of the Euribor-OIS spread. However, we do not think
that the ECB is uncomfortable with this moderate tightening of money market
conditions. In its monthly bulletin the ECB states that the decline in excess
liquidity is mainly a result of improved market access for euro-area banks and
is likely to decline further. They also state that money market rates have
remained largely stable and that in anticipation of further decline in excess
liquidity future money market rates are unlikely to remain anchored to the
deposit facility rate but should remain below the main refinancing rate.
1: Excess liquidity has declined to
~EUR 130bn down from EUR 280bn
around year-end
900,000
Excess liquidity (EUR mn)
800,000
700,000
600,000
500,000
400,000
300,000
200,000
100,000
0
Jan-12
May-12
Sep-12
Jan-13
May-13
Sep-13
Jan-14
Source: Deutsche Bank, Bloomberg Finance LP
The ECB would consider money market conditions to not be reflective of its
monetary policy stance either because the EUR front-end responds to external
factors such as the Fed monetary policy stance or because liquidity conditions
have tightened the effective monetary policy stance of the ECB.
As far as the response of the EUR front-end to the Fed is concerned the Fed
taper and the recent increase in USD front-end rates has had far less of an
effect on EUR rates compared to that in June or September of last year (Figure
2). This should provide some comfort to the ECB.
As far as the liquidity position and its impact on the effective monetary policy
stance is concerned in a liquidity neutral world Eonia would be expected to fix
~6bp above the main refi rate. Given that the ECB has already extended its
fixed rate full allotment regime until mid 2015 unless forward Eonias exceed
25bp meaningfully before mid-2015 ECB should remain comfortable on the
liquidity front.
Also, given that the ECB does not expect inflation to return to close to the 2%
level for at least two years as long as the first rate hike is not priced in before
Q1 2016 ECB should also be comfortable with its forward guidance language.
3: Forward Eonia remain broadly in
2: Moderate increase in money
market rates
line with ECB policy stance
1.20
1.25
USD 18x21 FRA
1M Eonia
EUR 18x21 FRA
1.00
1.00
0.80
0.75
0.60
0.50
0.40
0.25
0.20
0.00
Jan-17
Oct-16
Jul-16
Jan-16
Apr-16
Oct-15
Jul-15
Jan-15
Deutsche Bank AG/London
Apr-15
Source: Deutsche Bank, Bloomberg Finance LP
Jan-14
Oct-14
Oct-13
Jul-14
Jul-13
Jan-14
Apr-13
Apr-14
0.00
Jan-13
Source: Deutsche Bank
Page 39
17 January 2014
Global Fixed Income Weekly
Further, even if the situation were to change and EUR money market rates do
increase, it is likely to be easier for the ECB to address this by either cutting its
main-refi rate/deposit facility rates, providing further liquidity or strengthening
its forward guidance language. Therefore, while the front-end might face
upward pressure mechanically as the excess liquidity in the system declines or
because of developments elsewhere it is unlikely to overshoot given the ECB’s
willingness and commitment to bring it under control. Therefore, it is no
surprise to find that volatility on the EUR front-end remains low despite the
grind higher in rates and the Eonia curve is moderately inverted following the
recent increase in fixings.
4: Lower vol on EUR front-end
reflects greater ECB control
EUR 3M2Y rate (LHS)
EUR 3M2Y vol (RHS)
1.00
80
0.90
70
0.80
60
0.70
50
0.60
0.50
40
0.40
30
0.30
Beneficiaries and the disadvantaged in a broad based ECB
QE
ECB QE: A monetary policy tool not a credit policy tool
At the January ECB meeting, President Draghi made repeated references to
the Governing Council’s willingness to implement any measure permitted by
the Treaty in order to achieve its price stability mandate. This has been
interpreted by many (including us) to be a veiled reference to the possibility of
a QE programme should inflation expectations deteriorate significantly. If an
ECB QE programme is intended to be used as a monetary policy tool it would
probably take the form of a broad based QE programme under which the ECB
purchases government bonds of all Eurozone member states and not just the
peripheral countries. This approach is likely to be easier to defend given the
prohibition of monetary financing in the treaty. While a broad based QE
programme is likely to lower Eurozone government bond yields across all
countries there might still be some winners and losers in such a programme.
GDP weighted/ECB capital keys weighted QE should favour countries with
lower debt/GDP ratios
The country split of a broad based QE by the ECB is unlikely to be a function of
their yield levels (i.e. more buying of higher yielding debt) or a function of
outstanding government debt (i.e. more buying of the member states with
greater debt). Instead, it is far more likely that the ECB in order to highlight the
monetary policy nature of the QE programme would buy government debt of
the member states in proportion of (i) their ECB capital keys or (ii) GDP.
The ECB capital keys are, themselves, a function of the GDP of the countries1
and therefore it is not surprising that in either of these two cases the absolute
size of the buying is skewed in favour of the bigger Eurozone countries. It
follows that in terms of the market impact, countries with lower debt/GDP
ratios would stand to benefit compared to countries with higher debt/GDP ratio
as the ECB purchases will account for a greater proportion of the outstanding
govt. debt of the former group of countries.
0.20
Jan-13
20
Apr-13
Jul-13
Oct-13
Jan-14
Source: Deutsche Bank, Bloomberg Finance LP
5: Share of QE for Eurozone
countries according to ECB capita
key or GDP weight
ECB Capital
key weights
GDP weights*
Germany
25.7%
28.4%
France
20.3%
21.5%
Italy
17.6%
16.2%
Spain
12.6%
10.6%
Netherlands
5.7%
6.3%
Belgium
3.5%
4.0%
Greece
2.9%
1.9%
Austria
2.8%
3.3%
Portugal
2.5%
1.7%
Finland
1.8%
2.0%
Ireland
1.7%
1.7%
Others
2.9%
2.4%
Source: Deutsche Bank, ECB
*For the GDP weights we have used Eurostat’s 2013 forecasts of
nominal annual GDP
We can define a simple metric to determine which countries stand to gain or
lose based on an ECB capital key weighted purchase programme. The metric is
the difference between a countries share in the ECB capital key and share of
general govt. debt divided by its share of general govt. debt. The metric tells
one how much a country stands to benefit from the ECB purchases based on
capital key weights relative to its share of the general govt. debt.
The countries that stand to gain the most relatively would be Finland, Spain
and Netherlands while the countries which would stand to lose the most,
relatively, would be Italy, Belgium and Greece.
1
The ECB capital keys are based on population and GDP with an equal weighting given to both
Page 40
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
(1)
(2)
[(1)-(2)]/(2)
ECB capital
key weight
General go vt.
debt share
Winners/
Lo sers
25.7%
20.3%
17.6%
12.6%
5.7%
3.5%
2.9%
2.8%
2.5%
1.8%
1.7%
2.9%
23.6%
21.0%
22.8%
10.4%
4.9%
4.4%
3.5%
2.6%
2.4%
1.2%
2.2%
1.2%
9.1%
-3.5%
-22.9%
21.9%
17.8%
-19.0%
-16.5%
9.7%
5.6%
48.4%
-26.2%
145.8%
Germany
France
Italy
Spain
Netherlands
B elgium
Greece
A ustria
P o rtugal
Finland
Ireland
Others
Share of Eurozone general govt. debt
6: Countries with general govt. debt share lower than the ECB capital key
weights would stand to gain in a broad based ECB QE
30%
25%
IT
DE
Losers
20%
15%
10%
ES
Winners
5%
0%
0%
5%
10%
15%
20%
25%
30%
ECB capital key share (only Eurozone countries)
Source: Deutsche Bank
Structure of outstanding govt. debt matters
At a macro level, the statement that countries with lower debt/GDP ratios
relative to their ECB capital keys would stand to gain is correct. However, the
structure of the outstanding government debt in the Eurozone countries could
prove to be relevant for determining the market impact on govt. bonds and
bills.
In particular, it is important to consider that the ECB buying is likely to be
limited to EUR denominated, domestically issued central government bonds of
the Eurozone member states. This is particularly relevant because securities
which meet this criteria account for a varying proportion of total outstanding
government debt in the Eurozone countries. For example, central government
marketable debt accounts for 52% of German general govt. debt but as much
as ~80% of the general government debt in Netherlands, Austria and Italy.
Given the pressures on the pension and insurance community in the Eurozone,
it is also likely that the ECB would refrain from buying government bonds
beyond the 10Y sector while bills have been excluded from the Fed, BoE and
the BoJ QE programmes. In order to determine the market impact, it might be
better to compare the ECB capital keys to the EUR denominated, central govt.
domestic bonds issued with remaining maturity less than 10Y. On this basis
we find that Germany and Spain could be beneficiaries while France and Italy
could be at a disadvantage. Given the relatively limited outstanding amount of
marketable debt in the countries which are either under or were under a full
EU/IMF programme, it is not obvious whether an ECB QE would involve buying
of debt of these countries. If bonds of these countries are indeed bought by the
ECB they could stand to gain significantly.
Another way to compare the market impact of an ECB QE would be to
compare the ECB capital key weights to the share of gross and net issuance of
bonds from each of the countries. Comparing the possible ECB buying to gross
issuance France and Italy would be at a disadvantage while Germany and
Spain would gain. However, comparing the possible ECB buying to net
issuance Germany would stand to gain while Spain, Italy and France would
stand to lose.
Deutsche Bank AG/London
Page 41
17 January 2014
Global Fixed Income Weekly
7: ECB capita key compared to govt.
bonds <10Y maturity
8: ECB capital key compared to
gross and net issuance
(1)
(2)
[(1)-(2)]/(2)
(1)
(2)
(3)
ECB capital
key weight
Go vt. bo nds
<10Y
Winners &
Lo sers
ECB capital
key weight
2014 Gro ss
issuance
2014 Net
issuance
Germany
25.7%
17.2%
49.1%
Germany
25.7%
19.3%
11.7%
France
20.3%
30.7%
-33.9%
France
20.3%
21.8%
27.9%
Italy
17.6%
23.7%
-25.8%
Italy
17.6%
28.5%
26.3%
Spain
12.6%
9.8%
29.0%
Spain
12.6%
14.8%
26.7%
5.7%
Netherlands
5.7%
5.3%
7.1%
Netherlands
5.7%
5.1%
B elgium
3.5%
4.4%
-19.8%
B elgium
3.5%
3.9%
3.2%
Greece
2.9%
0.8%
260.7%
Greece
2.9%
0.0%
-6.1%
A ustria
2.8%
3.0%
-5.0%
A ustria
2.8%
3.1%
2.0%
P o rtugal
2.5%
1.7%
48.7%
P o rtugal
2.5%
1.3%
0.4%
Finland
1.8%
1.2%
49.9%
Finland
1.8%
1.2%
1.6%
Ireland
1.7%
1.4%
16.9%
Ireland
1.7%
0.9%
0.4%
Others
2.9%
0.8%
267.6%
Others
2.9%
# N/A
# N/A
Source: Deutsche Bank
Source: Deutsche Bank
Conclusion
—
A broad based ECB QE is likely to use GDP or ECB capital keys as a
metric to determine the proportion of buying of govt. bonds of
Eurozone countries
—
Countries with lower debt/GDP ratio will stand to benefit compared to
countries with higher debt/GDP ratios
—
Countries with lower share of marketable govt. debt will stand to
benefit as the market impact of ECB’s purchases is likely to be greater
—
The ECB will probably refrain from buying at the long-end of the curve
to avoid pressures on the pension and insurance funds
—
While the periphery will stand to benefit from a broad based QE it
might not result in a spread tightening vs. Bunds as Bunds could be
one of the biggest beneficiaries
—
All govt. bonds including periphery should outperform swaps. We
maintain our ASW widener on Bunds for now and would recommend
switching periphery spread tighteners vs. swaps rather than vs. Bunds
—
Amongst the semi-core names France and Belgium are likely to benefit
less than Netherlands and Austria. We recommend switching our
semi-core spread widener in Austria to France
EUR 5Y-30Y steepeners
The moderate pressures on the front-end have resulted in some flattening
pressures on the EUR curve. However, as argued above, we believe that any
meaningful upward pressure on money market rates can be easily addressed
by the ECB. Further, if instead of tighter money market conditions it is a
deterioration in medium term inflation expectations which warrants further
ECB action in the form of a broad based QE, the 5Y-30Y or 10Y-30Y curve is
likely to steepen as QE will push real yields in the belly of the curve lower. The
outlook for the 5Y-10Y part of the curve in such an environment is not clear
and could depend on the magnitude of the decline in medium-term inflation
expectations, the confidence in the ECB’s ability to reflate and the exact nature
of the ECB’s purchases. Irrespective of the response of the 5s10s slope, if the
ECB refrains from buying at the long-end of the curve to avoid exaggerating
the low yield environment faced by pension and insurance funds the long-end
of the curve should steepen.
Page 42
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
To our model of the EUR 5Y-30Y slope (which includes as explanatory
variables front-end rates, medium-term inflation expectations, change in ECB
balance sheet size, peripheral spreads, implied volatility on long tenor
swaptions and expected budget balances), we add the solvency ratio of Dutch
pension funds as another explanatory variable. The coefficient on the solvency
ratio of Dutch pension funds has the appropriate sign, suggesting the curve
steepens as the solvency ratio improves and flattens as the solvency ratio
deteriorates. We note the coefficient is statistically significant as well.
The model shows that the EUR curve is close to fair value. However, we are
comfortable with a steepener recommendation given (i) the positive carry on
the trade, (ii) the belief that either of the two ECB policy actions is likely to
result in a steepening of the curve and (iii) also to position for a normalisation
of long-dated forwards in EUR, which still remain very low.
solvency ratio to EUR 5Y-30Y slope
model
EUR 5Y-30Y slope, sample daily data since Apr-2007
Beta
T-stat
EUR 2Y swap (%)
-39.61
-79.4
EUR 5Y5Y inflation swap (%)
31.34
18.3
Italy-Germany spread (bp)
-0.08
-21.0
EUR 1Y30Y implied vol (bp)
-0.36
-14.9
Budget balance (% of GDP)
-0.94
-4.0
Dutch solvency ratio (%)
0.46
8.6
R-sq
94.7%
Source: Deutsche Bank
11: Carry and roll down remains attractive on steepeners
10: EUR 5Y-30Y curve is close to fair value
30
9: Adding Dutch pension fund
25
EUR 5s30s slope residual
6M carry and roll down
20
20
10
15
0
-10
10
-20
5
-30
Jan-14
Jan-13
Jan-12
Deutsche Bank AG/London
Jan-11
Jan-10
Jan-09
Jan-08
Source: Deutsche Bank
0
1Y
2Y
3Y
4Y
5Y
7Y
10Y 12Y 15Y 20Y 25Y 30Y
Source: Deutsche Bank
Page 43
17 January 2014
Global Fixed Income Weekly
Europe
Credit
Covered Bonds
Securitisation
Conor O'Toole
Research Analyst
(+44) 20 754-59652
[email protected]
European ABS Update
Excerpt from European Asset Backed Barometer at https://gm.db.com/absEurope
European ABS secondary markets have begun 2014 in earnest and picked up
where 2013 left off, with strong volumes and price performance. While GBP
UK Prime is tighter by c.5-10 bps, the Dutch RMBS curve is tighter by 10-15
bps. In the periphery, sovereign yield compression has been the prominent
theme. We highlighted in our Outlook 2014 publication that Portuguese RMBS
particularly stands to benefit from such compression – indeed since the
beginning of the year, 5-year Portuguese sovereign yields have tightened by
c.1%, which has been followed by RMBS seniors from the region higher by 2-3
points. Selected Italian senior RMBS from shelves such as BPMO, BERCR and
CORDR are tighter by about 30 bps since Christmas, dovetailing the 5-year
BTPs.
Other Articles in the European Asset
Backed Barometer include
RMBS/ABS Noticeboard
„
Expert Group reviews
repossession processes in
Ireland
While the primary in ABS has yet to open its account for 2014, there has been
EUR 20 bn of bank senior unsecured, and EUR 10 billion of covered bond
issuance in 2014 YTD, as the chart of the week below shows. The pipeline for
ABS however remains active, with CLOs featuring prominently (some 8
transactions announced). Primary activity in peripheral financial credit further
points to a move towards core pricing for ABS credit in the periphery. The
pricing of BBVA and SANTAN senior unsecured bonds for example at MS +
118 bps (5 year @ 2.375% coupon) and MS + 93 bps (2 year issue @ 1.45%
coupon) respectively indicates that secured RMBS seniors (currently trading at
150-200 bps for decent names/deals) from Spain could have further room to
rally as relative value decisions come to the fore.
On the regulatory front, late on Tuesday, US regulators announced that US
banks could continue to retain interests in TruPS CDOs, with some
qualifications. However, a decision on whether investments in CLO debt would
qualify towards the Volcker rule exemption is still being awaited – the
definition of “ownership interest” currently also encompasses debt
investments in leveraged loan CLOs due to “removal for cause” clauses, which
industry bodies have pushed back on. In Europe, clarifications regarding risk
retention have meant that CLO 1.0s would be grandfathered. A series of
European regulatory announcements around Solvency II, risk weights, risk
retention and LCR to name a few marked the latter half of December. We
published a summary of these announcements in a report published last Friday
– please ask us if you would like a copy.
Chart of the week: YTD primary issuance from Western European banks
2014 ytd issuance (EUR bn)
25
Core
Periphery
20
15
10
5
0
Senior Unsecured
Covered
Subordinated
ABS
Source: Deutsche Bank, Informa
Page 44
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
Global
Credit
Covered Bonds
Bernd Volk
Strategist
(+41) 44 227-3710
[email protected]
Covered Bond Update
„
Despite a somewhat struggling new issue of PBB Pfandbriefe (8Y
ms+17bp), the primary market for EUR benchmark covered bonds
remained very strong, particularly in case of prime peripheral covered
bonds, confirmed by an over two times oversubscribed orderbook for 10Y
UniCredit covered bonds and a new issue spread which was 75bp tighter
than Italian sovereign bonds.
„
Covered bonds tightened significantly since Sept 2012, particularly
peripheral covered bonds. For example, Portuguese covered bonds
tightened from over 800bp versus swaps to below 200bp. However, iBoxx
EUR Covered still trades wider versus iBoxx Pfandbriefe than end of 2009
and certainly still significantly wider than pre-crisis. Given our overall
constructive view on Spanish and Italian sovereign bonds, iBoxx EUR
Covered should tighten further versus iBoxx EUR Pfandbriefe.
„
Despite declining versus 2013, net supply of Eurozone sovereign bonds
will still be at around EUR 270bn in 2014, compared to negative net supply
of around EUR 50bn in case of EUR benchmark covered bonds.
Consequently, the share of iBoxx EUR covered in iBoxx EUR bonds will
decline further in 2014. Given the low yield environment, this remains
supportive for higher yielding covered bonds. Key risk is that this seems a
full consensus trade.
„
With banks accounting for 62% in case of new 5Y Aareal, 52% in case of
10Y UniCredit Austria and 41% in case of 3Y UniCredit frn, bank buying of
covered bonds remains significant. In our view, while not being a crucial
topic for spreads of EUR benchmark covered bonds, covered bonds
getting recognition as Level 1 LCR asset under CRR is not completely off
the table yet (in case of covered bonds rated at least AA-). Overall, we
think banks will remain large buyers of EUR benchmark covered bonds.
„
Moody's upgrading numerous Spanish Cedulas end of Dec and affirming
the A3 of Sabadell Cedulas this week (despite the recent downgrade of the
unsecured rating to Ba2), confirms the trend of stabilising covered bond
ratings. While downgrade of the unsecured rating increased the expected
loss of Cedulas, the high OC held by Sabadell in both cover pools (130.3%
in case of CH and 102% in case of CT) compensates the increase. A
multiple-notch downgrade of Sabadell Cedulas might occur in case of (1) a
sovereign downgrade, (2) a multiple-notch unsecured downgrade or (3) a
material reduction of the pool value, confirming that macro topics remain
crucial for covered bond ratings in general.
„
Depfa ACS are the highest yielding non-peripheral covered bonds. As of 30
Sep 2013, Depfa ACS Bank had EUR 20.6bn of outstanding Asset Covered
Securities (A3s/BBBs/An) backed by a cover pool amounting to EUR
22.8bn. Nominal OC was 10.8%. With 29.6%, German assets dominated
the cover pool, followed by the US (21.9%), Spain (12.2%), Belgium (7.3%),
Netherlands (5.5%), France (5.3%), Nordic (3.1%), Austria (2.8%), Canada
(2.5%), Italy (2.3%) and others.
„
On 26 Aug 2013, a public tender offer for Depfa Bank Plc was launched by
its parent, Hypo Real Estate (HRE). If no buyer is found at an acceptable
price - which is the real challenge - Depfa will continue to be in orderly
wind down under German government ownership without significant risk
Deutsche Bank AG/London
Page 45
17 January 2014
Global Fixed Income Weekly
for unsecured and particularly for covered bond investors. The EU is not
forcing privatisation at uneconomic prices, i.e. in case bids are too low,
there will be no privatisation. While privatisation and resulting rating
downgrade risk seems binary, we remain constructive.
„
The current outstanding volume of German Pfandbriefe amounts to around
EUR 450bn and, in our view, will decline by at least EUR 25bn in 2014.
With German insurance companies and pension funds desperate for
alternatives that provide at least some yield, besides others, local
sovereign debt is in focus. It seems, unless there is an explicit government
guarantee, the standard rating/duration-driven spread risk formula of
Solvency 2 applies, requiring capital charges for local sovereign debt.
However, it seems also possible to use internal models positively
impacting capital charges. In our view, capital charges for sub-sovereign
debt will be low, if any. We highlight that European local sovereigns do
usually not benefit from an explicit guarantee but from support
mechanisms, supervision and potential interventions differing significantly
between countries.
Please find more details in our separate publications "Covered Bond and
Agency Update".
Figure 1: EUR covered and unsecured bonds issued this week
Ticker
Coupon
Maturity
Volume
(bn)
Announcement
Date
Type
Spread
Ratings
ABNANV
2.375
23-Jan-24
1.50
16-Jan-14
Covered
ms+35bp
Aaa/AAA/AAA
Aa3/AA/AA
DEXGRP
2.000
22-Jan-21
1.25
15-Jan-14
Gov guaranteed
ms+42bp
RABOBK
1.750
22-Jan-19
1.50
15-Jan-14
Unsecured
ms+63bp
Aa2
UCGIM
3.000
31-Jan-24
1.00
15-Jan-14
Covered
ms+98bp
A2/-/A+
PBBGR
1.875
21-Jan-22
0.50
14-Jan-14
Covered
ms+17bp
Aa2/AA+/-
POPSM
2.500
1-Feb-17
0.50
13-Jan-14
Unsecured
ms+190p
Ba3/-/BB+/AL
ISPIM
3.500
17-Jan-22
0.75
13-Jan-14
Unsecured
ms+175bp
Baa2/BBB/BBB+/AL
VICEN
3.500
20-Jan-17
0.50
13-Jan-14
Unsecured
ms+300bp
-/BB/BB+/BBB
BESPL
4.000
21-Jan-19
0.75
13-Jan-14
Unsecured
ms+285bps
-/-/BB-/BBBL
AARB
1.125
21-Jan-19
0.50
13-Jan-14
Covered
ms flat
-/ -/ AAA/-
BACA
2.375
22-Jan-24
0.50
13-Jan-14
Covered
ms+35bp
Aa1/-/-
Source: Deutsche Bank
Page 46
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
Figure 2: iBoxx Euro Covered versus iBoxx Euro Germany
Covered
250
Figure3: Share of iBoxx EUR Covered in iBoxx EUR total
declined since Jan 2012
9000
iBoxx Euro Covered
iBoxx Euro Germany Covered
200
8000
7000
150
6000
100
5000
4000
50
0
Covered
Corporates
Other Collateralized
Share of covered(rhs)
Sub-Sovereign
Financials
Sovereings
16%
14%
12%
10%
8%
6%
4%
3000
2%
2000
0%
Jan-07
Apr-07
Jul-07
Oct-07
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
Oct-09
Jan-10
Apr-10
Jul-10
Oct-10
Jan-11
Apr-11
Jul-11
Oct-11
Jan-12
Apr-12
Jul-12
Oct-12
Jan-13
Apr-13
Jul-13
Oct-13
Jan-14
-50
Source: iBoxx
Deutsche Bank AG/London
Source: iBoxx
Page 47
17 January 2014
Global Fixed Income Weekly
United Kingdom
Rates
Gov. Bonds & Swaps
Inflation
Rates Volatility
Soniya Sadeesh
Strategist
(+44) 0 207 547 3091
[email protected]
UK Strategy
The decline in inflation to target will prolong the goldilocks period the economy
has been enjoying, and provide the MPC with some relief even as the
unemployment target is being reached faster than expected
Looking at the front end over historical periods of rates on hold, current
valuations do not appear excessive
The long end “excess richness” that was prevalent last year remains in place,
and looking at the 10Y30Y50Y fly suggests that it is the 30Y sector in particular
that has richened of late.
From an RV perspective, the 20Y has cheapened against the 10Y (UKT 34_23
spread), while 10Y spreads start to look rich against the wings
Meeting all the targets
Spot CPI declined back to target for the first time in four years and the
possibility of it declining, albeit temporarily, below target over the coming
quarter remains. The November labour market report released next week is
also expected to show a further decline (DBe 7.2%, current bbg consensus
7.3%), bringing it closer to the 7% threshold.
As noted in our outlook, the decline in inflation will prolong the goldilocks
period the economy has been enjoying, providing the MPC with some relief
even as the unemployment target is being reached faster than expected.
That the 7% is not a trigger arguably is priced, with the first hike fully priced
around March 15. The initial pace of hikes is 72bps in the first twelve months.
Looking at the independent BoE’s record, previous hiking cycles have not
exceeded twelve months, and ranged between 75-100bp of hikes.
Previous monetary policy cycles, post independence
Hike
Cut
Hike
Cut
Hike
Hike
Cut
Start
Jul-97
Oct-98
Sep-99
Feb-01
Feb-03
Jul-03
Nov-03
Aug-05
Aug-06
Dec-07
Rate
6.75
7.25
5.25
5.75
3.75
3.5
3.75
4.5
4.75
5.5
End
Jun-98
Jun-99
Feb-00
Nov-01
Rate
7.5
5
6
4
Duration
11
8
5
9
Amount
75
-225
75
-175
Notes
1 dissent
1 dissent
Aug-04
4.75
9
100
Jul-07
Mar-09
5.75
0.5
11
15
100
-500
split vote 5:4
Source: Deutsche Bank, BoE
There are a few periods in which rates remained on hold, with the average
“turnaround” time around 8 months. We consider three specific periods where
rates were on hold and followed by a hiking cycle - Jul-Nov 2003, Aug 05-Aug
06, Feb 10-Oct11 - and look at what was priced by the front end, specifically,
the spread of 1Y1Y over Base Rates. In the 2003 period it averaged 98bp, in
Page 48
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
the second 27bp, and the most recent 76bp, and currently around 40bp. In that
context, the front end does not appear excessively priced at current valuations.
Pre crisis
Post crisis
7
Base Rate
6
Ave 98bp
1Y1Y-Base
2.00
6
1.50
5
5
1.00
4
0.50
3
0.00
Base Rate
1Y1Y-Base
Ave 76bp
Ave 27bp
-0.50
1.00
0.50
0.00
2
-0.50
-1.00
1
-1.00
1
0
Jan-01
-1.50
0
Jan-08
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Source: Deutsche Bank, Bloomberg Financial LP
2.00
1.50
4
3
2
2.50
-1.50
-2.00
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Source: Deutsche Bank, Bloomberg Financial LP
The surprise decline in the Oct unemployment rate to 7.4% has started to raise
questions already of how policy will evolve once the 7% is reached.
As our economist noted the week before, there are several options open to the
BoE. It’s unclear how much time pushing out the threshold would buy - most
consensus forecasts do not extend beyond 6.9% level (BoE plateaus at 6.9%
under market rates, HMT consensus forecasts is 6.9% for Q414). In addition,
assuming the medium term NAIRU forecasted by the Bank remains 6.5%, it
would arguably be more of a trigger than the 7% would be.
Indeed, the forward guidance publication in August 2013 notes that “ To
ensure that CPI inflation remains on track to return to the 2% target, the
Committee will need to withdraw some of the monetary stimulus before the
unemployment rate falls back to its medium-term equilibrium. The
unemployment rate threshold therefore needs to be set somewhere between the
current unemployment rate of 7.8% in the three months to May 2013 and Bank
staff’s estimate of the medium-term equilibrium rate of around 6.5%.”
Thus, while the Bank’s next move will clearly be a focus, history suggests
valuations will remain highly data dependent. A fuller repricing of the rate
cycle is likely to require more evidence of a sustainable recovery via a pick up
in real wage growth and investment. Additionally, there may be more scope
for macroprudential interventions, (for example alterations to Help-to-Buy) to
cause a moderation in pricing to the extent it is expected to slow growth
momentum. This week’s FPC testimony , however, indicates that for the time
being, it is content to let housing momentum continue.
On an RV basis, the 20Y has cheapened against the 10Y (UKT 34_23 spread),
while 10Y spreads start to look rich against the wings.
5Y10Y30Y ASW
10Y20Y ASW Box
12
11
8
10Y20Y ASW Box
4
9
2
8
7
0
6
-2
5
-4
4
-6
3
2
Jul-13
5Y10Y30Y (18_23_44)
6
10
Oct-13
Source: Deutsche Bank
Deutsche Bank AG/London
Jan-14
-8
Jun-13
Sep-13
Dec-13
Source: Deutsche Bank
Page 49
17 January 2014
Global Fixed Income Weekly
Deficits improve, long end richness remains
The improvement in longer yields and risk asset performance seen over the
past year, has helped drive an improvement in funding ratios. The long end
“excess richness” that was prevalent over the second half of 2013 remains in
place, and looking at the 10Y30Y50Y fly suggests that it is the 30Y sector in
particular that has richened of late.
10Y30Y50Y vs 10Y
Ultra long end curve also too rich
6.0
1.2
30y50y vs 10y
Residual
4.0
2.0
0.30
10Y30Y50Y Fly
1.1
Residual v 10Y
0.20
1
0.0
0.10
0.9
-2.0
0.00
0.8
-4.0
0.7
-6.0
-0.10
0.6
-8.0
Apr-11
Apr-12
-0.20
0.5
Residuals: - too flat, + too steep
-10.0
Apr-10
Apr-13
-0.30
0.4
Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13
Source: Deutsche Bank
Source: Deutsche Bank
In aggregate, net purchases of Gilts amounted to GBP 7.4bn in third quarter
(both linkers and conventional). Pension funds were net buyers of GBP 7.7bn,
up from GBP 4.6bn in the second quarter. In the third quarter however, the
bulk was in linkers ( + GBP 5.2bn) with GBP 2.4bn in conventional, compared
to the previous quarter where demand was largely all conventionals. Insurers
disposed of GBP 0.9bn, selling GBP 2.3bn nominals, while buying GBP 1.4bn
linkers.
Aggregate risk asset allocations
Aggregate Gilts
30000.0
All Gilts
9000.0
20000.0
7000.0
5000.0
10000.0
3000.0
0.0
1000.0
-1000.0
-10000.0
-3000.0
Q3-10
Q1-11
Q3-11
Q1-12
Q3-12
Q1-13
Q3-13
Q1-11
Q3-11
Q1-12
Q3-12
Q1-13
Q3-13
Q1-10
Q3-09
Q1-09
Q3-08
Q1-08
Q3-07
Q1-07
Q3-06
Q3-10
Source: Deutsche Bank, ONS
Q1-06
Q1-05
-30000.0
Q1-04
Q3-04
Q1-05
Q3-05
Q1-06
Q3-06
Q1-07
Q3-07
Q1-08
Q3-08
Q1-09
Q3-09
Q1-10
Q3-10
Q1-11
Q3-11
Q1-12
Q3-12
Q1-13
Q3-13
-7000.0
Q3-05
Overseas corp bonds
Overseas equity
UK corporate bonds+pref shares
UK equities
-20000.0
-5000.0
Source: Deutsche Bank, ONS
Insurers, long term funds
Pension funds
8000.0
10000
8000
Conventionals
6000.0
6000
IL
4000.0
4000
Conventionals
IL
2000.0
2000
0.0
0
-2000.0
-2000
-4000.0
-4000
-6000.0
Pension Funds, GBP, mn
Page 50
Q1-10
Q3-09
Q1-09
Q3-08
Q1-08
Q3-07
Q1-07
Q3-06
Q1-06
Q3-05
Q3-13
Q1-13
Q3-12
Q1-12
Q3-11
Q1-11
Q3-10
Q1-10
Q3-09
Q1-09
Q3-08
Q1-08
Q3-07
Q1-07
Q3-06
Q1-06
Q3-05
Q1-05
Source: Deutsche Bank, ONS
Insurance Co, GBP mn
-8000.0
-8000
Q1-05
-6000
Source: Deutsche Bank, ONS
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
Europe
Rates
Gov. Bonds & Swaps
Nordic Strategy
Christian Wietoska
Strategist
(+44) 20 754-52424
[email protected]
Abhishek Singhania
Strategist
(+44) 207 547-4458
[email protected]
Sweden – surprise to inflation but don’t be too hawkish
„
Market reaction – sell off in short end of SEK curve but long end almost
unchanged The market bear flattened on the back of the better than
expected data releases. However, while the short end closed the week
~4bp higher (3Y at 1.56) the 5Y to 10Y sector rallied later in the week and
remained hardly unchanged (5Y at 2.11 +1bp and 10Y -1bp).
„
Interest rate expectations – market turned a bit more hawkish For the
Feb-meeting the market expects the Riksbank to remain on hold at 0.75%.
In addition the market has fully priced out the probability of another
interest rate cut in 2014 and now expects the Riksbank to hike to 1.00% by
Q2-15. We continue to expect the Riksbank to remain on hold until the end
of 2014 before we forecast the first interest rate hike to 1.00% in Feb-15.
„
Inflation remains key for monetary policy As highlighted in our previous
Nordic/Swiss Weekly next to the recovery of the Euro-area – Sweden’s
main export market - we believe spot inflation will be the key driver for the
Riksbank’s monetary policy over the next couple years. Although the
previous interest rate cut will weigh on headline inflation in the short term,
we nevertheless believe that underlying economic data will be supportive
for a pickup in inflation pressure over the course of 2014. We forecast CPI
to come in at 1.0% in 2014 (Riksbank: 0.6%). However even in case our
above consensus view on inflation pressure for 2014 will be realized we
don’t expect this to be enough to justify rate hikes by the Riksbank to be
moved into 2014. This said we believe that inflation expectations at the
end of 2014 will be high enough to start the hiking cycle in early 2015.
Deutsche Bank AG/London
Housing market – how long can the
rally last?
Real Estate: Average Purchase Price in Thous. Kronor
Jul-13
Oct-13
Jan-13
Apr-13
Jul-12
Oct-12
Jan-12
-10%
Apr-12
-5%
1800
Jul-11
0%
1900
Oct-11
5%
2000
Jan-11
10%
2100
Apr-11
15%
2200
Jul-10
20%
2300
Oct-10
2400
Jan-10
The December inflation report surprised to the upside. CPI came in at
0.14% YoY compared to -0.1% expected while CPIF increased by 0.76%
YoY vs. 0.6% expected. Overall for 2013 headline CPI remained flat while
core-inflation increased by 0.9%. The report was better than expected and
reduces deflation risks as well as concerns about further interest rate cuts
in 2014. However, we highlight that inflation continues to be significantly
below the target of 2.0% and will in our view not reach the target until Q215. Furthermore we got house prices this week which surged to a new all
time high in December. The YoY increase exceeded 5% again for the first
time since Q1-13. This further contributes to the concerns of a housing
bubble in Sweden and also reduces the risk of additional interest rate cuts.
Apr-10
„
% change YoY - rhs
Source: Deutsche Bank, Haver Analytics
Interest rate expectations in Sweden
Sweden
rate
repo rate
weekly
DB
Sweden
expectations
path
change in bp forecast
on Thursday
Q1-14
Q2-14
Q3-14
Q4-14
Q1-15
Q2-15
Q3-15
Q4-15
0.73
0.71
0.71
0.71
0.89
1.25
1.59
1.88
0.75
0.75
0.74
0.78
0.90
1.07
1.20
1.39
1.0
1.0
1.3
2.0
2.8
5.0
3.5
4.0
0.75
0.75
0.75
0.75
1.00
1.00
1.25
1.50
Source: Deutsche Bank, Riksbank, Bloomberg Financial LP
Page 51
17 January 2014
Global Fixed Income Weekly
Inflation – above expectations in Dec but inflation pressure remains on the low side – HCPI comparison (YoY)
2013
2.0%
2.21%
1.46%
0.69%
1.5%
0.5%
Source: Deutsche Bank, Haver Analytics
Jul/13
Oct/13
Jan/13
0.0%
-0.5%
Apr/13
-1.01% -0.96%
-1.92% -2.24%
-1.22% -0.77%
1.26% 1.87%
1.01% 0.96%
Jul/12
-1.01%
-1.33%
-1.52%
1.02%
1.09%
Oct/12
-0.15%
-2.88%
-0.65%
1.25%
1.12%
Jan/12
14%
4%
12%
6%
6%
Apr/12
Transport
Post and telecommuncations
Reacreation and culture
Restaurants and accommodation
Various goods and services
1.0%
Jul/11
-0.12% 0.50% 0.20% -0.77%
-1.43% -1.57% -1.70% -2.43%
2.21% 1.78% 1.92% 1.90%
Oct/11
26%
5%
4%
Jan/11
Housing
Household furnishings
Healthcare
Apr/11
1.41%
1.26%
0.72%
2.5%
Jul/10
1.58%
1.26%
0.39%
3.0%
Oct/10
1.03%
1.17%
1.12%
3.5%
Jan/10
Dec-13 Nov-13 Q4-13
2013
0.44%
-0.04%
0.86%
Apr/10
0.27%
0.07%
0.70%
Jul/09
0.29%
0.12%
0.74%
Oct/09
0.36%
0.14%
0.76%
Jan/09
Food / nonalcoholic beverages
Alcoholic beverages
Clothing and shoes
Dec-13 Nov-13 Q4-13
Apr/09
Harmonized consoumer prices
National CPI
CPIF
Riksbank
forecast for Dec
-0.07%
0.57%
weightings
for CPI
13%
4%
5%
-1.0%
Sweden
Norway
Euro-area
Germany
Source: Deutsche Bank, Haver Analytics
Norway – Trade Balance – it’s worth a closer look
„
„
-40,000
-60,000
-80,000
-100,000
-120,000
-140,000
-160,000
-180,000
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Page 52
-20,000
2003
Sweden the different export market In 2013, Sweden’s exports have been
hit hard by the European debt crisis and in particular by decreasing
demand from the core countries of the Euro-area (Germany, Netherlands
and France). Until Nov-13 total exports in goods were down ~7.5% YoY vs.
-3.5% in 2012. If we don’t see a significant rebound for Dec this is the
second largest decrease since 1990. In this context we highlight that the
expected increase in GDP for 2013 of 0.9-1.0% was mainly driven by
strong domestic demand.
0
500,000
450,000
400,000
350,000
300,000
250,000
200,000
150,000
100,000
50,000
0
2002
Norway’s international trades in more detail It is not a surprise that the
development of total exports depends significantly on oil related products.
Looking into the details we see that petroleum and gas related products
account for ~67% of total exports in goods. Other than that only “Fish”
(7%) and to some extent “Industrial Products” (>4%) can be seen as
important exports. Looking into the distribution of products we highlight
that nearly 85% of the products are sold to countries in the Europe while
Asia and North America account for only 7.5% and 5.9%, respectively.
widest gap in NOK since
2001
„
Distinguish between oil related exports and “Others” It is worth pointing
out that exports excl oil related goods account for only 40% of total
exports while imports of the same category account for 98% of total
imported goods. This said the balance of trades excl oil related goods has
consistently been negative for the last few years and showed in 2013 with
NOK -155bn the widest negative gap since at least 2000. In fact as % of
GDP the balance of trades for the first three quarters of 2013 decreased to
a new record of -5.2% while the current account balance also decreased
to +13.1% - but from a record high of +15.1% in 2012. The share in
exports has remained more or less unchanged since 2000 but slightly
increased vs. 2012 (+2pp) driven by a better development of non-oil
related exports compared to oil-related exports (+1.2% vs. -7.2%).
Trade balance excl oil and gas with
2000
„
Trade Balance highlight of the week The week has been light in terms of
economic data releases in Norway. We only got the trade balance for Dec
on Thursday which came in at NOK 33.4bn compared to 33.9bn in Nov.
This accounts to a surplus of NOK 371bn in the balance of trades
compared to NOK 428bn in 2012. Total exports in goods decreased by
3.8% while imports surges by 4.3%.
Balance of trades
Balance of trade (ex oil, natural gas & condensates) - rhs
Source: Deutsche Bank, Haver Analytics
Exports by countries Norway vs.
Sweden
Norway
UK
%
2013
Sweden
of total YoY
24% -11% Norway
3%
4%
Germany
UK
% of 2013
total YoY*
11% -3%
Netherlands
Germany
13%
13%
10% -7%
8% -22%
France
Sweden
6%
6%
4% Finland
-12% USA
7%
7%
3%
-11%
USA
Denmark
5%
4%
-12% Denmark
-7% Netherlands
7%
6%
-3%
-9%
Belgium
Italy
3%
2%
13%
0%
France
China
5%
3%
-8%
4%
Spain
China
2%
2%
12% Poland
17% Italy
3%
2%
-6%
-5%
Poland
Other
2%
18%
14% Russia
21% Other
2% -5%
29% -3%
Source: Deutsche Bank, Haver Analytics, Note: Data for Sweden
based on data until Nov-13
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
Exports by Product for Norway and Sweden
Norway
Exports by Product
Petroleum and
prodcuts
Natural and
manufactures gas
Fish
Nonferrousmetals
Industrial machinery
Specialized machinery
Electrical machinery
and apparatus
Other
%
2013
2013
of total in NOK YoY
899,746 -3.8%
37%
336,753 -9.0%
29%
263,462 -5.2%
7%
4%
2%
2%
60,375 18.8%
35,802 -10.2%
19,158 15.7%
16,057 1.9%
2%
14,294
17%
153,872
%
of total
Sweden
Exports by Product
Machinery&
2012
2013
in SEK
YoY
1,170,100 -7.5%
39%
451,102
19%
220,832 -10.0%
Mis. manufactured products
Inedible crude materials
11%
10%
9%
7%
131,003 -0.2%
117,540 -21.9%
106,333 -5.0%
77,716 -10.2%
14.3%
Food and live animals
4%
48,360
10.9%
4.1%
Other
1%
17,544
-9.2%
Transport equipment
Manufactured goods
classified chiefly by material
Chemicals&related products
Mineral fuels and lubricants
-8.0%
Source: Deutsche Bank, Bloomberg Haver Analytics, Note: Data for Sweden based on data until Nov-13
„
„
„
Details in Swedish exports Looking into the details of the Swedish export
structure we see that the Euro-area remains with ~50% of total exports the
main market. From the product side Sweden exports in particular
“Machinery (39%)”, “Manufactured goods (19%)” and “Chemicals (11%)”
more sensitive to the business cycle.
Oil demand/price key for exports in Norway while Sweden’s exports
sensitive to Euro-area recovery We compared the impact of a) GDP Euroarea b) natural gas prices and c) the oil price on the development
Sweden’s and Norway’s exports. For Norway we see that the development
of the oil price (with 1Y lag) has the most significant impact on the export
market. While the development of GDP in the Euro-area has also a positive
impact on Norway’s exports (given the positive correlation between oil
prices and GDP growth in Euro-area) the impact is more significant on
Swedish exports (correlation 74% vs. 58%). This is in line with what we
would have expected by looking into the details of the Swedish export
structure. We also ran a Principal Component Analysis (PCA) which shows
that the oil price is the key variable for export growth in Norway while GDP
growth in the Euro-area is the key variable in Sweden.
Demand for oil related products key
for Norway while Sweden sensitive
to Euro-area recovery
Correlation
Norway
Exports
Sweden
Exports
Natural Oil Price - GDP Euro - Norway Sweden
Gas
1 lag
Area
Exports Exports
51.3%
75.0%
58.0%
100.0%
66.7%
15.0%
41.9%
73.7%
50.9%
100.0%
Source: Deutsche Bank, Bloomberg Financial LP, Haver Analytics
What does this tell us Overall we remain constructive on the economies in
Norway and Sweden and expect both countries to show strong GDP
growth rates in 2014 (Sweden 2.4% and Norway 2.5%). However, while
both countries will benefit from a gradual recovery in the Euro-area
Sweden should disproportional benefit given their above mentioned export
structure. We believe exports will contribute positive to real GDP in 2014
following 2013 where exports of goods were down almost 8.0% YoY. In
Norway we believe the environment for exports will be more challenging.
Although exports of goods excl. oil/gas should show another increase over
the year in particular supported by the rapid depreciation of NOK in 2013 (13% vs. the Euro) oil related exports could once again underperform in
2014. However, overall we expect total exports in Norway to be flat to
slightly positive.
Implications for trade recommendations in Nordics
„
Implications for our trade recommendation Long SEK vs. NOK We
currently favor to remain short NOK vs. SEK in swaps (3Y and 10Y sector).
While we like the positive carry in this trade we also highlight that we see
rates in the NOK swap curve as too low – historically and on a crosscountry basis. In the 10Y sector we justify our view with the fact that in
Deutsche Bank AG/London
Page 53
17 January 2014
Global Fixed Income Weekly
our view the market has not yet fully priced in the higher inflation pressure
over the next few years. In the short end we like the trade given our view
that the Riksbank will not deliver its current interest rate path of 4 ½ hikes
until the end of 2015. Given the low inflation pressure we could see the
Riksbank to remain on hold for longer if markets don’t reprice global
interest rate expectations. On the other hand we see further interest rate
cuts by the Norges Bank as unlikely given the robust economic activity,
inflation pressure close to the target of 2.5% and the high credit growth.
Hence in our view the spread in 3Y NOK-SEK could widen to 75bp
(currently at 46bp).
Risks to our Long SEK vs. NOK position However, in the following
economic scenario we see the risk that the NOK-SEK spread could tighten
further over the next few months. In our base case scenario we assume a
gradual economic recovery of the Euro-area driven in particular by the
core-European countries. However, as highlighted above in case of
significant upside surprises to growth in the Euro-area in addition with flat
to low increases in oil-related products the Swedish exports should
disproportional benefit relative to Norway. In this case the market could
start to price in earlier a more aggressive interest rate path for Sweden.
However, we could only see this scenario to be realized in Sweden if in
addition inflation surprises significantly to the upside or macroprudential
measures currently in place have no impact on the pace of credit growth.
„
Risks limited in the medium term Although we could see markets to price
in higher interest rates in Sweden in the short term on the back of positive
momentum in domestic spot inflation and improvements in exports as well
as upside to growth in the Euro-area we don’t expect the Riksbank to
deliver even in this scenario. We continue to see it as rather unlikely that
the Riksbank can aggressively hike interest rate much earlier than other
central banks. Firstly, despite further improvements in economic activity
the Swedish economy is not yet over the hill. Secondly, even in case our
above consensus view on inflation for 2014 (1.0% in headline CPI vs.
Riksbank’s forecast of 0.6%) would be realized we don’t expect this to be
enough to justify rate hikes by the Riksbank to be moved into 2014. Last
but not least we also doubt that the Riksbank will realize its very steep
interest rate path given the high share of mortgages on floating rates. In
case aggressive hikes will be realized by the Riksbank this will have a
significant impact on domestic demand and therefore GDP. Hence we
expect the hiking cycle to be smooth and with not more than 2-3 hikes a
year.
„
Riksbank vs. Norges Bank – current paths imply the
3Y NOK-SEK spread remains at tight levels
spread to narrow over the next few years
Repo Rate in Sweden
Feb/16
Aug/16
Feb/15
Aug/15
0.0
Feb/14
Sep/13
Spread in bp - rhs
Jan/14
May/13
Sep/12
Jan/13
May/12
Sep/11
Jan/12
May/11
Sep/10
3Y NOK
Source: Deutsche Bank, Bloomberg Financial LP
Page 54
Jan/11
May/10
Sep/09
Jan/10
May/09
Sep/08
Jan/09
May/08
Jan/08
3Y SEK
1.0
Aug/14
0
Feb/13
20
0.0
Aug/13
1.0
2.0
Aug/12
40
Feb/12
60
2.0
3.0
Feb/11
80
Aug/11
3.0
4.0
Feb/10
100
Aug/10
120
4.0
5.0
Feb/09
140
5.0
6.0
Aug/09
6.0
160
Feb/08
180
Aug/08
7.0
Deposit Rate in Norway
Source: Deutsche Bank, Riksbank, Norges Bank, Bloomberg Financial LP
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
The week ahead in Nordics
„
„
The week ahead in Sweden The upcoming week is rather light in term of
economic data releases. We get the employment report for Dec on
Thursday (8.0% SA in Nov). Overall the labor market has surprised to the
upside in 2013 and if nothing exceptional happens the unemployment rate
should come in at 8.0% for 2013 compared to 8.0% in 2012.
The week ahead in Norway Similar to Sweden the data flow in Norway is
again on the light side. However, on Monday we will get house price data
for Q4-13. Following a rapid increase in house prices over the last four
years (prices up almost 30% since Q3-09) fears have intensified that
Norway could face a strong decline in house prices over the course of the
year. Although house prices have dropped by 1.8% QoQ in Q3-13 and the
YoY-increase fell to 2.9% - the lowest increase in four years - we
nevertheless highlight that the reading has still been positive YoY. Overall
we believe that house prices will decline modestly by ~3% in 2014 (for
further information please refer to the Nordic/Swiss 2014 Outlook).
Robust employment market situation in Sweden
Increased focus on housing market in Norway
expected to remain well supported in 2014
180
20%
160
15%
8.5
10%
8.0
5%
7.5
Source: Deutsche Bank, Haver Analytics
Deutsche Bank AG/London
5.5
Q3-15
Q1-15
Q3-14
Q1-14
Q3-13
Q1-13
Q3-12
Q1-12
Q3-11
Q1-11
Q3-10
5.0
Q1-10
Housing Price Index
YoY % change in House Prices - rhs
Average monthly increase (YoY) - rhs
6.0
Q3-09
-10%
Q1-09
80
6.5
Q3-08
-5%
Q1-04
Q3-04
Q1-05
Q3-05
Q1-06
Q3-06
Q1-07
Q3-07
Q1-08
Q3-08
Q1-09
Q3-09
Q1-10
Q3-10
Q1-11
Q3-11
Q1-12
Q3-12
Q1-13
Q3-13
100
7.0
Q1-08
0%
Q3-07
120
Q1-07
140
9.0
unemployment rate (SA YoY %-change) - Riksbank's December forecast
Source: Deutsche Bank, Riksbank
Page 55
17 January 2014
Global Fixed Income Weekly
Japan
Rates
Gov. Bonds & Swaps
Makoto Yamashita, CMA
Strategist
(+81) 3 5156-6622
[email protected]
Japan Strategy
Overview
„
We are basically bullish on Japanese equities given that the Abe Cabinet is
likely to remain in office until at least 2016 and will probably make full use
of monetary and fiscal policy to shore up its approval rating if the economy
falls into recession. However, defeat for the candidate supported by the
ruling Liberal Democratic Party in the upcoming Tokyo gubernatorial
election could potentially weaken the perceived mandate of the Abe
government.
„
Domestic private-sector banks have accelerated their lending but still face
a combined deposit-loan gap in excess of JPY180 trillion as funds continue
to flow into deposits. Domestic banks have been net sellers of foreign
bonds since April (overall), suggesting that they are not yet earning ample
carry on foreign bond positions. We continue to recommend staying long
JGBs, believing that banks as a whole remain keen to buy into any
temporary weakness (rises in yields).
Tokyo gubernatorial election a potential threat to equities
The Nikkei 225 has lost a little ground after rising past 16,000, with weak
December US jobs data and a brief strengthening of the yen seemingly
contributing factors. However, we expect equities prices to continue climbing
in the longer term. Our basically bullish view is based not on fundamentals, but
on the likelihood that Prime Minister Shinzo Abe and his government will
remain in office until at least 2016 given that upper and lower house elections
do not need to be held before that time. Prime Minister Abe will however need
to maintain a comparatively high public approval rating, which could prove
difficult unless economic growth remains strong and equities keep climbing.
History has shown a tendency for Cabinet approval ratings to rise soon after a
new government takes office, but then fall in the event of sluggish stock price
performance. We therefore expect to see rapid political intervention if the
economy looks to be threatened by either domestic or overseas factors. For
example, a downturn in exports due to a deterioration in the global economy
would probably see the government step up its "national resilience"
infrastructure strengthening initiatives and other fiscal stimulus measures,
while a sharp appreciation of the yen would likely be countered by yen-selling
intervention and additional Bank of Japan easing. The ruling Liberal
Democratic Party (LDP) / New Komeito coalition currently controls both the
lower and upper houses and is thus able to make full use of its policy tool kit
(whereas the Obama government continues to be constrained by the
Republican-controlled House). We therefore expect to see a strong response
from the government in the event that the Japanese economy takes a turn for
the worse, and believe that this safety net should help to keep equities in bull
mode for the foreseeable future.
Page 56
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
Figure 1: Cabinet approval rating vs. Nikkei 225
Nikkei 225 (lhs)
(JPY)
Cabinet approval rating (rhs)
→ LDP government
LDP government → DPJ government
(%)
80.0
19000
18000
70.0
17000
16000
60.0
15000
50.0
14000
13000
40.0
12000
30.0
11000
10000
20.0
9000
10.0
8000
7000
0.0
2006
2007
2008
2009
2010
2011
2012
2013
2014
Note: Vertical lines denote changes of Cabinet
Source: Nikkei Research, Bloomberg Finance LP, Deutsche Securities
The key proviso is that the Abe government will need to maintain a sufficiently
high approval rating. Prime Minister Abe's approval rating has fallen to 56%
following passage of the controversial law toughening penalties for those who
leak state secrets, while the LDP's approval rating has dropped from as high as
56% to 42%. The percentage of "uncommitted" voters has risen to 32% as the
opposition Democratic Party of Japan is no longer picking up the slack. The
upcoming Tokyo gubernatorial election—to be officially declared on January 23
and held on February 9—warrants close attention in this regard. Former health
minister Yoichi Masuzoe will be running with official LDP backing, but former
Prime Minister Morihiro Hosokawa has also indicated that he will contest the race
on an "anti-nuclear" platform with the support of former Prime Minister Junichiro
Koizumi. A Hosokawa victory would not immediately derail the Abe government's
plans to restart idled nuclear reactors, but could make the prime minister and the
LDP less popular among voters, thereby making it more difficult for the
government to deploy the various policy measures necessary to keep the stock
market in bull mode.
Figure 2: Party approval ratings
LDP
%
60
DPJ
Undecided
50
40
30
20
10
0
05
06
07
08
09
10
11
12
13
Note: Vertical lines denote changes of Cabinet
Source: Nikkei Research, Deutsche Securities
Deutsche Bank AG/London
Page 57
17 January 2014
Global Fixed Income Weekly
Banks still have ample surplus funds to invest in domestic
bonds
Principal Figures of Financial Institutions show growth in outstanding loans and
discounts for major and regional banks accelerating from +2.4% YoY in
November to +2.6% in December, reflecting particularly strong growth for city
banks. Growth in deposits and CDs slowed from +4.0% to +3.8%, but deposit
balances still exceed loan balances by more than JPY180 trillion for the
banking sector as a whole, meaning that there are ample funds to channel into
JGBs and other domestic (JPY-denominated) assets.
Figure 3: Bank lending versus real deposits (year-on-year growth rates)
yoy, %
Lending
Real deposits + CDs
5
4
3
2
1
0
-1
-2
-3
-4
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Source: Bank of Japan, Deutsche Securities
Banks appear to be well on track to meet their FY2013 profit targets, but could
face a somewhat more challenging investment climate in FY2014. From a
fundamentals perspective interest rates are liable to face at least some upward
pressure as the BOJ targets +2% inflation and the Abe government looks to
shore up its approval rating by stimulating the economy. Portfolio managers
might therefore be tempted to cut back their JGB holdings and exposure to
duration risk, but doing so would make it difficult to secure sufficient market
investment returns. Assuming that banks are reluctant to take on greater FX
risk or significantly increase their allocations to equities, they may ultimately
see little option but to invest in foreign bonds using funds raised overseas.
Banks were big net sellers of foreign bonds & notes in April–June 2013, and
while they did start to buy once the 10y UST yield moved above 2.5%, still
ended up selling some JPY1.5 trillion more than they bought over the April–
December period, suggesting that they are not yet earning sufficient carry
from foreign bond holdings. We therefore see only limited potential for JGB
yields to move higher, believing that domestic banks will be keen to buy into
any temporary weakness.
Page 58
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
Figure 4: Foreign bond investment by the banking sector vs. 10y UST yield
(Billion yen)
Investment in foreign bonds & notes (lhs)
4000
10y UST yield (rhs)
(%)
3.5
3000
3.0
2000
1000
2.5
0
2.0
-1000
-2000
1.5
-3000
-4000
1.0
11
12
13
Source: Ministry of Finance, Deutsche Securities
Makoto Yamashita, +81 (3) 5156-6622
Deutsche Bank AG/London
Page 59
17 January 2014
Global Fixed Income Weekly
Europe
Eurozone
United States
Rates
Gov. Bonds & Swaps
Inflation
Rates Volatility
Trade
Recommendation
Jerome Saragoussi
Strategist
(+33) 1 4495-6408
[email protected]
Global Relative Value
„
This week we look at optimal ways to position for a repricing of the 5y
sector in the US towards higher levels i.e. for a repricing of the pace of rate
hikes. We also look at an attractive carry trade in Europe benefiting both
from curve and vol carry.
„
How to position for a more aggressive Fed hiking cycle? The aim of this
section is to provide investors with insight as for the optimal points and
slope trades to choose in the belly of the US curve to express a bearish
view in the 5y sector. Optimal points are those that are likely to sell-off the
most once the market starts pricing in a more aggressive Fed rate hike
cycle (beyond the one implied by the median FOMC dots which is currently
priced in) and that are also likely to suffer the least from an adverse
scenario of poor macro data and more dovish. Similarly optimal slope
trades should benefit from a repricing of a more aggressive hiking cycle
while being fairly immunized in case of renewed Fed dovishness. The
methodology consists in calculating the fair value of key forward rates in
the 2015-2018 sector for different symmetrical dovish and hawkish Fed
scenarios. More precisely, we consider the rate hike cycles implied by the
December dots of the 3rd and 5th most dovish FOMC members and by the
dots of the 3rd and 5th most hawkish FOMC members. We can then
calculate the average expected P&L of being short these different forward
rates, the dispersion of the P&L, the resulting Sharpe ratio, and the
convexity of the returns (max gain against max loss or average gain
against average loss). Being short the 3Y1Y rate and the Dec-16 and Jun17 Eurodollar contracts stand out as the best opportunities outright. The
analysis also suggests that the most asymmetrical way to position for a
higher rate scenario is the Dec-16 vs. Dec-18 ED flattener or 3Y1Y-4Y1Y
swap flattener. Indeed while hawkish scenarios would imply a bear
flattening of the ED strip in this sector, dovish scenarios would also imply
some mild bull flattening pressures, hence particularly convex trades.
„
Conditional bear steepener-buy 5y30y ATMF payer vs sell 5y5y OTM+30bp
payer, premium neutral: The 5Y fwd 5s30s steepener is a particularly
attractive carry trade thanks to the shape of the curve and of the vol
surface. The 5y fwd 5y-30y slope is virtually flat (~5bp), while the 5s30s
spot slope is around 155bp, hence about 30bp of average annual curve
carry. Simultaneously the 5y5y to 5y30y implied normal vol ratio is close to
historically high levels providing an opportunity to implement the bear
steepener at zero cost by setting the strike on the 5y5y payer 30bp OTM
relative to the 5Y30Y leg. The strike slope of the premium neutral
conditional bear steepener is worth -25bp. The 5s30s spot slope has never
been more inverted than -25bp historically while the 30y rate has generally
been higher than what is currently priced by the 5y30y forward rate hence
an extremely low empirical probability to suffer a loss at expiry. Moreover
we find that the high vol ratio is already fully reflecting the directionality of
the curve and that the forward slope is too flat relative to the low vol
regime. The ATMF vol roll is flat for the first couple of years but the higher
rates roll down and steeper payer skew on the 5y5y leg make the vol ratio
Page 60
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
roll very favorably. Carry, therefore, looks particularly attractive both from
a curve and vol perspective, protecting against substantial bear flattening.
# 1 – How to position for a more aggressive Fed hiking
cycle?
The aim of this section is to provide investors with insight as for the optimal
points and slope trades to choose in the belly of the US curve to express a
bearish view in the 5y sector. Optimal points are those that are likely to sell-off
the most once the market starts pricing in a more aggressive Fed rate hike
cycle (beyond the one implied by the median FOMC dots) and that are also
likely to suffer the least from an adverse scenario of poor macro data and more
dovish Fed. Similarly optimal slope trades should benefit from a repricing of a
more aggressive hiking cycle while being fairly immunized in case of renewed
Fed dovishness.
The 5y sector has sold off substantially since the December FOMC meeting. At
the time the market was pricing in an aggressive explicit change in forward
guidance but the Fed simply projected marginally lower short rates relative to
September without changing the definition of forward guidance. The market
therefore repriced the Fed Funds strip higher towards the new median
projections of the target rate by the FOMC. The market is currently pricing in a
target rate at roughly 75bp in Dec-15, 130bp in Jun-16 and 180bp in Dec-16, in
other words the market is embedding a marginal 5bp risk premium above the
median FOMC dots. We expect these median FOMC forecasts to be a lower
bound for market expectations given the positive macro outlook (positive fiscal
impulse and credit impulse), upcoming rotation of dovish voting members
replaced by more hawkish regional presidents, and the positive reaction of US
risky assets since December in spite of a higher 5y rate.
In order to identify sweet spots, we calculate the fair value of key forward rates
in the 2015-2018 sector implied by four symmetrical dovish and hawkish Fed
rate hike scenarios. More precisely we consider the rate hike cycles implied by
the December dots of the 3rd and 5th most dovish FOMC members and by the
dots of the 3rd and 5th most hawkish FOMC members. The two dovish and
two hawkish rate hike cycle scenarios are described in the table and charts
below (first hike ranges between Mar-15 and Mar-16 and pace between 25bp
and 50bp per quarter).
Figure 1: Rate hike scenarios from most dovish and most
hawkish FOMC members
4.5
3rd most dovish
5th most dovish
5th most hawkish
3rd most hawkish
4
3.5
3
2.5
Figure 2: Description of the hawkish and dovish FOMC
scenarios
Fed rate
Dec-14
Dec-15
Dec-16
Terminal
3rd dove
0.25
0.25
1.25
3.50
5th dove
0.25
0.50
1.50
3.75
5th hawk
0.25
1.25
2.75
4.00
3rd hawk
0.25
2.00
3.25
4.00
2
First hike
1.5
1
0.5
0
Dec-13
Dec-14
Dec-15
Source: Deutsche Bank
Deutsche Bank AG/London
Dec-16
Dec-17
Dec-18
Dec-19
Pace of rate hikes in
first year
End of
cycle
3rd dove
Mar-16
25bp per quarter
Mar-20
5th dove
Dec-15
25bp per quarter
Dec-19
5th hawk
Mar-15
37.5bp per quarter
Mar-18
3rd hawk
Mar-15
45bp per quarter
Sep-17
Source: Deutsche Bank
Page 61
17 January 2014
Global Fixed Income Weekly
Once we have the fair value of the different forward starting swaps and
Eurodollar rates implied by these rate projections we calculate the implied selloff or rally that market rates would have to go through in order to match these
fair value levels. We can then calculate the expected P&L for being short these
different forward rates in each scenario and obtain a global average expected
P&L, we also obtain the dispersion of the P&L in these different scenarios. We
then calculate the resulting Sharpe ratio i.e. the expected average return
divided by the dispersion of these expected returns. We finally extract some
measures of convexity of returns (ratio of maximum expected P&L gain against
maximum expected P&L loss, as well as ratio of average gain against average
loss). We show the results in the table below:
Figure 3: Table of results
3rd most 5th most 5th most
dovish
Outright short
dovish
hawkish
3rd most
Avg
Sharpe
Worst
Max
Convexity
hawkish
P&L
Ratio
loss
gain
Max gain Avg gain
to Max
loss
Change in rates from current (in %)
to avg
loss
1y1y
(0.31)
(0.20)
0.32
0.72
0.13
0.28
(0.31)
0.72
2.33
2.06
2y1y
(0.61)
(0.36)
0.66
1.23
0.23
0.27
(0.61)
1.23
2.02
1.96
3y1y
(0.55)
(0.33)
0.98
1.43
0.38
0.40
(0.55)
1.43
2.62
2.76
4y1y
(0.57)
(0.42)
0.93
0.94
0.22
0.26
(0.57)
0.94
1.65
1.88
Dec-15
(0.51)
(0.28)
0.55
1.19
0.24
0.31
(0.51)
1.19
2.36
2.22
Jun-16
(0.55)
(0.30)
0.74
1.29
0.29
0.34
(0.55)
1.29
2.34
2.39
Dec-16
(0.54)
(0.29)
0.93
1.43
0.38
0.41
(0.54)
1.43
2.67
2.87
Jun-17
(0.52)
(0.29)
1.00
1.50
0.42
0.43
(0.52)
1.50
2.90
3.12
Dec-17
(0.54)
(0.39)
1.09
1.26
0.35
0.37
(0.54)
1.26
2.30
2.50
Jun-18
(0.59)
(0.44)
0.91
0.91
0.20
0.24
(0.59)
0.91
1.55
1.77
Dec-18
(0.58)
(0.43)
0.62
0.62
0.06
0.09
(0.58)
0.62
1.07
1.23
1.16
Flatteners
2y1y-4y1y
(0.03)
0.06
(0.26)
0.28
0.01
0.05
(0.26)
0.28
1.06
3y1y-4y1y
0.02
0.09
0.05
0.49
0.17
0.76
0.02
0.49
∞
dec16-dec18
0.04
0.14
0.31
0.81
0.33
0.95
0.04
0.81
∞
Jun16-Jun18
0.04
0.14
(0.17)
0.38
0.10
0.42
(0.17)
0.38
2.25
∞
∞
1.10
Steepeners
1y1y-2y1y
(0.30)
(0.16)
0.34
0.51
0.10
0.25
(0.30)
0.51
1.7092
1.85
1y1y-3y1y
(0.24)
(0.13)
0.66
0.71
0.25
0.50
(0.24)
0.71
2.9943
3.72
Source: Deutsche Bank
We note being short the 3Y1Y rate and the Dec-16 and Jun-17 Eurodollar
contracts are the best opportunities outright. Indeed the average expected P&L
on these short positions is the highest, assuming that the four scenarios have
the same probability to happen. Relative to other rates they present a more
substantial risk of sell-off while they are unlikely to rally more than the other
rates. We note they offer the best Sharpe ratio but also the best convexity.
The analysis also suggests that the most asymmetrical way to position for a
higher rate scenario is via the Dec-16 vs. Dec-18 ED flattener or 3Y1Y-4Y1Y
swap flattener. Indeed while hawkish scenarios would imply a bear flattening
of the ED strip in this sector (the 3y1y sector has also more room to sell-off in a
repricing of the hiking cycle than the 4y1y rate which is already close to 3.5%),
dovish scenarios would also imply some mild bull flattening pressures. In other
words while the P&L of these flatteners is expected to be significantly positive
in case of repricing of an aggressive rate hike cycle, the P&L could well be
Page 62
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
close to flat or marginally positive in an adverse scenario of soft macro and
dovish Fed (which would affect the perception of the long term equilibrium FF
rate, would increase QE expectations without delaying considerably the timing
of the first hike). In other words these flatteners are likely to be profitable in
both bearish and bullish environments, making these trades very convex.
The charts below illustrates the still remarkable historical steepness of the
current slopes EDZ6-EDZ8 on the one hand (constant time period), and 3Y1Y4Y1Y (constant forward starting time implying varying time frames).
Figure 4: Extreme steepness of ED slope Dec16/Dec18
Figure 5: Still impressive steepness in 3y1y/4y1y
200
100
180
90
EDZ6 vs EDZ8 slope
160
USD 3Y1Y-4Y1Y slope
80
140
70
120
60
100
50
80
40
60
30
40
20
20
10
0
09
10
Source: Deutsche Bank
11
12
13
14
0
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
Source: Deutsche Bank
The risk of these trades would be one of extreme delay of the first rate hike
well into 2016 or 2017, followed by a very fast normalization in 2017 or 2018.
This could limit the magnitude of the sell-off in ED Dec-16 or in 3Y1Y relative
to the sell-off in ED Dec-18 or 4y1y.
# 2 – EUR 5Y fwd 5Y-30Y conditional bear steepener
We recommend investors willing to position for a strategic carry trade to
implement a premium neutral EUR 5Y fwd 5Y-30Y conditional bear steepener
with OTM payers. The trade would consist in buying EUR100Mln 5Y30Y ATMF
payer vs. selling EUR418Mln of 5Y5Y OTM+30bp, premium neutral.
1.
The trade benefits from very attractive curve carry. The 5y fwd 5y-30y
slope is virtually flat (~5bp only), while the 5s30s spot slope is ~155bp. As
time goes by the slope will have a propensity to steepen back by 150bp.
Average annual carry is thereby around 30bp but is not linear. In the first
year carry is 22bp and then it increases to 28bp, 32bp, 34bp and 30bp.
This carry is currently close to historically high levels (see figure 2 below).
Deutsche Bank AG/London
Page 63
17 January 2014
Global Fixed Income Weekly
Figure 1: Attractive roll of the 5Y fwd slope towards spot
175
Figure 2: Historically high positive carry
200
150
150
125
Term structure of
forward 5s30s
slope
100
100
75
50
50
25
0
0
99
-25
0y
1y
Source: Deutsche Bank
2.
3.
2y
3y
4y
5y
6y
00
01
-50
02
03
04
05
06
07
08
09
10
11
12
13
14
Carry on the 5y fwd 5s30s steepener
Source: Deutsche Bank
Simultaneously the trade benefits from a very attractive vol ratio. The 5y5y
to 5y30y implied normal vol ratio is close to historically high levels around
1.24 (see figure 3 below) providing an opportunity to implement the bear
steepener at zero cost by setting the strike on the 5y5y payer 30bp OTM
relative to the 5Y30Y leg. This has many benefits:
a.
It lowers the delta on the short 5y5y payer position so that the net
delta of the position is not perfectly neutral any longer. The
premium neutral structure trades slightly short, reducing the
marked to market risk in case of short term bear flattening.
b.
It accelerates the time decay on the short 5y5y payer as time goes
by and as 5y5y rate rolls down towards lower levels.
c.
The 5y5y payer skew is more expensive i.e. steeper than 5y30y
payer skew so that the vol ratio captured by the trade is higher
than the ATMF vol ratio at nearly 1.27 instead of 1.24.
d.
Finally it makes the strike slope negative at -25bp. In other words
the slope needs to be steeper than -25bp at expiry for the trade to
be in the money in a higher rate environment.
Historically the 5s30s spot slope has never been more inverted than the
strike slope of -25bp while the 30y rate has generally traded substantially
above the level of 3.10% currently priced by the 5y30y forward rate over
the past 15 years (see figure 4). The empirical probability of being in the
money is therefore particularly elevated.
Page 64
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
Figure 3: Extreme ratio of EUR 5y5y to 5y30y implied
normal volatility
1.3
Figure 4: Empirical likelihood to end up making money at
expiry is extremely high (higher rate and slope >-25bp)
200
5s30s vs. 30y
P&L>0
5y30y
strike
1.2
150
1.1
100
1.0
0.9
50
Neutral
P&L
0.8
5y5y/5y30y vol ratio
0
1.5
0.7
02
03
04
05
06
07
08
09
10
11
12
13
14
2.0
2.5
strike slope
-50
Source: Deutsche Bank
3.5
4.0
4.5
5.0
5.5
6.0
6.5
P&L<0
Source: Deutsche Bank
4.
The historical high vol ratio is already fully pricing in the directionality of
the slope: looking at the relationship between the vol ratio and the actual
rolling beta of the 5y fwd 5s30s slope vs. 5y5y rate, we find that the vol
ratio is in fact overestimating a bit the recent regime of directionality of the
slope with the level of 5y5y rate (see figure 5 below). From this perspective
there is increasingly limited room for further outperformance of 5y5y vol
vs. 5y30y. Moreover part of the recent cheapening of 5y30y vol has been
seasonal, related to expectations of an increase of callable issuance in Q1.
This wave of vol supply still has to materialize. Going forward a higher rate
environment may reduce the need for German insurers to sell some
optionality to capture higher yields which could reduce supply at the
bottom right corner of the vol surface, contributing to the outperformance
of 5y30y vol vs. 5y5y.
5.
The forward slope 5y fwd 5s30s is too flat relative to vol/convexity: the
forward slope 5y5y vs. 5y30y is a spread between two long dated forward
rates supposed to both reflect long term expectations of nominal GDP
growth in Europe. The difference between the two rates comes from a
term premium which tends to make the slope positive, and from the
pricing of a convexity advantage for longer dated forward rates, which
tends to invert the slope. In a high vol environment the expected excess
returns on 5y30y vs. 5y5y (due to higher convexity for the 5y30y swap)
leads to a richening of 5y30y vs. 5y5y and to an inversion of the spread.
Currently the low vol regime suggests that the forward slope should be
steeper and converge towards its pre crisis equilibrium around 20bp (see
figure 6).
Deutsche Bank AG/London
3.0
Page 65
17 January 2014
Global Fixed Income Weekly
Figure 5: 5y5y to 5y30y vol ratio is already adequately
reflecting the directionality of the slope with rates
1.5
-1.3
-1.1
1.4
-0.9
-0.7
1.3
-0.5
1.2
-0.3
-0.1
1.1
0.1
0.3
1.0
Figure 6: The forward slope 5y fwd 5s30s could be
steeper given the lack of vol at the long end
10
0.4
30
0.2
50
0.0
70
90
-0.2
110
-0.4
130
150
-0.6
170
0.5
0.9
0.7
0.9
5y5y/5y30y vol ratio
0.8
1Y rolling beta of 5y fwd slope vs. 5y5y rate (rhs, inv)
0.7
03
04
Source: Deutsche Bank
05
06
07
08
09
10
11
12
13
14
1.1
1.3
190
-0.8
-1.0
210
Vol regime 30y gamma (rhs)
230
-1.2
250
06
07
08
09
10
11
12
13
14
Source: Deutsche Bank
6.
Forward 5s30s slopes would likely steepen if the ECB delivers QE: the
context of persistently soft inflation in Eurozone increases the likelihood of
a new monetary stimulus by the ECB in the next 12 months, in the form of
a vLTRO or of a QE program (which would be concentrated in the front
and intermediate part of the curve but would avoid the long end to avoid
negative implications of pension funds) should help compressing the belly
of the curve and containing vol on EUR rates, which would contribute to
steepening pressures. Moreover the positive impact of QE on inflation
expectations and on the chance of success to boost the EU economy
could lead to an increase in inflation risk premium and term premium at
the long end, contributing to some steepening.
7.
Beyond the favorable rates roll down, the vol roll and skew roll are also
source of positive carry: while the vol ratio between ATMF 5y5y and 5y30y
is expected to be stable in the next couple of years with the ATMF 3y5y vs.
5y30y vol ratio also at 1.24, the trade should actually benefit from the fact
that the roll down on the 5y5y rate will push the 5y5y payer struck
OTM+30bp (3.35% at the time of writing) more and more out of the
money over time relative to the underlying rate. Given the steepness of the
payer skew on the 5y tenor (outright and relative to 30y tenor), the
effective vol roll would instead be very favorable to the trade. After one
year the 4y5y rate at 2.78% (assuming roll down is realized) would make
the 4y5y payer OTM by nearly 60bp and would imply a vol roll up from
85.8bp on the 5y5y 30bp OTM payer to 89.7bp on the 4y5y 60bp OTM
payer. In comparison the 4bp 1y roll down on the 5y30y rate would only
make the 4y30y payer OTM by 4bp after one year. Given a relatively flat
skew slope that would push the 5y30y payer vol from 67.7bp at inception
to 68bp only after one year. In other words the vol ratio should increase
from 1.27 to 1.32. After 2 years, the 3y5y payer would be OTM by 90bp
(vol would jump to 92.3bp) while the 3y30y payer would be OTM by 10bp
(vol would be 67bp) and the vol ratio would increase further mechanically
towards 1.37. Consequently the carry profile of the trade would be
significantly positive: providing ~EUR750k for an unchanged curve and vol
surface after 6M (using 100Mln notional on 5Y30Y leg), ~EUR1.5Mln after
1Y, ~EUR2.7Mln after 2Y, ~EUR3.3Mln after 3Y (see figure 7 below). Carry
is so significant that even assuming a 1.3 beta going forward between the
5y5y rate and the 5y30y rate (i.e. a bear flattening dynamics or bull
steepening dynamics, worse than the one recently observed with beta
around 1.2), the trade would provide a positive P&L after one year in a 100bp / +100bp range for the 5y30y rate (see figure 8). A 1.3 beta means
Page 66
5y fwd 5s30s
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
that in a 100bp sell-off in 5y30y, the 5y5y rate would sell-off by 130bp and
the slope would bear flatten by 30bp.
Figure 7: Strong carry from curve and vol provides
Figure 8: Attractive P&L profile after one year even in
attractive P&L profile in parallel shift of the curve
adverse slope scenario (bear flattening with 1.3 beta)
5,000,000
P&L in 1Y assuming 5y5y moves with 1.1 beta vs 5y30y
P&L in 1Y assuming 5y5y moves with 1.2 beta vs 5y30y
P&L in 1Y assuming 5y5y moves with 1.3 beta vs 5y30y
Instant P&L assuming 5y5y moves with 1.1 beta vs 5y30y
Instant P&L assuming 5y5y moves with 1.2 beta vs 5y30y
Instant P&L assuming 5y5y moves with 1.3 beta vs 5y30y
12,000,000
P&L profile after 6M
P&L profile after 12M
P&L profile after 2Y
P&L profile after 3Y
Instantaneous P&L profile
10,000,000
8,000,000
4,000,000
3,000,000
2,000,000
6,000,000
1,000,000
4,000,000
0
2,000,000
-1,000,000
0
-2,000,000
Parallel shift of the curve
-2,000,000
-1.0%-0.8%-0.6%-0.4%-0.2% 0.0% 0.2% 0.4% 0.6% 0.8% 1.0%
Source: Deutsche Bank
Shift in 5Y30Y rate
-3,000,000
-0.8% -0.6% -0.4% -0.2% 0.0% 0.2% 0.4% 0.6% 0.8% 1.0%
Source: Deutsche Bank
The risk of the trade would be a very sharp bear flattening of the curve in the
near term and a massive inversion of the 5s30s spot slope below -25bp in a
rate sell-off in 5 years time.
Deutsche Bank AG/London
Page 67
17 January 2014
Global Fixed Income Weekly
Pacific
Australia
New Zealand
Rates
Gov. Bonds & Swaps
Rates Volatility
David Plank
Macro strategist
(+61) 2 8258-1475
[email protected]
Dollar Bloc Strategy
Ken Crompton
Strategist
(+61) 2 8258-1361
[email protected]
„
The AUD front-end rallied on weak employment data and is now pricing
around a 50% chance of a rate cut by mid-year. We would characterise
current market pricing as being broadly in line with the domestic data. We
don’t think pricing of rate cuts can extend much further unless the
unemployment rate clearly starts to trend higher.
„
The 10Y ACGB/UST spread is back to where it was in October. Looking
forward we expect the 10Y ACGB/UST spread to narrow to at least 100bp
over the course of 2014 and quite possibly to around 75bp. We see this
happening in a bearish fashion. That is, by a rise in the 10Y UST yield
relative to the 10Y ACGB rather than by a drop in the 10Y ACGB yield
toward the 10Y UST. For this to happen requires the US front-end to price
more Fed rate hikes into 2015 than is currently the case.
Soft December employment report has AUD front-end thinking about a rate cut
Australian employment fell 22.6k in Australia, after a revised gain of 15.4k in
November. This number, the first major Australian data release of 2014, came
in well below market expectations - though the stability of the unemployment
rate at 5.8% tempered the weakness somewhat. Having said that, the job loss
was concentrated in full-time so hours worked were flat for the month and are
now up just 0.3% over the year.
Employment growth soft in December
Monthly change in Australian employment
100.0
'000
Seasonally adjusted
80.0
Trend
60.0
40.0
20.0
0.0
-20.0
-40.0
-60.0
Jan-06
Jan-08
Jan-10
Jan-12
Jan-14
Source: Deutsche Bank, ABS
The softness in employment continues to be at odds with the range of partial
labour market indicators that we look at. Our economists are left thinking that
we are in the (always) uncomfortable period between leading labour market
indicators turning (job ads, business surveys and consumer sentiment etc) and
that being reflected in actual hiring and the official employment data. They
remain of the view that the gap evident between these indicators and the
Page 68
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
ABS's official employment data will ultimately be revised in favour of stronger
employment growth.
And continues to run well behind the partial indicators
Monthly newspaper and internet job ads, business surveys and
consumer surveys calibrated to Australian employment growth
50.0
mom 000s
40.0
30.0
20.0
10.0
0.0
-10.0
-20.0
-30.0
Newspaper and internet job ads calibrated
to employment growth
Monthly business survey employment
indexes calibrated to employment growth
Monthly consumer surveys calibrated to
employment growth
Average of the above
Employment (trend)
-40.0
Jan-04
Jan-06
Jan-08
Jan-10
Jan-12
Jan-14
Source: Deutsche Bank, ABS, NAB, AIG, DEWR, ANZ, WBC-MI
The market reacted to the data as we might expect, by increasing the pricing
of a near-term rate hike. On a 6 month time horizon the market is pricing
around a 50% chance of a rate cut. Beyond that point the market starts to
scale back the chance of a cut, with only a few basis points of cuts priced for
the end of 2014.
Market pricing for the RBA cash rate in 6M time
2.6
Cash rate implied by 6th IB
contract
2.5
2.4
2.3
2.2
2.1
Jun-13
Jul-13
Aug-13
Sep-13
Oct-13
Nov-13
Dec-13
Jan-14
Source: Deutsche Bank, Reuters
We would characterise current market pricing as being broadly in line with the
domestic data. This is in contrast to pricing in 2012 when the market was
prepared to run well ahead of the data.
Deutsche Bank AG/London
Page 69
17 January 2014
Global Fixed Income Weekly
Market pricing broadly in line with the data
200
-0.8
150
-0.6
-0.4
100
-0.2
50
0.0
0
0.2
-50
0.4
-100
-150
0.6
3M rate implied by IR2 less cash rate, bp
(LHS)
0.8
-200
1.0
3M ppt change in the unemployment rate,
inverted (RHS)
-250
1.2
Jan-97 Sep-98 May-00 Jan-02 Sep-03 May-05 Jan-07 Sep-08 May-10 Jan-12 Sep-13
Source: Deutsche Bank, Bloomberg Financial LP
That it isn’t doing so now reflects the actual level of the cash rate and the
global environment, in our view. That is, globally things are looking up, the
Fed has changed direction and the RBA has already taken the cahs rate to a
record low. Against this backdrop we think it is difficult for the AUD front-end
to pre-empt the data in the manner it did during 2012. Thus we don’t think
pricing of rate cuts can extend much further unless the unemployment rate
clearly starts to trend higher.
Since we aren’t expecting this to happen should we take advantage of the
recent rally to go short? The problem is that we don’t think the unemployment
rate is going to trend lower anytime soon either. This means we have no
expectation that the AUD front-end is going to price rate hikes. Rather we can
see it bouncing round in a relatively narrow range for an extended period, until
the unemployment rate starts trending in one way or the other. For now,
pricing simply isn’t far enough away from where we think it ‘should be’ to
entice us into recommending a specific front-end trade.
10Y ACGB/UST spread back to where it was in October
The weak Australian employment data came on a day when the 10Y UST yield
was pushing higher. As a consequence the 10Y ACGB/UST spread fell back a
few basis points to 130bp. It has remained around that level even as the 10Y
UST has rallied overnight.
Page 70
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
10Y ACGB/UST spread vs front-end pricing
170
10Y ACGB/UST spread, bp (LHS)
280
160
4th AUD bank bill/Eurodollar futures spread, bp
(RHS)
270
260
150
250
240
140
230
130
220
210
120
200
110
100
Dec-12
190
180
Feb-13
Apr-13
Jun-13
Aug-13
Oct-13
Dec-13
Source: Deutsche Bank, Bloomberg Financial LP
Given the relative shift in front-end pricing caused by the employment data we
might have expected a bigger move in the 10Y spread. But the 10Y spread
appears to have been too tight compared to relative front-end pricing since the
later part of December. In effect the front-end has caught up to the 10Y
spread in the past few days.
We don’t actually think it was the lower 10Y spread that ‘caused’ the front-end
spread to narrow. We usually think of causality as running the other way.
There are plenty of occasions when the two spreads diverge for a period,
however, as even the above chart shows over a relatively limited time frame.
But there is a very strong tendency for any gaps that open up to close, as
evidenced by the stability of the relationship over many years.
Looking forward we expect the 10Y ACGB/UST spread to narrow to at least
100bp over the course of 2014 and quite possibly to around 75bp. We see this
happening in a bearish fashion. That is, by a rise in the 10Y UST yield relative
to the 10Y ACGB rather than by a drop in the 10Y ACGB yield toward the 10Y
UST. For this to happen requires the US front-end to price more Fed rate hikes
into 2015 than is currently the case.
Is spread compression a trade worth implementing? The negative carry on the trade
over the course of a year is a reasonable hurdle to overcome. Spread compression
to 100bp will beat the negative carry, but about half the move will be lost. We want
a wider entry point than something around 130bp to entice us into the trade.
David Plank +61 2 8258 1475
Deutsche Bank AG/London
Page 71
17 January 2014
Global Fixed Income Weekly
Dollar Bloc Relative Value
„
Semi spreads to both bond and swap are generally near their tightest
levels for several years, although there has been a little weakness since the
New Year began, especially in the 4Y sector.
„
Our models show the QTC Sep-17 to be trading somewhat dear, whilst the
WATC Jun-16 is a little cheap.
„
The past month has seen significant cheapening of most Semi butterflies,
especially the WATC curve. One butterfly that has lagged and which we
think has some potential to cheapen from current levels, is the TCorp Feb18 / May-20 / Apr-23 butterfly. In Semi pair trades, we note that the QTC
Feb-18 has cheapened to the SAFA Sep-17 whilst the QTC Sep-17 has
richened relative to the WATC Jun-17.
„
SSAs have generally outperformed Semis over the past month. The TCV
Nov-16 and Nov-17 look especially cheap to the KfW Jul-16 and IBRD Jan18 respectively.
„
2Y to 3Y bonds from TCorp and QTC lead the list of most attractive Semis
on a carry/breakeven basis, i.e. the bonds which have a relatively lower
chance of losses on a carry basis over 12 months.
„
Trades we recommend: Sell the belly of the TCorp Feb-18 / May-20 / Apr23 bond butterfly; buy QTC Feb-18 vs SAFA Sep-17; buy TCV Nov-16
against KfW Jul-16 and buy TCV Nov-17 against IBRD Jan-18.
Semi performance relative to swap over the past month has been mixed. 2Y
bonds from most issuers have seen especially good demand with swap
spreads tightening by as much as twelve basis points (in the case of the Tascor
Apr-15).
Ten best performing Semis vs swap since 13 Dec
Best Semis vs Swap
Maturity
S/Q ASW
Δ1W
Δ1M
15-Apr-15
-1
-1.2
-11.9
WATC 6.00
23-Jul-25
26
0.0
-9.1
SAFA 6.00
20-Apr-15
3
-1.1
-9.0
WATC 5.75
15-Apr-15
3
-1.2
-8.3
QTCG 6.00
14-Oct-15
-8
-1.0
-7.6
1-Apr-15
-2
-1.2
-7.2
17-Nov-26
15
-0.4
-5.6
1-May-23
-2
-1.1
-5.1
20-May-21
25
-2.0
-5.0
8-Mar-22
29
-1.8
-4.7
TASCOR 6.00
NSWTC 6.00
TCVIC 3.50
NSWTCG 6.00
SAFA 4.00
TASCOR 6.25
Source: Deutsche Bank
Amongst the wideners over the past month the 4Y sector has seen the
weakest performance led by a 5bp widening to swap by the QTC Feb-18.
Ten worst performing Semis vs swap since 13 Dec
Worst Semis vs Swap
Maturity
S/Q ASW
Δ1W
Δ1M
21-Feb-18
14
4.3
4.9
WATC 6.00
15-Jul-17
12
4.6
4.9
NSWTC 6.00
1-Feb-18
6
4.2
4.2
NSWTC 4.00
20-Mar-19
9
3.5
3.8
WATC 6.00
15-Oct-19
20
4.4
3.0
TCVIC 3.50
15-Nov-18
5
4.3
2.8
QTC 6.00
21-Sep-17
9
3.0
2.7
TCVIC 4.00
17-Nov-17
3
2.4
2.4
QTC 6.00
21-Jun-19
20
3.4
2.2
TCVIC 4.00
15-Nov-16
-1
2.3
1.9
QTC 2.75
Source: Deutsche Bank
Page 72
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
Overall, however, spreads are generally at their tightest levels to both swap
and bond since mid-2011.
Spreads to bond and swap are both at recent lows
10Y AAA Semi to Swap
100.0
10Y AA Semi to Swap
80.0
60.0
40.0
20.0
0.0
-20.0
Jan-11
Jun-11
Nov-11
Apr-12
Sep-12
Feb-13
Jul-13
Dec-13
180.0
10Y AAA Semi to ACGB
160.0
10Y AA Semi to ACGB
140.0
120.0
100.0
80.0
60.0
40.0
20.0
0.0
Jan-11
Jun-11 Nov-11 Apr-12
Sep-12 Feb-13
Jul-13
Dec-13
Source: Bloomberg Financial LP, Deutsche Bank
Semi Curve Relative Value: Bond cheap/dear and butterflies
Each day we use market observed yields for Semi bonds to build a zero curve
for each Semi issuer. Typically, we find that the bonds tend to trade a few
basis points rich or cheap to these fitted curves.
Deutsche Bank AG/London
Page 73
17 January 2014
Global Fixed Income Weekly
QTC cheap/dear vs spline curve
QTC
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0
-2.5
-3.0
Nov-14 Mar-17
Cheap (+) / Dear (-)
Jul-19
Nov-21 Mar-24
Jul-26
Nov-28 Mar-31
Source: Deutsche Bank
At present, the QTC Sep-17 and WATC Jun-16 stand out as being the most
mispriced Semis relative to the fitted curve. The QTC Sep-17 is 2.8bp rich
whilst the WATC Jun-16 is 3.1bp cheap.
WATC cheap/dear vs spline curve
4.0
WATC
3.0
2.0
1.0
0.0
-1.0
Cheap (+) / Dear (-)
-2.0
Apr-14 Sep-15 Feb-17 Jul-18 Dec-19 May-21 Oct-22 Mar-24
Source: Deutsche Bank, Reuters
Our principal components analysis (PCA) model also identifies the QTC Sep-17
as being dear, to a statistically significant extent.
Page 74
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
PCA analysis of QTC curve
QTC
1.5
<- Dear / Cheap ->
1.0
0.5
0.0
-0.5
-1.0
Jul-24
Jul-23
Jul-22
Jun-21
Feb-20
Jun-19
Feb-18
Sep-17
Apr-16
Oct-15
-1.5
Source: Deutsche Bank, Reuters
Interestingly, however, the PCA model identifies the WATC Jun-16 as being
close to fair, whilst the WATC Oct-19 is statistically cheap.
PCA analysis of WATC curve
2.0
WATC
<- Dear / Cheap ->
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0
Apr-15
Jun-16
Jul-17
Oct-19
Jul-21
Oct-23
Source: Deutsche Bank, Reuters
The cheapness of the WATC Oct-19 identified by the PCA model is the legacy
of a significant shift in the WATC butterfly over the past month – as the graph
below shows the WATC Jun-16/Oct-19/Oct-23 ‘fly has moved from +5bp to
+21bp since late November.
WATC Jun-16 / Oct-19 / Oct-23 ‘fly
25
20
15
10
5
0
Jul-13
WATC Jun-16 / Oct-19 / Jul-25 'fly
Aug-13
Sep-13
Oct-13
Nov-13
Dec-13
Jan-14
Source: Deutsche Bank, Reuters
Deutsche Bank AG/London
Page 75
17 January 2014
Global Fixed Income Weekly
Although the WATC Oct-19 is now considered cheap on the PCA analysis, it is
still trading rich relative to the fitted WATC curve. Additionally, the WATC ‘fly
itself is not compellingly cheap after its recent correction.
TCorp PCA analysis
<- Dear / Cheap ->
2.0
NSWTC
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
Aug-24
Apr-23
Mar-22
May-20
Mar-19
Feb-18
Feb-17
Apr-16
Apr-15
-2.0
Source: Deutsche Bank, Reuters
Instead, the butterfly that stands out to us is the TCorp Mar-19/May-20/Mar-22
butterfly. The TCorp May-20 appears rich on the PCA model against the Feb18 and Apr-23. The butterfly is currently at -2.2bp, just short of its lowest
levels since July.
Belly of the TCorp Feb-18 / May-20 / Apr-23 ‘fly is rich
6
4
2
0
-2
-4
NSWTC Feb-18/May-20/Apr-23 'fly
-6
Jul-13
Aug-13
Sep-13
Oct-13
Nov-13
Dec-13
Jan-14
Source: Deutsche Bank, Reuters
We recommend paying the belly of the butterfly at the current level of -2bp,
looking for a rise toward +3bp. The key risk of the trade is a flattening of the
long end of the TCorp 5Y/10Y slope.
Semi pair trades: Buy QTC Feb-18 vs SAFA Sep-17; Sell QTC Sep-17 vs WATC
Jun-17
Two moves in spreads over the past three months stand out to us are the
widening of the QTC Feb-18 relative to the SAFA Sep-17 and the widening of
the WATC Jul-17 to the QTC Sep-17.
Page 76
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
QTC Feb-18 has cheapened to SAFA Sep-17
SAFA Sep-17 swap spread
QTC Feb-18 swap spread
20
15
10
5
0
-5
-10
Oct-13
Oct-13
Nov-13
Nov-13
Dec-13
Dec-13
Jan-14
Source: Deutsche Bank, Reuters
The QTC Sep-17 appeared statistically rich on our QTC PCA model – the Jul-17
is also a little rich on a WATC PCA analysis, although not to a statistically
significant amount.
Sell rich QTC Sep-17 to buy WATC Jun-17
QTC Sep-17 swap spread
WATC Jul-17 swap spread
20
15
10
5
0
-5
Oct-13
Oct-13
Nov-13
Nov-13
Dec-13
Dec-13
Jan-14
Source: Deutsche Bank, Reuters
Of these two trades, we prefer the QTC vs SAFA because we think that QTC’s
long term fundamentals are stronger. Thus we recommend buying the QTC
Feb-18 against the SAFA Sep-17 – the key risk to the trade is that the QTC Feb18’s relative cheapness is extended further.
Carry vs Breakeven: 2Y to 3Y QTC and TCorp bonds offer best protection of
carry income
Carry income relative to alternative investments – typically either ACGBs or
swap – is one of the key reasons that investors buy spread products. The risk,
however, is that extra income from carry can be offset or even eliminated by
unfavourable movements in spreads.
Deutsche Bank AG/London
Page 77
17 January 2014
Global Fixed Income Weekly
Top breakeven/carry ratios
Semi bond
Carry (over ACGB)
12M breakeven spread
Ratio
9.5
13.1
1.4
QTC Oct-15
21.3
28.7
1.3
NSWTC Apr-16
20.8
18.1
0.9
QTC Apr-16
27.4
22.7
0.8
WATC Jun-16
31.2
23.0
0.7
TCVIC Nov-16
23.4
13.5
0.6
NSWTC Feb-17
28.1
14.5
0.5
NSWTCG Mar-17
17.9
9.1
0.5
WATC Jul-17
33.6
14.7
0.4
QTCG Sep-17
16.1
6.6
0.4
QTCG Oct-15
Source: Deutsche Bank
We use the “breakeven” to measure the change in spread required to negate
carry income. The key variable in determining breakeven is the width of the
spread to begin with and the duration of the bond.
The full carry/breakeven tables can be found at the end of this Monthly, but the
table above shows the Semis with the highest ratio of breakeven to carry. The
list of bonds is dominated by 2Y to 3Y bonds from QTC and TCorp (both CGG
and SGG) although a notable “outlier” in the list is the TCV Nov-16, which
trades at a spread of just over 23bp to ACGB curve. TCV/ACGB spread would
need to widen more than 13bp over the coming year for the TCV holder to
suffer net underperformance relative to the ACGB.
Kenneth Crompton +61 2 8258 1361
Page 78
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
United States
Rates
Gov. Bonds & Swaps
Inflation
Rates Volatility
Alex Li
Steven Zeng, CFA
Research Analyst Research Analyst
(+1) 212 250-5483 (+1) 212 250-9373
[email protected] [email protected]
Inflation-Linked
„
The December CPI report points to a benign inflation outlook. In February,
TIPS carry will be negative from the shortest issues out to the 2019
maturity. We believe TIPS breakevens moved too high relative to Treasury
yields from early December to early January, and therefore, are vulnerable,
particularly in the five-year sector. We favor being short five-year
breakevens.
„
We expect Treasury to introduce smaller and more frequent five-year TIPS
auctions this year; two new five-year TIPS CUSIPS per year followed by
one or two reopening auctions are likely. If the supply in five-year TIPS
increases due to smaller and more frequent auctions, it will likely
compress five-year breakevens, in our view.
5yr TIPS breakevens seem high on Treasury yield levels
2.50
past 1yr's data
5yr TIPS BEs
2.25
1/17/2014
2.00
1.75
1.50
0.50
y = -0.4792x + 2.5472
R² = 0.6498
0.75
1.00
1.25
1.50
1.75
2.00
5yr Treasury yield
Source: Bloomberg and Deutsche Bank
Good Luck Beating 5yr Inflation Breakevens
The December CPI report points to a benign inflation outlook with the yearover-year NSA CPI at 1.50%. While the housing inflation was strong (+2.5% on
the OER), core CPI ex-housing was weak. The year-over-year rate in our NSA
CPI forecast drops to below 1.00% in the February data before returning to
1.50% area by midyear. In February, TIPS carry will be negative from the
shortest issues out to the 2019 maturity. The five-year TIPS will have about 1.4bp carry in February. There is small positive carry ranging from +0.2bp to
+0.5bp in the 2022 maturity and longer sector.
We believe TIPS breakevens moved too high relative to Treasury yields from
early December to early January, and therefore, are vulnerable, particularly in
the five-year sector (breakevens currently at 1.87%). There is probably too
much core inflation priced into the five-year breakevens that is unlikely to be
fully realized.
Deutsche Bank AG/London
Page 79
17 January 2014
Global Fixed Income Weekly
On supply, we expect Treasury to introduce smaller and more frequent fiveyear TIPS auctions this year; two new five-year TIPS CUSIPS per year followed
by one or two reopening auctions are likely. Treasury has no plans to change
the supply in 10s and 30s; it plans to make an announcement on TIPS issuance
on February 5, 2014. If the supply in five-year TIPS increases due to smaller
and more frequent auctions, it will likely compress five-year breakevens, in our
view.
The risk in our trade is a sharp increase in five-year breakevens, which we
believe is unlikely in light of the recent inflation data.
TIPS carry in February
2.0
0.0
-2.0
-4.0
-6.0
-8.0
TIPS carry from 1/31/14 to 2/28/14
-10.0
-12.0
-14.0
-16.0
TII 0.75% 02/42
TII 0.625% 02/43
TII 2.125% 02/41
TII 2.125% 02/40
TII 3.375% 04/32
TII 2.5% 01/29
TII 3.875% 04/29
TII 1.75% 01/28
TII 3.625% 04/28
TII 2% 01/26
TII 2.375% 01/27
TII 2.375% 01/25
TII 0.375% 07/23
TII 0.125% 01/23
TII 0.125% 07/22
TII 0.125% 01/22
TII 0.625% 07/21
TII 1.25% 07/20
TII 1.125% 01/21
TII 1.375% 01/20
TII 1.875% 07/19
TII 2.125% 01/19
TII 1.375% 07/18
TII 0.125% 04/18
TII 1.625% 01/18
TII 2.625% 07/17
TII 0.125% 04/17
TII 2.5% 07/16
TII 2.375% 01/17
TII 2% 01/16
TII 0.125% 04/16
TII 0.5% 04/15
TII 1.875% 07/15
TII 1.625% 01/15
-18.0
Source: Deutsche Bank
Auction preview: 10-year TIPS
Treasury is offering a new ten-year TIPS for $15bn of notional next week. The
auction will settle on Friday, January 31. Indirect bidder participation has been
strong in the last six auctions averaging 53.3% as compared to 44% in the
prior six. However this strength was tempered by direct bidder takedown
which average at 9.9% in 2013 versus 13.9% in the year before. But direct
bidders were unusually solid in the last auction taking down 21.5% of the
supply picking up the slack from indirect bidders. Indirect bidders were at
46.7% in November as compared their one-year average of 53.3%. Foreign
investors’ 33.7% allotment share however was a record since at least January
2001. But Fund investors’ share hit the lowest level of 32.4% in the last 21/2
years. Bid-to-cover ratio was slightly above the average at 2.59 but the last
auction came through by a hefty 4.4 basis points.
Page 80
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
10yr TIPS auction statistics
1yr Avg
Nov-13
Sep-13
Jul-13
May-13
Mar-13
Jan-13
Nov-12
Sep-12
Jul-12
May-12
Mar-12
Jan-12
Nov-11
Sep-11
Jul-11
May-11
Mar-11
Jan-11
Size Primary Direct
($bn) Dealers Bidders
$ 13.67
36.8%
9.9%
$ 13.00
31.8% 21.5%
$ 13.00
44.6%
1.6%
$ 15.00
35.4%
6.9%
$ 13.00
30.9% 12.4%
$ 13.00
43.0%
5.7%
$ 15.00
35.4% 11.3%
$ 13.00
41.3% 10.4%
$ 13.00
48.5%
7.7%
$ 15.00
39.7% 16.1%
$ 13.00
34.5% 14.8%
$ 13.00
38.5% 21.1%
$ 15.00
50.3% 13.4%
$ 11.00
42.1% 11.6%
$ 11.00
33.9% 35.7%
$ 13.00
44.6% 13.7%
$ 11.00
56.3%
3.1%
$ 11.00
67.7%
7.1%
$ 13.00
58.8%
3.2%
Indirect
Bidders
53.3%
46.7%
53.8%
57.7%
56.8%
51.3%
53.3%
48.3%
43.8%
44.2%
50.7%
40.4%
36.3%
46.3%
30.4%
41.6%
40.7%
25.2%
37.9%
Cover Stopout 1PM BP Direct +
Ratio Yield WI Bid Tail Indirect
2.56
-0.6
63%
2.59 0.560 0.604 -4.4
68%
2.38 0.500 0.475
2.5
55%
2.44 0.384 0.410 -2.6
65%
2.52 -0.225 -0.243
1.8
69%
2.74 -0.602 -0.600 -0.2
57%
2.71 -0.630 -0.620 -1.0
65%
2.52 -0.720 -0.751
3.1
59%
2.36 -0.750 -0.810
6.0
51%
2.62 -0.637 -0.650
1.3
60%
3.01 -0.391 -0.350 -4.1
66%
2.81 -0.089 -0.102
1.3
62%
2.91 -0.046 -0.010 -3.6
50%
2.64 0.099 0.085
1.4
58%
2.61 0.078 0.057
2.1
66%
2.62 0.639 0.670 -3.1
55%
2.66 0.887 0.875
1.2
44%
2.97 0.920 0.965 -4.5
32%
2.37 1.170 1.111
5.9
41%
Source: US Treasury, SMR, and Deutsche Bank
Whither inflation?
The December CPI-U NSA Index came in at 233.049 versus 233.16 forecasted
by DB. The seasonally-adjusted monthly change was 0.3%, and the annual
inflation rate rose to 1.5% from 1.2% in November. The inflation print was soft
against expectations for a third consecutive month.
Details of the report showed an unchanged pace of food inflation from last
month (0.1% m/m), a rebound in energy prices (2.1% m/m), and a slowdown in
core inflation (0.1% m/m). Within the core inflation basket, the prices of core
goods were unchanged from last month, while the prices of core services rose
just 0.1%, the smallest increase in eight months. The weakness in core
services was contributed by a 0.4% drop in transportation services prices.
Shelter, the largest component of core services by weight, held decent at 0.2%
m/m, where it’s been in 22 of the last 30 months.
The inflation trend has been weak in the last couple of months. As we
discussed last week, changes in retail gas prices have historically been a good
predictor of changes in the headline inflation. A regression of 108 monthly data
points has an r-square of 87%. As the right chart shows, over the last three
months, headline inflation has been running softer than predicted by retail gas
prices.
Our projection for January CPI is 233.677, or a 0.27% month-over-month
increase. We expect headline inflation to reach the 2% annual rate in the
middle of 2015.
Deutsche Bank AG/London
Page 81
17 January 2014
Global Fixed Income Weekly
Annual rate of inflation is projected to rise to 2 percent in
mid-2015
6.0
Headline inflation has been softer than predicted by retail
gasoline prices in the final quarter
%y/y CPI-U
5.0
% MoM change in CPI-U NSA
Projected
4.0
3.0
2.0
1.0
0.0
-1.0
1.5
2005 to present
1.0
Oct-13
Nov-13
0.5
Dec-13
0.0
(0.5)
y = 0.0595x + 0.1424
R² = 0.8666
(1.0)
(1.5)
(2.0)
(2.5)
(40)
-2.0
(30)
(20)
(10)
0
10
20
% MoM change in retail gasoline prices
-3.0
03
04
Source: Deutsche Bank
Page 82
05
06
07
08
09
10
11
12
13
14
15
Source: Deutsche Bank
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
Global
Economics
Rates
Gov. Bonds & Swaps
Inflation
Markus Heider
Strategist
(+44) 20 754-52167
[email protected]
Global Inflation Update
USDEUR
GBPUSD
GBPEUR
CPI swap spreads:
z-scores
2.0
1.5
4.5
5500
3.5
6500
2.5
7500
8500
1.5
9500
0.5
10500
-0.5
1988
1991
1994
1997
2000
2003
2006
2009
2012
2015
Source: Deutsche Bank
2. Swap-bond B/E spreads
1.5
swap-bond B/E spread, 1y z-score
1.0
0.5
0.0
-0.5
-1.0
UKTi40
OATei40
TIIFeb40
UKTi22
TIIJan22
-1.5
Source: Deutsche Bank
4. USD/EUR CPI spreads v FX, PMIs, spot CPI, oil & risk
3. Cross-market spreads: z-scores
2.5
earnings, % y/y (rhs)
DBRei23
Cross markets: Chart 3 shows (6m, 1y and 2y) z-scores for cross-market
spreads between CPI swaps, for 2y, 5y, 10y and 30y maturities. USD/EUR
spreads remain at least one standard-deviation above historical averages, for
all maturities. To a large extent, higher US B/Es would however seem justified
given differences in the macro backdrop. Regressing spreads on the exchange
5.5
unemplyt ex LT, 18m lead (lhs, inverted)
4500
UKTi17
B/E curves flattened this week, with valuations falling in USD and EUR, and (up
to 15y) rising in GBP; yields declined, at least in EUR and GBP. The December
CPI prints were close to expectations and did not bring significant further
insights into the underlying inflation trend, which remains relatively subdued
for now. Past declines in commodities prices mean that food and energy
inflation are expected to remain weak (and even fall further), and lower
imported costs are weighing on the recovery in domestic inflation as well. We
see core inflation rising slightly in EUR (but remaining at subdued levels),
trending broadly sideways to marginally higher in the US, and sideways to
lower in the UK in the coming months. Economic data are expected to provide
some support for B/Es, and recent trends would seem consistent with a pickup in domestic drivers of inflation (chart 1). While this may be a slow process
any signs of rising wage growth in our view would be a positive for B/Es. While
the tactical case for long B/Es is less clear in this environment, we continue to
see medium-term upside for valuations. This week we focus on RV.
3500
TIIJan18
In RV, across markets, we prefer 30y UK RPI over 30y USD CPI and 1y1y
EUR HICP v 1y1y FRF CPI. In USD, 5y CPI looks relatively low v 2y and 10y
wings. In GBP and EUR, we find 10y RPI/CPI rich compared to 5y and 30y.
„
1. US wage growth to rise
OBLei18
Leading indicators point to a pick-up in wage growth in the US and UK this
year, which would be a positive for B/Es, but may be a slow process; we
see medium-term upside for B/Es.
„
FRFEUR
6M
1Y
60
2Y
residual, USD/EUR CPI swap spread
50
USD rich
v EUR
40
1.0
30
0.5
20
0.0
10
-0.5
-1.0
0
-1.5
-10
-2.0
-20
-2.5
2Y 5Y 10Y 30Y
2Y 5Y 10Y 30Y
2Y 5Y 10Y 30Y
2Y 5Y 10Y 30Y
-30
stdev
-40
2y
Source: Deutsche Bank
Deutsche Bank AG/London
max
5y
min
-stdev
last
-1w
10y
Source: Deutsche Bank
Page 83
17 January 2014
Global Fixed Income Weekly
rate, oil prices, risk proxies and spreads in PMIs and spot inflation would
suggest that 10y and 30y B/E spreads are close to fair, while EUR swaps would
look slightly cheap v USD in 2y and 5y (chart 4). We would have a marginal
preference for 5y EUR into the January CPI prints, which remains somewhat
cheaper against baseline inflation forecasts.
GBP RPI has recently underperformed USD CPI, with 3m (not shown) and 6m
z-scores of spreads in negative territory across all maturities (chart 3). 2y zscores remain mostly positive, but this is impacted by the 2012 uncertainty
about RPI statistics. The 10y spread looks close to fair against regressions on
macro variables (similar to those shown in chart 4), and in 5y GBP looks
marginally (but not significantly) cheap. Over the medium-term, we would
probably see more upside for 5y GBP B/Es, which are relatively cheaper
against our baseline inflation forecasts, but given FX trends and the risk of
lower RPI inflation into this spring, we would be neutral for now. We see the
best opportunity in 30y where we would prefer GBP over USD. This applies
above all to swaps, given that 30y TIPS B/Es are more than one standarddeviation cheap relative to swaps when compared to 1y averages (chart 2).
FRF CPI swaps from 5y are cheap relative to EUR when compared to past
averages—more than one standard-deviation in 10y (chart 3). The Livret A rate
is likely to remain low, and better economic prospects could lead to some reallocation into other investments. At the same time, higher yields would mean
better hedging terms and a rising probability of pent-up hedging demand
materializing. We would have a bias towards wider FRF/EUR spreads in 10y. At
the short-end, we prefer EUR over FRF. 2y spreads are high relative to past
averages (chart 3), and in our view too wide relative to the economic and
inflation outlook. Rising VAT may well push French inflation above the EUR
aggregate in early 2014, but leading indicators, such as business surveys of
price setting intentions, have been weaker in France than elsewhere. We are
short 1y1y FRF CPI against EUR.
5. USD 5y CPI cheap v 2y/10y
25
US5 US2 US10
20
average
15
10
5
0
-5
-10
Jan-12
Jun-12
Nov-12
Apr-13
Sep-13
Source: Deutsche Bank
6. GBP 10y RPI rich v 5y/30y
0
-5
-10
-15
UK10 UK5 UK30
-20
average
-25
Dec-10
May-11
Oct-11
Mar-12
Aug-12
Jan-13
Jun-13
Nov-13
Source: Deutsche Bank
USD: Chart 7 shows (3m, 6m, 1y and 2y) z-scores for some USD CPI curve
spreads and flies. The 5y point appears to be sticking out as relatively cheap by
historical standards. 2y5y is flatter than average and 5y10y steeper than 6m,
1y or 2y averages, despite having flattened somewhat over the past three
months (chart 7). As a result, the 2y5y10y fly is about one standard-deviation
below longer averages (chart 7), although off the extremes seen around the
turn of the year (chart 5). 10y30y looks somewhat steep relative to the ‘twist’
period, but is in line with more recent averages.
8. GBP RPI spreads & flies: z-scores
7. USD CPI spreads & flies: z-scores
1.5
USD CPI swaps: z-scores
1.0
3m
6M
4.0
1Y
2Y
3.0
GBP CPI swaps: z-scores
3m
6M
1Y
2Y
2.0
0.5
1.0
0.0
0.0
-0.5
-1.0
-1.0
-2.0
-1.5
-3.0
2Y5Y
Source: Deutsche Bank
Page 84
5Y10Y
10Y30Y
2Y5Y10Y
5Y10Y20Y
5Y10Y30Y
2Y5Y
5Y10Y
10Y30Y
2Y5Y10Y
5Y10Y20Y
5Y10Y30Y
Source: Deutsche Bank
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
GBP: Chart 8 shows equivalent z-score metrics for GBP RPI. 2y5y looks steep v
past averages, but that would seem justified given that (i) spot inflation has
eased a little from the unusually high levels seen over the past few years and
(ii) an economic recovery and resulting policy rate normalization could be
expected to benefit 5y B/Es via expectations of a rise in cyclical inflation,
higher MIPS inflation and wider inflation risk premia. We would see scope for
further 1y5y steepening, and see medium-term upside for 5y B/Es.
9. EUR 10y HICP rich v 5y/30y
4
EU10 EU5 EU30
2
average
0
With 5y10y still somewhat steep, and 10y30y having flattened ahead of longend supply later this month, 10y looks rich in the 5y10y30y fly (chart 8) which
has moved towards extremes recently (chart 6). We would expect the long-end
to recover post UKTi syndication and into the more LDI active period at the end
of the fiscal year, and like short 10y v 5y and 30y RPI.
-2
-4
-6
-8
-10
-12
Dec-10
EUR: The EUR swap curve remains very steep out to 10y, despite some
flattening since the start of the year, with 2y5y and 5y10y spreads significantly
above past averages; 10y30y on the other hand is not particularly steep by
historical standards (chart 11). A subdued near-term inflation outlook probably
justifies the wide 2y5y spread, and we would see scope for 2y1y or 3y1y
forwards to rise if spot inflation stabilizes and economic growth continues to
recover as we expect.
May-11
Oct-11
Mar-12
Aug-12
Jan-13
Jun-13
Nov-13
Source: Deutsche Bank
10. FRF CPI: 10y20y steeper in 2013
30
FR20 FR10
25
average
20
15
The 10y point on the other hand looks extreme; the 5y10y30y fly is well above
past averages (chart 11), and remains close to 3y highs (chart 9). It has shown
some directionality in the past, with 10y outperforming in a B/E sell-off, so
being short this fly would likely benefit from any normalization in B/Es. On the
other hand, should deflation concerns increase significantly, 9y1y at around
2.50% (more than 100bps above 2y1y) could fall, and 10y30y steepen.
10
5
0
-5
Dec-10
May-11
Oct-11
Mar-12
Aug-12
Jan-13
Jun-13
Nov-13
Source: Deutsche Bank
FRF: Contrary to EUR, 10y looks somewhat cheap on the FRF CPI curve. 5y10y
has recently flattened (while remaining relatively steep from a long-term
perspective, chart 12), and 10y20y has steepened significantly through 2013
(chart 10); as a result, the 5y10y20y fly is about one standard-deviation cheap
compared to past averages (chart 12). To some extent, the 10y20y steepening
in 2013 can however probably be seen as a normalisation from unusually flat
levels on the back of strong hedging demand in 5y and 10y (chart 10), and this
slope still remains less steep than in EUR.
12. FRF CPI spreads & flies: z-scores
11. EUR HICP spreads & flies: z-scores
2.0
EUR HICP swaps: z-scores
3m
1.5
1Y
2.0
6M
FRF CPI swaps: z-scores
1.5
2Y
3m
6M
1Y
2Y
1.0
1.0
0.5
0.5
0.0
0.0
-0.5
-0.5
-1.0
-1.0
-1.5
-1.5
-2.0
2Y5Y
5Y10Y
10Y30Y
Source: Deutsche Bank
Deutsche Bank AG/London
2Y5Y10Y
5Y10Y20Y
5Y10Y30Y
2Y5Y
5Y10Y
10Y20Y
2Y5Y10Y
5Y10Y20Y
5Y10Y30Y
Source: Deutsche Bank
Page 85
17 January 2014
Global Fixed Income Weekly
Auction Calendar
Market
Ticker/Coupon/Maturity
AUSTRALIA
AUSTRIA
BELGIUM
CANADA
ACGB
4.75%
Nothing Expected
Nothing Expected
DENMARK
FINLAND
FRANCE
Tap/New Issue
Size
04/27 Fri, 24 Jan 2014
Date
Tap
AUD 800 mn
DGB
1.5%
DGB
4.5%
Nothing Expected
11/23 Tue, 21 Jan 2014
11/39 Tue, 21 Jan 2014
Tap
Tap
TBA
BTF
BTF
BTF
04/14 Mon, 20 Jan 2014
06/14 Mon, 20 Jan 2014
01/15 Mon, 20 Jan 2014
New Issue
Tap
Tap
Nothing Expected
0%
0%
0%
Upto EUR 4.5 bn
Upto EUR 2.2 bn
Upto EUR 2.2 bn
BTNS
FRTR
FRTR
0.45%
0.25%
0.25%
07/16 Thu, 23 Jan 2014
07/18 Thu, 23 Jan 2014
07/24 Thu, 23 Jan 2014
Tap
Tap
Tap
FRTR
FRTR
FRTR
3.25%
1%
1%
04/16 Thu, 23 Jan 2014
05/18 Thu, 23 Jan 2014
05/19 Thu, 23 Jan 2014
Tap
Tap
New Issue
12/15 Wed, 22 Jan 2014
Tap
EUR 7.0-8.0 bn
EUR 4 bn
03/14
12/18
04/14
12/33
04/14
06/14
EUR 1.2-1.7 bn
GERMANY
GREECE
IRELAND
ITALY
BKO
0%
Nothing Expected
Nothing Expected
JAPAN
JGB
0%
JGB
1.4%
JGB
0%
JGB
1.9%
DTB
0%
DTB
0%
Nothing Expected
Nothing Expected
Nothing Expected
SAGB
8%
SAGB
8.5%
SAGB
8.75%
SGLT
0%
SGLT
0%
SWTB
0%
SGBi
0.5%
Tue, 21 Jan 2014
Tue, 21 Jan 2014
Thu, 23 Jan 2014
Thu, 23 Jan 2014
Mon, 20 Jan 2014
Mon, 20 Jan 2014
New Issue
Tap
New Issue
Tap
Tap
Tap
JPY 2500 bn
JPY 2700 bn
JPY 5700 bn
JPY 1200 bn
Upto EUR 2 bn
Upto EUR 2 bn
01/30 Tue, 21 Jan 2014
01/37 Tue, 21 Jan 2014
02/48 Tue, 21 Jan 2014
07/14 Tue, 21 Jan 2014
01/15 Tue, 21 Jan 2014
04/14 Wed, 22 Jan 2014
06/17 Thu, 23 Jan 2014
Tap
Tap
Tap
Tap
New Issue
Tap
Tap
ZAR 550 mn
ZAR 1 bn
ZAR 800 mn
SWITZERLAND
SWISTB
04/14 Tue, 21 Jan 2014
New Issue
TBA
UK
UKT
UKTB
B
B
B
TII
09/23 Thu, 23 Jan 2014
TBA Fri, 24 Jan 2014
04/14 Wed, 22 Jan 2014
07/14 Wed, 22 Jan 2014
02/14 Thu, 23 Jan 2014
01/24 Fri, 24 Jan 2014
Tap
Tap
Tap
Tap
TBA
New Issue
GBP 3.25 bn
TBA
USD 28 bn
USD 25 bn
TBA
USD 15 bn
NETHERLANDS
NEW ZEALAND
NORWAY
PORTUGAL
SOUTH AFRICA
SPAIN
SWEDEN
US
Nothing Expected
0%
2.25%
0%
0%
0%
0.5%
TBA
SEK 10 bn
SEK 1 bn
Source: Deutsche Bank
Page 86
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
Contacts
Name
Title
Telephone
Email
Head of European Rates Research
44 20 7545 4017
[email protected]
EUROPE
Francis Yared
Alexander Düring
Euroland & Japan RV
44 207 545 5568
[email protected]
Global Inflation Strategy
44 20 754 52167
[email protected]
Covered Bonds/SSA
41 44 227 3710
[email protected]
Global RV & Rates Vol
33 1 44 95 64 08
[email protected]
Euroland Strategy/ EUR Govt. bonds
44 20 754 74458
[email protected]
UK Strategy & Money Markets
44 20 7547 3091
[email protected]
Nordic & Swiss Strategy
44 20 7545 2424
[email protected]
Nick Burns
Credit Strategy
44 20 7547 1970
[email protected]
Stephen Stakhiv
Credit Strategy
44 20 7545 2063
[email protected]
Sebastian Barker
Markus Heider
Bernd Volk
Jerome Saragoussi
Abhishek Singhania
Soniya Sadeesh
Christian Wietoska
Credit Strategy
44 20 754 71344
[email protected]
Conon O’Toole
ABS Strategy
44 20 7545 9652
[email protected]
Paul Heaton
ABS Strategy
44 20 7547 0119
[email protected]
Rachit Prasad
ABS Strategy
44 20 7547 0328
[email protected]
US
Dominic Konstam
Global Head of Rates Research
1 212 250 9753
[email protected]
Steven Abrahams
Head of MBS & Securitization Research
1-212-250-3125
[email protected]
Aleksandar Kocic
US Rates & Credit Strategy
1 212 250 0376
[email protected]
Alex Li
US Rates & Credit Strategy
1 212 250 5483
[email protected]
Richard Salditt
US Rates & Credit Strategy
1 212 250 3950
[email protected]
Stuart Sparks
US Rates & Credit Strategy
1 212 250 0332
[email protected]
Daniel Sorid
US Rates & Credit Strategy
1 212 250 1407
[email protected]
Steven Zeng
US Rates & Credit Strategy
1 212 250 9373
[email protected]
Head of APAC Rates Research
61 2 8258 1475
[email protected]
Japan Strategy
81 3 5156 6622
[email protected]
ASIA PACIFIC
David Plank
Makoto Yamashita
Kenneth Crompton
$ bloc RV
61 2 8258 1361
[email protected]
Head of Asia Rates & FX Research
65 6423 6973
[email protected]
Asia Strategy
852 2203 8709
[email protected]
Asia Rates Strategy
65 6423 5925
[email protected]
Asia Strategy
852 2203 5932
[email protected]
Head of European FX and cross markets
strategy
44 20 754 79118
[email protected]
Sameer Goel
Linan Liu
Swapnil Kalbande
Kiyong Seong
CROSS-MARKETS
George Saravelos
Source: Deutsche Bank
Deutsche Bank AG/London
Page 87
17 January 2014
Global Fixed Income Weekly
Appendix 1
Important Disclosures
Additional information available upon request
For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this
research, please see the most recently published company report or visit our global disclosure look-up page on our
website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr
Analyst Certification
The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s). In addition,
the undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation
or view in this report. Francis Yared/Dominic Konstam
Page 88
Deutsche Bank AG/London
17 January 2014
Global Fixed Income Weekly
Regulatory Disclosures
1. Important Additional Conflict Disclosures
Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the
"Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing.
2. Short-Term Trade Ideas
Deutsche Bank equity research analysts sometimes have shorter-term trade ideas (known as SOLAR ideas) that are
consistent or inconsistent with Deutsche Bank's existing longer term ratings. These trade ideas can be found at the
SOLAR link at http://gm.db.com.
3. Country-Specific Disclosures
Australia and New Zealand: This research, and any access to it, is intended only for "wholesale clients" within the
meaning of the Australian Corporations Act and New Zealand Financial Advisors Act respectively.
Brazil: The views expressed above accurately reflect personal views of the authors about the subject company(ies) and
its(their) securities, including in relation to Deutsche Bank. The compensation of the equity research analyst(s) is
indirectly affected by revenues deriving from the business and financial transactions of Deutsche Bank. In cases where
at least one Brazil based analyst (identified by a phone number starting with +55 country code) has taken part in the
preparation of this research report, the Brazil based analyst whose name appears first assumes primary responsibility for
its content from a Brazilian regulatory perspective and for its compliance with CVM Instruction # 483.
EU
countries:
Disclosures
relating
to
our
obligations
under
MiFiD
can
be
found
at
http://www.globalmarkets.db.com/riskdisclosures.
Japan: Disclosures under the Financial Instruments and Exchange Law: Company name - Deutsche Securities Inc.
Registration number - Registered as a financial instruments dealer by the Head of the Kanto Local Finance Bureau
(Kinsho) No. 117. Member of associations: JSDA, Type II Financial Instruments Firms Association, The Financial Futures
Association of Japan, Japan Investment Advisers Association. This report is not meant to solicit the purchase of specific
financial instruments or related services. We may charge commissions and fees for certain categories of investment
advice, products and services. Recommended investment strategies, products and services carry the risk of losses to
principal and other losses as a result of changes in market and/or economic trends, and/or fluctuations in market value.
Before deciding on the purchase of financial products and/or services, customers should carefully read the relevant
disclosures, prospectuses and other documentation. "Moody's", "Standard & Poor's", and "Fitch" mentioned in this
report are not registered credit rating agencies in Japan unless "Japan" or "Nippon" is specifically designated in the
name of the entity.
Malaysia: Deutsche Bank AG and/or its affiliate(s) may maintain positions in the securities referred to herein and may
from time to time offer those securities for purchase or may have an interest to purchase such securities. Deutsche Bank
may engage in transactions in a manner inconsistent with the views discussed herein.
Russia: This information, interpretation and opinions submitted herein are not in the context of, and do not constitute,
any appraisal or evaluation activity requiring a license in the Russian Federation.
Risks to Fixed Income Positions
Macroeconomic fluctuations often account for most of the risks associated with exposures to instruments that promise
to pay fixed or variable interest rates. For an investor that is long fixed rate instruments (thus receiving these cash
flows), increases in interest rates naturally lift the discount factors applied to the expected cash flows and thus cause a
loss. The longer the maturity of a certain cash flow and the higher the move in the discount factor, the higher will be the
loss. Upside surprises in inflation, fiscal funding needs, and FX depreciation rates are among the most common adverse
macroeconomic shocks to receivers. But counterparty exposure, issuer creditworthiness, client segmentation, regulation
(including changes in assets holding limits for different types of investors), changes in tax policies, currency
convertibility (which may constrain currency conversion, repatriation of profits and/or the liquidation of positions), and
settlement issues related to local clearing houses are also important risk factors to be considered. The sensitivity of fixed
income instruments to macroeconomic shocks may be mitigated by indexing the contracted cash flows to inflation, to
FX depreciation, or to specified interest rates - these are common in emerging markets. It is important to note that the
index fixings may -- by construction -- lag or mis-measure the actual move in the underlying variables they are intended
to track. The choice of the proper fixing (or metric) is particularly important in swaps markets, where floating coupon
rates (i.e., coupons indexed to a typically short-dated interest rate reference index) are exchanged for fixed coupons. It is
also important to acknowledge that funding in a currency that differs from the currency in which the coupons to be
received are denominated carries FX risk. Naturally, options on swaps (swaptions) also bear the risks typical to options
in addition to the risks related to rates movements.
Deutsche Bank AG/London
Page 89
David Folkerts-Landau
Group Chief Economist
Member of the Group Executive Committee
Guy Ashton
Global Chief Operating Officer
Research
Michael Spencer
Regional Head
Asia Pacific Research
Marcel Cassard
Global Head
FICC Research & Global Macro Economics
Ralf Hoffmann
Regional Head
Deutsche Bank Research, Germany
Richard Smith and Steve Pollard
Co-Global Heads
Equity Research
Andreas Neubauer
Regional Head
Equity Research, Germany
Steve Pollard
Regional Head
Americas Research
International Locations
Deutsche Bank AG
Deutsche Bank Place
Level 16
Corner of Hunter & Phillip Streets
Sydney, NSW 2000
Australia
Tel: (61) 2 8258 1234
Deutsche Bank AG
Große Gallusstraße 10-14
60272 Frankfurt am Main
Germany
Tel: (49) 69 910 00
Deutsche Bank AG London
1 Great Winchester Street
London EC2N 2EQ
United Kingdom
Tel: (44) 20 7545 8000
Deutsche Bank Securities Inc.
60 Wall Street
New York, NY 10005
United States of America
Tel: (1) 212 250 2500
Deutsche Bank AG
Filiale Hongkong
International Commerce Centre,
1 Austin Road West,Kowloon,
Hong Kong
Tel: (852) 2203 8888
Deutsche Securities Inc.
2-11-1 Nagatacho
Sanno Park Tower
Chiyoda-ku, Tokyo 100-6171
Japan
Tel: (81) 3 5156 6770
Global Disclaimer
The information and opinions in this report were prepared by Deutsche Bank AG or one of its affiliates (collectively "Deutsche Bank"). The information herein is believed to be reliable and has been obtained from public
sources believed to be reliable. Deutsche Bank makes no representation as to the accuracy or completeness of such information.
Deutsche Bank may engage in securities transactions, on a proprietary basis or otherwise, in a manner inconsistent with the view taken in this research report. In addition, others within Deutsche Bank, including
strategists and sales staff, may take a view that is inconsistent with that taken in this research report.
Opinions, estimates and projections in this report constitute the current judgement of the author as of the date of this report. They do not necessarily reflect the opinions of Deutsche Bank and are subject to change
without notice. Deutsche Bank has no obligation to update, modify or amend this report or to otherwise notify a recipient thereof in the event that any opinion, forecast or estimate set forth herein, changes or
subsequently becomes inaccurate. Prices and availability of financial instruments are subject to change without notice. This report is provided for informational purposes only. It is not an offer or a solicitation of an
offer to buy or sell any financial instruments or to participate in any particular trading strategy. Target prices are inherently imprecise and a product of the analyst judgement. As a result of Deutsche Bank’s March 2010
acquisition of BHF-Bank AG, a security may be covered by more than one analyst within the Deutsche Bank group. Each of these analysts may use differing methodologies to value the security; as a result, the
recommendations may differ and the price targets and estimates of each may vary widely. The financial instruments discussed in this report may not be suitable for all investors and investors must make their own
informed investment decisions. Stock transactions can lead to losses as a result of price fluctuations and other factors. If a financial instrument is denominated in a currency other than an investor's currency, a change
in exchange rates may adversely affect the investment. Past performance is not necessarily indicative of future results. Deutsche Bank may with respect to securities covered by this report, sell to or buy from
customers on a principal basis, and consider this report in deciding to trade on a proprietary basis.
Derivative transactions involve numerous risks including, among others, market, counterparty default and illiquidity risk. The appropriateness or otherwise of these products for use by investors is dependent on the
investors' own circumstances including their tax position, their regulatory environment and the nature of their other assets and liabilities and as such investors should take expert legal and financial advice before
entering into any transaction similar to or inspired by the contents of this publication. Trading in options involves risk and is not suitable for all investors. Prior to buying or selling an option investors must review the
"Characteristics and Risks of Standardized Options," at http://www.theocc.com/components/docs/riskstoc.pdf . If you are unable to access the website please contact Deutsche Bank AG at +1 (212) 250-7994, for a
copy of this important document.
The risk of loss in futures trading and options, foreign or domestic, can be substantial. As a result of the high degree of leverage obtainable in futures and options trading losses may be incurred that are greater than
the amount of funds initially deposited.
Unless governing law provides otherwise, all transactions should be executed through the Deutsche Bank entity in the investor's home jurisdiction. In the U.S. this report is approved and/or distributed by Deutsche
Bank Securities Inc., a member of the NYSE, the NASD, NFA and SIPC. In Germany this report is approved and/or communicated by Deutsche Bank AG Frankfurt authorized by the BaFin. In the United Kingdom this
report is approved and/or communicated by Deutsche Bank AG London, a member of the London Stock Exchange and regulated by the Financial Conduct Authority for the conduct of investment business in the UK
and authorized by the BaFin. This report is distributed in Hong Kong by Deutsche Bank AG, Hong Kong Branch, in Korea by Deutsche Securities Korea Co. This report is distributed in Singapore by Deutsche Bank AG,
Singapore Branch or Deutsche Securities Asia Limited, Singapore Branch (One Raffles Quay #18-00 South Tower Singapore 048583, +65 6423 8001), and recipients in Singapore of this report are to contact Deutsche
Bank AG, Singapore Branch or Deutsche Securities Asia Limited, Singapore Branch in respect of any matters arising from, or in connection with, this report. Where this report is issued or promulgated in Singapore to a
person who is not an accredited investor, expert investor or institutional investor (as defined in the applicable Singapore laws and regulations), Deutsche Bank AG, Singapore Branch or Deutsche Securities Asia
Limited, Singapore Branch accepts legal responsibility to such person for the contents of this report. In Japan this report is approved and/or distributed by Deutsche Securities Inc. The information contained in this
report does not constitute the provision of investment advice. In Australia, retail clients should obtain a copy of a Product Disclosure Statement (PDS) relating to any financial product referred to in this report and
consider the PDS before making any decision about whether to acquire the product. Deutsche Bank AG Johannesburg is incorporated in the Federal Republic of Germany (Branch Register Number in South Africa:
1998/003298/10). Additional information relative to securities, other financial products or issuers discussed in this report is available upon request. This report may not be reproduced, distributed or published by any
person for any purpose without Deutsche Bank's prior written consent. Please cite source when quoting.
Copyright © 2014 Deutsche Bank AG
GRCM2014PROD031217