Barclays Capital - The - W - Ides of March

INTEREST RATES RESEARCH
Global Rates Strategy | 30 March 2012
GLOBAL RATES WEEKLY The (w)ides of March?

As data has been inconclusive, peripheral Europe has again come under pressure as post LTROs, some profit taking has coincided with supply. Going forward, the dynamics of flow tilt towards continued supply concessions.
Global Views on a Page Global Traders Guide Global Economics Calendar 2 50 51 54 55
United States
Treasuries: A grinding rally 3 The Treasury market has partially reversed the sharp post-March FOMC selloff amid dovish Fedspeak, slight weakness in economic data, and a rise in risk aversion. We maintain our long 2y Treasuries view, as the OIS rate and the Tsy-OIS basis have room to decline. Agencies: Continuing resolutions Swaps: Tightening risks remain Money Markets: Too much cash TIPS: Relative value in relative ASWs Volatility: A time to sell 7 10 12 16 18
Global Supply Calendar Global Bond Yield Forecasts
United States Ajay Rajadhyaksha +1 212 412 7669 ajay.rajadhyaksha@barcap.com Michael Pond +1 (212) 412 5051 michael.pond@barcap.com Rajiv Setia +1 212 412 5507 rajiv.setia@barcap.com Europe Laurent Fransolet +44 (0) 20 7773 8385 laurent.fransolet@barcap.com
Europe
Futures: New 10yr OAT future analysis 21 Having introduced the new BTP future contracts over the past few years, Eurex is now launching a new 10y French (OAT) future on 16 April. We estimate FRTR 3.75% Apr 2021 as the CTD to the June 12 contract. Money Markets: ECB: To exit or not? Sovereign Spreads: Eurozone supply expectations for Q2 2012 24 28
UK: Institutional flows and long yields 31 The latest data on domestic institutional flows in the gilt market suggest that demand for linkers remains healthy despite real yield levels. Covered Bonds: Depfa ACS covered bonds downgradedby six notches SSA: The National Loan Guarantee Scheme Euro Inflation-Linked: Positioning for the carry upswing Volatility: Buy EUR mid-curve, sell US mid-curve 35 37 41 42
Alan James +44 (0) 20 7773 2238 alan.james@barcap.com Japan Chotaro Morita +81 (3) 4530 1717 chotaro.morita@barcap.com
Australia
A 40bp gain in three days. Can we expect more? 45 After a 40bp rally, we believe investors who entered a receive AU 1y1y earlier in the week should lock in their gains.
www.barcap.com
Japan
Seasonality and fundamentals 47 The markets may try to move based on the pattern of the past two years, in which yields hit their peak for the fiscal year in April. However, JGBs, which would normally cheapen relative to USTs during this period, are, in fact, rich currently and could enter a bear steepening trend in the coming weeks.
PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 56
Barclays | Title of Document Goes Here
VIEWS ON A PAGE
US
Direction The market has pulled forward Fed hike expectations in response to the better tone of the FOMC statement. We believe that the market is still being too aggressive. We maintain our long view on 2y Treasuries.
EUROPE
EUR rates markets have continued to rally on the week as some volatility has arrived for the EGB periphery. The ECB meeting is held next Wednesday; we expect the ECB to keep policy rates and liquidity measures on hold. Given the shift in recent rhetoric, Mr Draghi is likely to be questioned on the exit strategies. QE has been extended by 50bn, with the BOEs purchase programme continuing to see a net duration withdrawal from the market over the next three months. Keep Schatz/Bund steepener. Hold onto long EUR 2s/5s/10s 6m fwd. For long-end steepening, receive EUR 5y5y fwd/5y10y fwd/5y15y fwd and long EUR 5s/10s/30s. UK: the redefining of the maturity baskets for the BOEs reverse operations leaves potential buying more evenly distributed. The 20y sector has borne the brunt of the curve correction but should stabilise here. Fall in realised vol leaves carry/vol ratio highest for bonds in the 2017-2020 part of the gilt curve. Change in MPC rhetoric should see bearish resteepening of the GBP forward curve. Pay GBP 1y2yf/1y4yf spread. EUR: Our tactical long Bund ASW from 35-40bp range is close to our target, start reducing the position. GBP: 10y10y fwd ASW is cheap relative to other parts of the ASW curve. Long 20yr ASW vs 10yr ASW. Retain long Gilts versus Bunds. Yield plus roll and carry pick-up is of increasing interest to international investors. Long 30y gilts versus Germany or AAA Europe. SEK: Hold Sept 12/Sept 13/Sept 14 FRA spread wideners and hold Dec 12/Dec 12 steepeners. Hold SEK/EUR 2y2y/5y5y fwd steepeners and 5y SGB (1050) ASW tighteners. , NOK: Hold 2s5s10s tighteners. Hold cross-market tighteners in 5y5yfwd versus EUR. Keep long 5yr Netherlands versus 50% 5yr France and 50% Belgium. OATi15 still offers tactical breakeven value into the positive carry season. New-style 3m lag UK linkers are rich to old-style issues, but April carry likely to be more positive for new-styles.
JAPAN
JGB markets have entered a correction phase, but the conviction among investors that the policy duration effect of the BoJs monetary easing will support the short and intermediate sectors may be sustaining the cash bond curve at rich levels. As the intermediate and long JGB sectors catch up with the steep falloff in futures, we would recommend a 5y or 10y JGB short or butterfly spread long on futures. JGB 5-7-10 long with short bias at 10y. JGB 7-10-20 short.
Curve/ Curvature
Remain 10s30s Treasury curve steepeners ahead of the bond auction. Expectations of QE3 have been greatly pared back. We remain long the 5s10s30s fly.
Swap spreads
FV invoice spreads as a dislocation trade. Receive 7s-10s-30s (2/3:1:1/3 wts) as a dislocation trade. 30y spread tighteners for asymmetric tightening risk. Front-end agencies have continued to outperform Treasuries; we recommend moving out to the 5y sector or owning frontend MTNs. Short-dated callables offer an opportunity to fade the sell-off in rates and spike in vol. We remain constructive on Canadian covered bonds, given their relative isolation from Europe and continued significant spread pickup to agencies.
20y ASW long vs 3m. Long 10y ASWand futures ASW. Short 5Y ASW. 20y 3v6 tightener. 5-10y Tibor-Libor spread steepener. (Note: for clarity, TiborLibor widener means that the swap rate against Tibor increases more than the swap rate against Libor. Therefore, steepener means that the 10y Tibor-Libor spread widens more than the 5y Tibor-Libor spread. In previous issues, we called it a 5-10y Tibor-Libor spread flattener.)
Other spread sectors
Inflation
Volatility
Neutral on breakevens outside the very front end; overweight on 30y breakevens versus 10s. Positive on Jul12s, hedged with crude puts. Long 10y relative TIPS ASWs, as the sector looks cheap. Long the belly of Jan16-Apr16-Jul16 real yield fly, as the floor premium on new 5s could rise with risk aversion. Sell mid-tail gamma (TY/ 3m*10y) to position for rates remaining in a rage. Buy 30y tails versus 10y tails, as the Fed would likely remain dovish longer than needed and little support from MBS hedgers is priced in.
Take profit on long BEI.
Buy EUR gamma vs. US gamma as levels are attractive and the risk of an event lingers on. Initiate 2y*5y - 2y*30y bear steepeners capped with SL curve caps.
Long 3mx10y volatility.
Source: Barclays Research
30 March 2012
Barclays | Global Rates Weekly
UNITED STATES: TREASURIES
A grinding rally
Anshul Pradhan +1 212 412 3681 anshul.pradhan@barclays.com
The Treasury market has partially reversed the sharp post-March FOMC selloff amid dovish Fedspeak, slight weakness in economic data, and a rise in risk aversion. We maintain our long 2y Treasuries view, as the OIS rate and the Tsy-OIS basis have room to decline. We also recommend initiating 10s30s curve steepeners to benefit from the auction concessions shift to the long end of the curve. The Treasury market rallied over the past week, with 10y yields declining to 2.16%, partially reversing the roughly 40bp selloff since the March FOMC meeting. While economic data have been somewhat on the weaker side since then, especially on housing and initial claims, and risk aversion has increased, with Italian and Spanish government bonds underperforming their German counterpart (Figure 1), statements from Chairman Bernanke suggesting caution have played a significant role as well. In his latest speech, Bernanke focused not just on the unemployment rate but also on the high level of long-term unemployed and the weakness in overall activity, suggesting that the Fed is not tied to one specific measure, which may have been the perception coming out of the March FOMC meeting. While the Chairman could very well be wrong in his explanation of the faster decline in the unemployment rate than should have been expected, given the pace of GDP growth, his focus on overall activity suggests that a continuation of the downward trend in the unemployment rate alone would not be enough to change his cautious view of the recovery. Price action since the peak of the selloff suggests expectations of a dovish Fed have been rebuilding. Figure 2 shows that 10y real yields have partially reversed the selloff and 10y breakevens, which had widened despite a hawkish perception of the Fed, simply reflecting, in our view, bad positioning in the nominal market, have also tightened. As we have argued recently (Will the bond market selloff be sustained, March 22, 2012), modest medium-term growth expectations amid the threat from fiscal tightening, tight credit conditions, and weakness in wage appreciation should keep a lid on rates.
Figure 1: Italian and Spanish government bonds underperformed over the past week
Spread vs 10y German bonds, bp 600 550 500 450 400 350 300 250 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Italy
Figure 2: 10y real yields fell and breakevens tightened, partially correcting the dislocation in the selloff
0 -10 -20 -30 -40 -50 Jan-23 Feb-07 Feb-22 10y breakevens, bp, rhs
250 Dovish Fed 240 230 220 210 Hawkish Fed Mar-08 Mar-23 200
Spain
Source: Bloomberg
10y real yields, bp, lhs
30 March 2012
Figure 3: Fed fund expectations have become more realistic

35 30 25 20 15 10
Figure 4: More room to go in the front end

100
75
50
25 5 0 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 2y OIS Rates, bp

Source: Bloomberg, Barclays Research
Effective Fed Funds Rate, bp
0 Apr-12 Oct-12 Apr-13 Oct-13 Fed Fund Futures,bp, As of Mar 29

Source: Bloomberg
Apr-14 Oct-14 As of Jan 31, bp
Maintain the long 2y Treasuries recommendation

In the near term, we maintain our long view on 2y Treasuries, which should benefit from a further decline in Fed hike expectations and from the tightening of the Treasury-OIS basis. Figure 3 shows that the 2y OIS rate, well within the late 2014 guidance, is still trading above post-March payroll levels and well above post-January FOMC levels, when the Fed introduced the late 2014 guidance. While better economic data since January do argue for a higher funds rate at the end of 2014, near-term pricing looks aggressive; Figure 4 shows that expectations for the next 1 year are 5bp higher. With the effective funds rate now beginning to decline, 2y OIS rates should trade at 15-20bp, compared with the current 24bp. The Treasury-OIS basis should also richen as primary dealer inventories decline in the near term, led by negative bill supply, and over the longer term, as the effect of Operation Twist fades. Figure 5 shows that the overnight GC-FF spread has been driven largely by the level of primary dealer inventory of US Treasuries; a rise in the latter leads to additional financing needs on behalf of dealers, which pushes the GC rate higher relative to the effective fed funds rate. In recent months, dealer inventories have risen not just in the <3y coupon sector, where the Fed is selling, but also in the bill sector, where supply has seasonally picked up (Figure 6). Figure 5: GC-FF spread has risen due to primary dealers having to finance elevated inventory of US Treasuries
120 100 80 60 40 20 (20) (40) (60) (80) Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Primary Dealer Inventory of US Tsys, $bn, LHS GC-FF Spread, 5d MA, bp, RHS
Source: New York Fed, Bloomberg, Barclays Research
Figure 6: Primary dealer inventory of US Treasuries in the <3y sector should gradually normalize
10 8 6 4 2 0 -2 -4 -6 -8
Primary Dealer Inventories, $bn 80 60 40 20 (20) (40) (60) (80) (100) Jan-10 Jul-10 Bills
Source: New York Fed, Barclays Research
Jan-11 <3y
Jul-11
Jan-12 >3y
30 March 2012
We expect bill supply to turn negative over the next few months as the Treasurys borrowing requirements fall below net coupon issuance. In Figure 7, we plot net bill supply over a one-month period against the 1m moving average of the GC-FF spread. As can be seen, net monthly bill supply peaked at $120bn on March 8 and should be -$75bn over April and -$30bn over May. This should not only ease the burden of primary dealers, but also lower the available supply for final investors, such as money market funds, who should in turn find repos attractive forcing repo rates lower at the same time. Over a longer horizon, as the effect of Operation Twist fades, dealer inventories in the <3y sector should normalize; pre-Operation Twist, they were close to 0 on average, compared with the latest ~$40bn. While there are still three months left until the scheduled end of the program, Figure 8 shows that the 2y Treasury-OIS basis reacts in advance of the actual event materializing. For instance, when Operation Twist was being priced in, the 2y basis cheapened and but it began richening later even as dealer inventories were rising and overnight GC-FF spread was widening. In other words, investors had already priced this in. Extending the same argument, investors should price in the reversal in advance as well. Hence, we maintain our long 2y Treasuries view. In our opinion, the risk-reward is better with outright long 2y Treasuries rather than the Treasury-OIS basis, as sterilized QE3 may widen the basis, but at the same time, for QE3 to occur, there should be a loss in growth momentum, which should lead to Fed hikes being pushed out. In addition, while sterilized QE3 argues for a cheaper basis, the cheapening should happen from richer levels, not from current ones. 2y Treasury yields should trade at 25-30bp.
Recommend 10s30s curve steepeners ahead of the bond auction

Separately, we recommend initiating 10s30s curve steepeners as the auction concession shifts to the long end of the Treasury curve. While the curve has indeed steepened from the lows, it seems that this was simply a payback of the earlier flattening. Figure 9 shows that the 10s30s curve is trading close to our fair value estimate of 111bp. From March 9 to March 23, the curve flattened 8bp, whereas our model implied a flattening of 4bp; in the steepening since then, the error to our model has shrunk to 0bp, suggesting that excess flattening was being reversed over the past few days.
Figure 7: Net bill supply should turn negative over the coming months, which should also lower dealer inventories
$bn 150 100 50 0 -50 -100 -150 Jan-11 bp 8 6 Forecast 4 2 0 -2 -4 -6 -8 Apr-11 Jul-11 Oct-11 Feb-12 May-12 Net Bill Supply, 1M Rolling Sum, $bn, LHS GC-FF Spread, 1M Rolling Average, bp, RHS
Source: New York Fed, Treasury, Barclays Research
Figure 8: 2y Treasuries cheapened to OIS even before the rise in inventory and GC-FF basis; expect the reverse as well
14 12 10 8 6 4 2 0 (2) Jul-10 Nov-10 Mar-11 Jul-11 Nov-11 Mar-12 2y Tsy-OIS basis,bp, LHS Primary Dealers' Govt Inventory, $bn, RHS
120 100 80 60 40 20 (20) (40) (60)
30 March 2012
Figure 9: The recent steepening simply a payback for the excessive flattening in the selloff; curve close to fair
bp 170 150 130 Reaction to language change Reaction to QE2
Figure 10: Expect the 10s30s curve to continue to steepen ahead of the bond auction
4.0 2.0 (2.0) Change in 10s30s curve ahead of the bond auction, bp
110 90 70 50 Sep-09 Reaction to Operation Twist
111
(4.0) (6.0) (10) (8) Days from the bond auction (6) (4) (2) 2 4 6 8 10
Non Refunding since Jan 2011 Ex Sep Mar-10 Sep-10 Mar-11 Aug-11 Feb-12 Refunding since Jan 2011 Average since Jan2011
10s30s Treasury Curve
Estimate
Note: Estimate reflects 20bp of flattening related to Operation Twist. Source: New York Fed, Barclays Research
We believe the curve can steepen another 5-6bp following month-end. Figure 10 shows that the curve typically steepens ahead of the bond auction; interestingly, the bulk of the steepening in a non-refunding auction happens well before the auction date. In a refunding auction, the market typically underestimates the concession needed to absorb the extra $3bn, which usually leads to those auctions tailing (over the past year, refunding auctions have tailed by 4.0bp on average, whereas non-refunding auctions have come through by 0.6bp).
30 March 2012
UNITED STATES: AGENCIES
Continuing resolutions
James Ma +1 212 412 2563 james.ma@barcap.com Rajiv Setia +1 212 412 5507 rajiv.setia@barcap.com
With the spike in rates having reversed halfway, we maintain our view on selling vol in parts of the surface that have not fully retraced by owning agency callables. USD covered bond outperformance amid record supply has been impressive and should continue.
Own callables to position for a continued reversal in rates/vol

Over the past 1-2 weeks, the sharp selloff in rates and spike in vols that gripped the market for much of the prior months has reversed roughly halfway. As we highlighted earlier, 1 we believe the impetus for the moves were imbalances in positioning, rather than a fundamental shift in the economic backdrop; we expect the reversal to continue. In our view, the rates market is still overestimating the probability of a Fed hike by YE13, which should keep a lid on front-end Treasury yields. Also, we expect vol to continue to subside as a rangebound rate environment is re-established. In particular, we favor selling gamma on 5y tails, which had reached as low as the mid-50s earlier in the year, before spiking to the mid-80s and now retracing about half that amount. Keep in mind that gamma on 5s has declined the least on the vol surface, as other parts have almost fully retraced to pre-selloff levels (Figure 1); thus, we believe it has the most room to decline. Against this backdrop, we maintain our view that investors should position for a further reversal in rates and vol by owning agency callables. Given the above discussion, we favor 5nc6m and 5nc1 structures. For example, an FHLMC 5nc6m European (2% 2/17s, trading above par), offers almost 90bp of protection against a selloff in 4.5y agency bullet rates over the next 6m. In our view, this amount of belly underperformance/agency-Treasury spread widening seems unrealistic.
Agency bellwether outperformance hits turbulence

Agencies have cheapened 1-2bp to Treasuries over the last 1.5 weeks of March, despite no threat of supply (Figure 2). While spread levels in the high single digits are unpalatable, we reiterate our view that the combination of rangebound rates and declining overall supply of Figure 1: 5y tails have not retraced on the vol surface
Change (3/9 - 3/28) 3m 6m 1y 2y 3y 5y 10y
Figure 2: Agency-Treasury spreads leak wider

bp
1y -5 -3 0 7 5 -1 -3
2y 0 1 4 6 4 -1 -3
5y 8 6 3 4 2 -2 -3
7y 6 4 1 1 0 -2 -3
10y 4 3 0 0 -2 -3 -3
30y -1 -2 -2 -2 -4 -4 -3
60 50 40 30 20 10 0 01-Jan-12
22-Jan-12
12-Feb-12
04-Mar-12 25-Mar-12 5y Agy-T 10y Agy-T
2y Agy-T
1
3y Agy-T
Source: Barclays Research Time to buy callables, Market Strategy Americas, 9 March 2012
30 March 2012
spread product (as evidenced by just $4bn of agency bellwether issuance in March) should keep spreads well supported. In addition, investors should be more willing to extend out the curve to pick up spread over time, and we continue to recommend owning agency bellwethers, particularly the 5y sector at ca. +21bp to matched-date Treasuries. For investors seeking further spread pickup in the front end, we suggest opportunities in MTN space (Figure 3); with bellwether supply dwindling, the liquidity premium for MTNs and other non-bellwethers should continue to decrease.
Studying abroad
While agency supply has been moribund of late, there has been record issuance of $16bn in USD covered bond issuance this month, versus a $4bn average in January-February (Figure 4). Of this amount, $7.5bn originated from Australian, Nordic, and Swiss issuers, which is surprising because they lack the benefit of government-guaranteed collateral in the cover pool common to most Canadian names. Importantly, valuations have not suffered despite the supply, highlighting the degree of demand; non-Canadian names have outperformed, likely reflecting improved investor attitudes towards riskier assets (Figure 5). We expect valuations to remain supported by relatively attractive spread levels and a dearth of competing product. However, worries about a global slowdown and/or a flare in European risk remain obvious risks. This last point has made us of two minds on the potential for further outperformance in SSA names. Note that we have been cautiously constructive on SSA names since last December, 2 but are becoming less so given their recent outperformance. At these levels, we are becoming more wary of sovereign risk-related concerns resurfacing. However, we are mindful that the calendar is entering a seasonal lull in supply for SSA paper after many issuers prefunded in January-February (Figure 4), which could keep spreads grinding tighter. For now, we remain constructive on the sector and believe investors should continue to harvest new issue concession in SSA paper, such as the recently issued 5y EIB USD benchmark (1.125% 6/17s), trading at L+25bp, or about 30bp behind agencies (Figure 6).
Figure 3: MTN pickup in the front end

L Spd, bp 100 80 60 40 20 0 -20 -40 0 5 10 Bellwether
2
Figure 4: USD covered bond issuance accelerates

$ bn 35 30 25 20 15 10 5 15 MTN
20
0 Jan-10
Jun-10
Nov-10
Apr-11 SSA
Sep-11
Feb-12
Covered
2012 Outlook: US Agencies, 14 December 2011
30 March 2012
Legislative developments underwhelm

Although the new Canadian government budget provided sparse details beyond heavier regulation of CMHC while allowing it to regulate a post-framework covered bond market, the eventual release of the legislative framework is expected to have implications for that countrys covered bond market, in two main aspects: Consistent with remarks by Finance Minister Flaherty, we believe the government could seek to reduce the availability of mortgage credit by limiting the amount of CMHCinsured collateral eligible for cover pools. It is not known if existing programs would be grandfathered. More broadly, the CMHC is nearing its CAD600bn limit on the notional amount of insurance written. While in the past Parliament has generally raised the limit without question whenever it was neared, the aforementioned stances within the government could lead to more resistance as legislators seek to reduce the leverage and overall risk posed to the system by what is perceived as excessive mortgage lending. We await further details before assessing specific implications for existing bonds. Here in the US, there has been very slow progress on GSE reform, despite Treasury Secretary Geithners comments that an update is forthcoming from his department soon. It remains unclear if this is a follow-up to the existing white paper or a substantially new proposal. In any case, there has been little progress from Congress, from where any real plan for housing finance/GSE reform would have to originate. Congress has already dragged its feet on the covered bond legislation; S 1435 is in limbo awaiting a SBC hearing, and HR 940 has yet to be picked up by Ways and Means, despite having received at least one extension which runs out on March 30. We reiterate our view that consensus on true GSE reform will take several years, if not decades, to accomplish.
Figure 5: But valuations do not necessarily suffer

L Spd, bp 160 140 120 100 80 60 40 20 0 26-May-11
Figure 6: Supras outperform, remain behind agencies

L Spd, bp 80 70 60 50 40 30 20 10 0 -10 Jul-11
26-Aug-11
26-Nov-11
26-Feb-12
CS 2.6 5/16 SPNTAB 2.125 8/16

BNS 2.15 8/16 ANZ 2.4 11/16
Sep-11 FNM 5y
Nov-11 FRE 5y
Jan-12
Mar-12 EIB 5y
KFW 5y
30 March 2012
UNITED STATES: SWAPS
Tightening risks remain

Amrut Nashikkar +1 212 412 1848 amrut.nashikkar@barcap.com
We believe that there are significant tightening risks to 10y spreads and would recommend going into wideners only if they go negative because of a spike in financial issuance. We continue to favor FVM2 invoice spread wideners relative to 10y spreads. The rate sell-off that began after payrolls in early March seems firmly in the rear-view mirror, as the market is coming to terms with the Feds view that the unemployment rate should stop falling; as a result, the probability of another round of asset purchases is higher than the market had thought. Rates have rallied all week, and spreads are marginally tighter. In More price action = more trade opportunities, published in Market Strategy Americas, March 15, we made the case that 10y spread wideners were appropriate for investors who believe that QE3 will not occur. In our view, this was because QE3 would likely take the form of mortgages purchases, which would put tightening pressure on spreads. This effect is in contrast with asset purchases of Treasuries in the belly and the long end of the curve, which would put widening pressure on spreads. In our view, it was too early for the market to begin pricing in Fed hikes in 2013; as a result, we believed that any sell-off in 10y rates would be an opportunity to go long and any consequent widening of spreads would be an opportunity to put on tighteners. However, during the most recent sell-off in rates, convexity flows do not appear to have had a significant effect on swaps, even though mortgage durations extended. This would lead some to question whether QE3 could lead to spread tightening because of mortgage hedgers. Traditionally, increases/decreases in durations of mortgage portfolios led to paying/receiving flows in swaps in the 10y sector, as a result of which there was a strong relationship between 10y swaps and overall mortgage index durations in the period before 2008. However, as Figure 1 shows, this relationship has been weak over the past two years. There are a number of reasons for this, including slow prepayment speeds, flat S-curves, GSE portfolios rolling off, and nearly 20% of outstanding MBS at the Fed. To a large extent, this explains why hedging flows from holders of mortgages have diminished.
Figure 1: The correlation between 10y spreads and the duration of the overall mortgage index has been poor over the past two years
bp 50 40 30 20 10 0 -10 -20 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 y 6 5 4 3 2 1 0
Figure 2: 10y swap spreads are much more strongly correlated with mortgages than 5y spreads
bp 25 20 15 10 5 0 Mar-11
bp 80 70 60 50 40 30 20 10 0 Jun-11 10y spd, LHS 5y spds, RHS Sep-11 Dec-11 FNCL 4.0 OAS, RHS
10y swap spd, LHS

MBS Index duration, RHS
30 March 2012
10
However, empirically, there still appears to be a link between mortgage spreads (whether nominal or option adjusted) and 10y swap spreads, which does not appear to exist for other parts of the spread curve 5y spreads, for instance. This can be seen from Figure 2, which plots the OAS of 4% 30y fixed rate mortgages against matched-maturity 10y and 5y swap spreads. This link may exist because of dealer and servicer hedging practices. For this reason, we believe that 10y swap spreads could still face tightening risk from increased expectations of QE3. Without QE3, we estimate that the fair value of 10y swap spreads should be around 5-6bp wider than they are trading currently. To gauge the extent of the tightening risk due to QE3, recall that after the March 2009 QE1 announcement, mortgage spreads compressed by more than 50bp. If QE3 is half the size of QE1, the sensitivity implied by Figure 2 suggests that the corresponding effect on 10y swap spreads could be 6-8bp of tightening from current levels, pushing them into negative territory on a matched-maturity basis. However, 5y swap spreads would be affected to a much smaller extent. Strong corporate issuance in late April/May (high seasonal issuance periods for the past few years) is another risk. Swapped issuance has been higher than expected over the past few weeks. Normalization of credit spreads in Europe could pose additional risks to swap spreads given that many institutions would have the incentive to term out their debt as much as possible. As Figure 3 shows, net issuance in dollar-denominated high-quality foreign debt picks up when financial credit risk declines. Given these risks, we recommend wideners only if 10y spreads go significantly negative because of a combination of QE3 expectations and a spike in swapped issuance. To express a spread widening view, we favor the 4-5y sector. As mentioned earlier, it is less affected by mortgage/insurance hedging flows. Second, unlike the very front end, the sector would be less affected if QE3 is sterilized through reverse repos by the Fed, which would put tightening pressure on spreads at lower maturities. Third, the spread curve generally rolls up in this sector. Finally, putting on a widener in this sector continues to offer exposure to any return of European financial concerns. Even in this sector, we specifically favor FVM2 invoice spreads wideners. As Figure 4 shows, a fly consisting of the FVM2 CTD spread against 3y and 5y spreads cheapened as the futures roll ended and has been unwinding since. Even though FVM2, on an outright basis, no longer appears too cheap, the FVM2 invoice spread has not yet recovered fully, as Figure 4 shows. In our view, this means that FVM2 wideners are still attractive. Figure 3: Dollar-denominated issuance by high quality foreign issuers increases when credit spreads are low
$bn 50 40 30 20 10 0 -10 -20 -30 Mar-10 Jul-10 Nov-10 Mar-11 Jul-11 Nov-11 bp 400 350 300 250 200 150 100 50 0 Itraxx-Financials (RHS)
Figure 4: FV invoice spreads still have room to widen relative to the rest of the spread curve
0 -1 -2 -3 -4 -5 -6 -7 -8 -9 29-Dec-11
19-Jan-12 09-Feb-12 01-Mar-12 22-Mar-12 3s-FV-5s spread fly (bp)
mom chg in $SSA idx (LHS)

30 March 2012
11
UNITED STATES: MONEY MARKETS
Too much cash

Joseph Abate +1 212 412 6810 joseph.abate@barcap.com
Non-financial corporate cash holdings continue to surge. Their balances held in savings deposits, savings accounts, and money funds are close to $2trn and increasingly concentrated at US banks. But where will these firms put their cash when unlimited deposit insurance expires and money funds are reformed? Cash-like instruments with immediate liquidity account for a record 12.1% of non-financial assets. Most of it belongs to technology, energy, and pharmaceutical companies. Data from the IRS on the 2004 foreign earnings dividend deduction (though dated) suggest that overseas cash buffers are overwhelmingly concentrated in European banks. The presence of unlimited FDIC deposit insurance has pushed cash balances toward US banks. Non-financials checking account balances have surged 51% in the past year, displacing cash in money fund balances. Pending money fund reforms could lock these balances at banks. But unlimited bank deposit insurance is set to expire at year-end, leaving non-financials in a bit of a bind as to where to leave their liquidity. Non-financial companies have few alternatives for same-day liquidity outside of money funds and bank deposits. But bank deposits and money funds could become significantly less attractive to non-financial corporations later this year.
Rising balances
Non-financial corporate cash totalled $1.85trn at year-end
We define cash as any asset with immediate liquidity and no (market) risk to the par value. For non-financial corporations, this covers their investments in bank deposits (savings and checking), money fund balances, and repo. In the past year, non-financial corporations have been on an aggressive shopping spree for these assets. At the end of December, they held nearly $1.85trn in these instruments, up 21.4% from 2010 and considerably faster than the growth in their other financial assets, which rose 4.8% over the period (Figure 1). Not surprisingly, cash has climbed to 12.1% of overall financial assets the highest share since the Fed began collecting this data in 1959. The non-financial companies with the largest cash balances are in technology, energy, and pharmaceuticals. Last week, one large technology company announced plans to spend close to $80bn of its cash hoard through dividends and stock buybacks. For those with a longer memory, another large tech company made a $32bn special dividend payout in early December 2004. This one-time payment temporarily reversed an established trend of rising non-financial corporate checking account balances and now shows up as a kink in the Feds data.
Tax motive
Foreign bank deposits account for 5% of aggregate holdings
While the payment of special dividends and share buybacks represents one use, companies also maintain cash stockpiles for other purposes, including facilitating transactions and maintaining precautionary liquidity buffers. Some is locked overseas on account of tax differences between countries. Since foreign earnings are not taxed until they return to the US, they may stay overseas in cash deposits and securities indefinitely. A survey conducted by the Association for Financial Professionals found that 53% of respondents held cash
30 March 2012
12
outside the US. 3 Despite the reported prevalence, the balances on deposit at foreign banks may not amount to much, at least compared with domestic allocations. Roughly $100bn belonging to non-financials is held in overseas bank accounts approximately 5% of their overall corporate cash holdings. Following a re-allocation away from these banks during the 2008-09 financial crisis, these balances have grown in line with the total accumulation of non-financial corporate cash so that over the past several quarters, their share has been pretty steady (Figure 2). A substantially larger amount is probably invested in higher yielding local securities. Indeed, a recent Internal Revenue Service study revealed that over $360bn in foreign earnings returned to the US following the 2004 special dividend deduction. 4 Since non-financial corporations held about $40bn in foreign bank deposits before the October 2004 announcement, a substantially larger amount must have been held in local (liquid) securities. Of course, these figures measure only direct non-US bank exposure. To the extent that non-financial corporations invest in prime money funds, they may have indirect non-US bank deposit exposure. Foreign bank deposits account for 15% of prime money fund assets, or roughly $216bn. 5
The recent surge in cash balances is likely driven by precautionary liquidity
The IRS study also revealed that funds coming from Europe accounted for 62% of the total, primarily from the Netherlands, Switzerland, Ireland and Luxembourg. And consistent with the current distribution of cash, pharmaceutical and tech companies were significant repatriaters. While there is undoubtedly a strong tax rationale for the location of deposits, we strongly suspect that the 21% y/y surge in the non-financial corporate cash hoard has more to do with precautionary liquidity hoarding than tax considerations.
Precautionary liquidity motive

Corporate cash has moved to bank deposits from money funds
There is further evidence of the precautionary liquidity motive in the relative allocations of non-financials domestic cash holdings. Before the financial crisis, these corporations typically kept most of their cash in money funds, as yields were higher than bank deposits. But since 2009, there has been a dramatic shift out of money funds toward checkable deposits, which have risen from less than 5% of non-financial corporate cash to almost 37% at the end of last year. At the same time, money fund holdings have shrunk to just 25%, reversing a multidecade trend (Figure 3). By the end of December 2011, non-financial corporations were Figure 2: Foreign deposits (% non-financial corp cash assets)
Figure 1: Non-financial corporate cash and non-cash assets (2007=100)

170 160 150 140 130 120 110 100 90 80 70 Mar-05 Jun-06 Sep-07 Dec-08 Mar-10 Jun-11 Non-cash Cash
7 6 5 4 3 2 1 0 Mar-00 Mar-02
Source: Federal Reserve Where is All That Corporate Cash, Anyway?, J. Doherty, Barrons, December 12, 2011 See, The One-Time Received Dividend Deduction, M. Redmiles, Statistics of Income Bulletin, Internal Revenue Service, Spring 2008 5 Non-financial corporations, like other institutional investors, however, concentrate their money fund holdings in government-only funds which do not hold foreign bank deposits.
4 3
Mar-04 Mar-06 Mar-08
Mar-10
Source: Federal Reserve, Barclays Research
30 March 2012
13
holding almost $700bn (up 51% from a year earlier) in checking account balances, considerably more than the $470bn (down 10%) held in money fund shares.
Money fund yields have compressed
The shift toward bank deposits likely reflects two additional factors. First, money funds no longer yield much over bank deposits, due to the Feds long-running easy policy of keeping the fed funds target pegged between 0 and 25bp. The average government-only money fund has yielded just 1bp since October 2010, and prime funds are barely yielding 3bp more (Figure 4). Second, and perhaps more significantly, the FDIC has provided unlimited deposit insurance on non-interest bearing checking account balances since the start of 2011 (there was an earlier program begun during the 2008 crisis that expired in 2010). With little yield difference between bank deposits and money fund balances, the only distinguishing feature between these two same-day liquidity accounts is the provision of unlimited government guaranteed insurance. The value of this government guarantee rose during the pickup in risk aversion last year amid concerns about European banks and sovereign risk. As we wrote several weeks ago, we estimate that the FDICs unlimited deposit insurance program appears to have shifted $500-600bn out of money funds into non-interest bearing checking deposits. 6 Interestingly, despite their concentration in European bank deposits and the heightened anxiety among institutional investors in money funds about European bank exposures, non-financials did not withdraw money from their non-US deposit holdings last year. This suggests that tax concerns about repatriating these balances to US banks may have overcome their other concerns. Of course, it is impossible to tell from the aggregate data if there was a shift in deposits between non-US banks.
Rock and a hard place?

Unlimited deposit insurance expires at year end
Non-financial corporations face a tough decision this year on where to allocate their burgeoning cash hoard. At the end of the year, unlimited deposit insurance on non-interest bearing checking accounts will expire. Although we believe the program will be extended on a voluntary basis for an explicit cost, we expect most of the money center banks to opt out. This spring, the SEC is preparing to revamp money fund regulation. However, the intense debate between the industry and regulators suggests that reform implementation could occur well after unlimited deposit insurance expires at the end of 2012.
Figure 3: Money fund and checking accounts (% nonfinancial corporate cash assets)
70 60 50 40 30 20 10 MMFs Checking accounts
Figure 4: Money fund 7d net yields (%)
5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 Gov-only 0.0 Jan-08
Source: imoney.net
6
Prime
0 Mar-80 Mar-85 Mar-90 Mar-95 Mar-00 Mar-05 Mar-10

Source: Federal Reserve
Jan-09
Jan-10
Jan-11
Jan-12
See, Unlimited Deposit Insurance: Here to Stay? Market Strategy Americas, March 1, 2012.
30 March 2012
14
Proposed money fund reforms include three themes
Although other reforms are still possible, the SEC has focused on three main themes meant to reduce systemic risk in money funds caused by sudden investor runs. Funds could be forced to move from stable NAV-amortized cost accounting to a floating NAV structure by which the portfolios mark-to-market value is calculated daily to determine the money funds share price. Alternatively, the SEC has discussed moving to capital buffers and redemption gates for stable NAV funds. Money fund sponsors would be required to hold a buffer of, say, 1-3% of assets under management. At the same time, investors would face a redemption gate of perhaps 3%; they would be able to withdraw only 97% of, for example, their average 30-day balance with the remaining 3% retained by the money fund for 30d. If the money fund breaks the buck over that 30d holding period, the investors remaining 3% would be subordinated to other redemptions and therefore vulnerable to principal loss. While we will write more on the merits of these proposals, we believe that these three do little to address run risk directly. A floating NAV will not make non-financial investors any less likely to run in periods of financial stress indeed, some short-duration bond funds (enhanced cash funds) experienced substantial redemptions in fall 2008. And while we believe that a capital buffer more closely aligns shareholder and fund sponsor interests with respect to asset quality and risk, it would do nothing to prevent a run. Instead, in a higher rate environment, we would expect the cost of the buffer to be passed onto non-financial (and other) shareholders in the form of lower returns. The only proposal (so far) to address run risk directly is the redemption gate, but this mechanism will be difficult to implement operationally and effectively requires money fund investors to maintain a minimum deposit, which, judging from the tone of comment letters submitted to the SEC, is deeply unpopular. While the popularity of the SECs reforms is not a primary concern of the agency, it cannot be ignored entirely. In the coming year, non-financial corporations will need to decide what to do with their almost $2trn cash hoard: keep it at banks in uninsured deposits or shift it back to money funds and face either floating NAVs or a stable NAV with a redemption gate. We do not have a firm conviction of what will matter to non-financial corporations more: unlimited government guaranteed insurance or 100% same-day liquidity. That said, potential reallocation of their $2trn could be severely disruptive and suggests regulators will move carefully.
And may not adequately address run risk
30 March 2012
15
UNITED STATES: INFLATION-LINKED MARKETS
Relative value in relative ASWs

Michael Pond +1 212 412 5051 michael.pond@barclays.com Chirag Mirani +1 212 412 6819 chirag.mirani@barclays.com
10y TIPS ASWs have richened relative nominals this month. Further richening is justified by fundamentals, though, and the TIIJan22s stand out as cheap on the curve. Therefore, we recommend positioning for continued compression.
10y relative ASW fair value around 23bp

Relative ASWs (TIPS ASWs relative to nominal Treasury ASWs) beyond the very front end out to the 10y sector have richened by 4-12bp since the beginning of the month (Figure 1). Some investors have begun to ask whether we think it is time to fade this move and position for TIPS to cheapen back out. Our relative ASW model indicates that the richening is not only justified, but that the decline in the relative spread should compress further at the 10y point. We find that risk uncertainty and liquidity variables have historically done well at explaining relative ASWs. Specifically, our model uses the 3m Libor-OIS spread, the VIX, and 3m rolling average daily trading volume of TIPS (Figure 2). The first two are more tactical factors while the latter is more structural. Because investors tend to flock to nominal Treasuries during times of market stress, as indicated by an increase in L-OIS and VIX, TIPS tend to cheapen relative to nominals. Over time, as the market grows and trading volume increases, the liquidity differential between TIPS and nominals should compress and the relative ASW should decline. Over the past several months, as European sovereign risk has become less of a concern and US economic data have been improving, investors risk appetites have risen and L-OIS and VIX have come down. Additionally, the 3m average of TIPS trading volume is at an all-time high and has been on the rise since the beginning of the year. These factors justify a decline in 10y relative ASWs to levels close to all-time lows and about 9bp below current valuations. The lag in 10y relative ASWs relative to improving fundamentals appears, in part, to be an issue of relative value. While all TIPS beyond the very short end have richened on relative ASWs since the beginning of the month, the spread on the TIIJan22s has compressed the least in the 5-10y sector. While the TIIJan22s have richened by about 5bp, the TIIJul19s, for
Figure 1: Relative ASWs (bp)

45 40 35 30 25 20 15 10 5 0 0 5 10 15 20 25 30 Relative Z spreads as of March 1st Relative Z-spreads as of March 28
Figure 2: Actual and model 10y relative ASWs (bp)

160 140 120 100 80 60 40 20 0 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 10yr Relative TIPS ASWs 10yr Model Rel ASWs (Factors: L-OIS, VIX, trading volume)
Note: Barclays Research
30 March 2012
16
example, has tightened by 11bp (Figure 3). We could understand this relative cheapening of the 10y sector if it was related to an auction concession or overhang. However, there appeared to be strong demand for the 10y sector going into and coming out of the recent auction, so we do not believe that redistribution of supply is the issue and instead think the relative cheapening is due to derivative, rather than cash, flows that are unlikely to have a sustained effect. If not for trading cost concerns, we would recommend a relative ASW switch between the TIIJul19s and TIIJan22s to focus on an apparent relative value opportunity. However, because full round trip bid-offers could equal expected gains in the mid spread, we instead recommend buying TIIJan22s on a relative ASWs trade to position for this issue to catch up to fundamentals and other TIPS ASWs. Using an entry level of 32bp, we use a stop of 38bp and a target of 25bp. Figure 3: TIIJul19 and TIIJan22 relative ASWs
40 38 36 34 32 30 28 26 24 22 20 Dec-11
Dec-11
Jan-12
Feb-12 TIIJul19 relative ASWs
Mar-12
TIIJan22 relative ASWs

30 March 2012
17
UNITED STATES: VOLATILITY
A time to sell
Piyush Goyal +1 212 412 6793 piyush.goyal@barcap.com
We turn bearish on mid-tail gamma as a vigorous rate sell-off does not seem to be in the offing. We recommend selling TY straddles systematically. Overall, the recent rate activity seems to have made investors a little more cautious in expecting a Fed-on-hold period or another round of asset purchases. Figure 1 shows the net change in implied vol between March 9 and March 29, the period subject to the gyrations in rates. As seen, gamma on 5y tails and intermediate expiry on short-tails, such as 2y*1y gained the most. This suggests some investors who were positioned for a dovish Fed (long front-end, curve steepener, etc) rushed to the exit when the Fed did not commit to another round of asset purchases at the March 13 FOMC meeting. This reshaped the vol surface appropriately.
Lower rates = lower vol

Although the jury is still out on the data, and payroll next month will be keenly watched, there are many reasons vol on mid-tails could come off over the next few months. We think the recent rate-vol price action clearly establishes a rise in rates is a prerequisite for a rise in vol (Figure 2). As highlighted in a recent publication 7, we believe a sell-off in Treasury yields may be capped. So while there may be positioning driven rate sell-offs, similar to the recent one, a powerful move such as in May-June 2009 or in Nov-Dec 2010 is unlikely. Consequently, any rise in mid-tail gamma would be limited too. Eventually, gamma would leak cheaper to reflect the low-rate-for-long environment, maybe to levels closer to JPY vol. More importantly, dealers continue to be long options, for two reasons. One, there is more than usual supply of short-expiry swaptions from real money managers (Figure 3). Most portfolio managers are deploying yield enhancement strategies, some via selling options. Figure 1: Fed expectations were re-priced in the rate sell-off.
Change (3/9 - 3/28) 3m 6m 1y 2y 3y 5y 10y 1y -5 -3 0 7 5 -1 -3 2y 0 1 4 6 4 -1 -3 5y 8 6 3 4 2 -2 -3 7y 6 4 1 1 0 -2 -3 10y 4 3 0 0 -2 -3 -3 30y -1 -2 -2 -2 -4 -4 -3
Figure 2: Rise in rate is a pre-condition for rise in vol

2.60 2.50 2.40 2.30 2.20 2.10 2.00 1.90 85 100 95 90 110 105
1.80 80 29-Dec-11 19-Jan-12 09-Feb-12 01-Mar-12 22-Mar-12 3m10y (%, L)

Note: The above grid shows the change implied vol between March 9 and March 28. Source: Barclays Research
,
3m*10y (bp/y, R)
Note: Last data point as of March 28 2012. Source: Barclays Research
Will the bond market selloff be sustained, published on 22nd March 2012
30 March 2012
18
Two, there remains a large issuance of callable notes, leading to dealers swamped with high-strike Bermudan options in the top-left as well as the bottom-right of the vol surface. The callable notes are popular as they are another way of boosting yield in fixed income asset portfolios. Unable to find a home for these options, dealers are likely delta-hedging the options, cushioning rate volatility. Finally, mortgage hedgers did not show up in the recent rate sell-off. Generally, in a rate sell-off like the recent one, mortgage hedgers shed duration and worsen the rate move. Their activity was the main reason 3m*10y revisited the record high levels in May-June 2009. And while it is well established that GSEs are running down their agency MBS portfolio and therefore not buying options (Figure 4) and mortgage servicers are factoring the weak relationship between prepay speeds and Treasury/ swap rates, we believe the actual absence of mortgage hedgers empirically indicates the lack of support from the hedging community. Their absence was also felt as little widening in 5y and 10y swap spreads despite the rise in rates. As the realization sets in, mid-tail gamma would be subject to an additional downward bias. We expect 3m*10y to cheapen beyond 80bp/y. Essentially, gamma has bounced off 8590bp/y many times since the Lehman crisis in 2008. In the last down-trade, 3m*10y came off from 120bpy+ to ~ 90bp/y between November last year and February this year. But given that the recent rate sell-offs likely did not satiate investors positioned for a repeat of prior episodes and the realization of lack of mortgage hedging sets in, 3m*10y would likely make a new low for since the 2008 crisis. We target 80bp/y for 3m*10y.
Sell TY options systematically

We see the best way to position as selling Treasury future options systematically. TY options are pricing a slightly higher vol than comparable swaptions. For example, as of March 29, 2012, TYM2 straddles are priced for 86bp/y while the comparable swaptions is pricing 83bp/y. So one can take in more premium and gain more in a range-bound rate environment. Furthermore, it is important to build a systematic portfolio. This allows the strategy to distribute the strike and expiry risk. At current levels, a short TYM2 straddle is priced for a Figure 3: Asset managers are short more options than usual Figure 4: GSEs own lesser amount of options
450 410 370 330 290 250 210 170 130 90 50 Q1 2009 Q2 2009 Q3 2009 $429
$147
$138 $105
Q4 2009
Q1 2010
Q2 2010
Q3 2010
Q4 2010
Q1 2011
Q2 2011
Q3 2011
Q1 2010
Q2 2010
Q3 2010
Q1 2011
Q2 2011
Q3 2011
Q4 2011
Notional ($bn)
FRE, FNM swaptions (notional, $bn)

Source: Fannie Mae, Freddie Mac SEC filings
30 March 2012
Q4 2011
19
50bp+ range for the 7y yield for the next two months, which is within the range in which the rate has traded for the past six months. By selling a straddle at regular intervals, say weekly, the portfolio would gain if the 7y rate remains within a wider range. Figure 5 shows how the performance of selling 1m*7y straddles systematically (un-deltahedged, held to expiry) for the past three years. H2 2009 and H2 2011 were the longest periods of consistent good returns. Both of them had one thing in common rates were rang bound. After the spurt in rates in May-June 2009, 7y swaps stayed within 2.8 and 3.8 for nine months, ie, a 100bp range. The strategy did well in that period. Then again, after the rally in July-August 2011, 7y swaps stayed within 1.4-2.1 for six months, ie, a 70bp range. Clearly a range-bound rate environment, even if the range is relatively large helps the strategy deliver good p&l. Figure 5: Selling gamma systematically did well in H2 2009 and 2011
60 40 20 0 -20 -40 -60 -80 Apr-10 Dec-09 May-09 Nov-10 Apr-11 Oct-09 Jun-10 Jul-09 Sep-09 Feb-10 Jul-10 Sep-10 Feb-11 Jun-11 Aug-11 Sep-11 Mar-09 Nov-11 Jan-11 Mar-12 Jan-12 QE1 Greec e QE2 Eurozon -1,000 2,000 1,500 1,000 500 0 -500
p&l (bp of swap01)

cum p&l (bp of swap01)
Conclusion
Sell mid-tail gamma systematically for the next few months (target 3m*10y = 80bp/y) as rate sell-off seems to have run out of steam, dealers are swamped with options and the absence of support from mortgage hedgers is empirically established.
30 March 2012
20
EURO FUTURES
New 10yr OAT future analysis

Cagdas Aksu +44 (0)20 7773 5788 cagdas.aksu@barcap.com
This articles was previous published on 30 March 2012. Having introduced the new BTP future contracts over the past few years, Eurex is now launching a new 10y French (OAT) future on 16 April. We estimate FRTR 3.75% Apr 2021 as the CTD to the June 12 contract. Assuming a successful launch, we believe the 10y OAT future is likely to be used as a hedging/risk-taking instrument for core EGBs outside of Germany, as well as a vehicle for positioning between core and peripheral bonds. Furthermore, the repo trading volumes for 10y OATs will likely be boosted as onthe-run benchmarks might trade less special going forward and basis trading strategies would support repo activity as well. On 21 March Eurex announced that it will introduce a new 10y OAT future with effect from 16 April. This comes on top of the introduction of long, short and medium-term BTP futures contracts in Sep 2009, Oct 2010 and Sep 2011, respectively. During the eurozone crisis, alongside the remarkable widening in peripheral country spreads, France has been the main underperformer within core country space, with the 10y FranceGermany spread widening from 30bp in early 2011 to about 200bp in autumn 2011. While this has tightened back since then, it is still at around 100bp currently. The main reason for creating the new BTP future contracts was to introduce a new hedging instrument for non AAA euro area government bonds (EGBs) as an addition to the Bund futures contract. However, given that since then there has been a notable widening of core country spreads versus Germany, and a substantial widening of BTP and Spanish government bond spreads versus all core paper, a need for another future representing the core countries ex Germany has arisen. With the introduction of the OAT future, investors will now have access to a various set of futures representing the broad EGB categories. Figure 1: 10y BTP Bund spread evolution vs 10y BTP future daily volume since inception
35000 30000 25000 20000 300 15000 10000 5000 0 Oct-09
Source: Bloomberg
10yr BTP future volume 10yr BTP - Bund (RHS)
600 500 400
200 100 0 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12
The average daily volume on the 10y BTP future since its inception in Sep 2009 until the end of H1 2011 has been c.5k contracts, rising to an average of c.10k contracts from July 2011 until now a period during which BTP Germany spread has been substantially volatile. While more volatile peripheral spreads have supported volumes on the BTP futures,
30 March 2012 21
volumes are still much lower than for the Schatz, Bobl and Bund future average daily volumes, each of which are in the order of multiples of 100k contracts. We think the volumes on the OAT future are likely to be between BTP and Bund contract volumes, as long as EGB spread volatility remains a theme.
Contract specifications
The contract specifications for the new 10y OAT future are very similar to those of the 10ry Bund future contract. The most important to highlight are: underlying maturity range for the deliverable bonds is 8.5-10.5 years with an original maturity of no longer than 17 years; notional coupon on the contract will be 6%; minimum outstanding size for the deliverable bonds will be 5bn and the three nearest quarterly months of the March, June, September and December cycle will be traded.
CTD analysis for the June 12 contract

The bonds in the June 12 contract delivery basket will have maturities ranging from 11 Dec 2020 and 12 Dec 2022 (and a minimum outstanding size of 5bn). Therefore, FRTR 3.75% Apr 21, FRTR 3.25% Oct 21 and FRTR 3% Apr 22 will be in the delivery basket for June. And the September delivery basket will include these and potentially the new 10y Oct 2022 benchmark, which is likely to be issued in the summer months. Figure 2 illustrates the bonds that are likely to be in the delivery basket for the next three cycles. Looking at the delivery basket, there are typically a few ways to determine the CTD: the bond with smallest net basis, or the bond with the highest implied repo rate (more accurately the bond with the highest implied repo versus the actual repo rate), is the most likely candidate for the CTD. Apart from these, there is also a rule of thumb that the bond in the basket with the lowest DVO1 tends to be the CTD in a low yield environment and the bond in the basket with the highest DVO1 tends to be the CTD in a high yield environment. As there is no price information on the new futures yet, we need to experiment with a few of these various methods to determine the CTD bond. Figure 2: Likely delivery baskets for Jun 12, Sep 12, Dec 12
Contract settlement date Deliverable maturity range lower bound(8.5y) Deliverable maturity range upper bound(10.5y) Bonds within deliverable range 11-Jun-12 11-Dec-20 12-Dec-22 FRTR 3.750% Apr 21 FRTR 3.250% Oct 21 FRTR 3.000% Apr 22 10-Sep-12 10-Mar-21 10-Mar-23 FRTR 3.750% Apr 21 FRTR 3.250% Oct 21 FRTR 3.000% Apr 22 NEW FRTR Oct 2022*
Note: * Assuming the new 10y OAT Oct 22 is issued some time during summer with a size bigger than 5bn. Source: Barclays Research
10-Dec-12 10-Jun-21 12-Jun-23 FRTR 3.250% Oct 21 FRTR 3.000% Apr 22 NEW FRTR Oct 2022
First, we focus on the rule of thumb mentioned above. The basic idea is that at 6% market yield level (in this case for the 10y OATs), all the bonds in the delivery basket are equally cheap to deliver against the futures contract on the delivery date. This is because all of the bonds will be trading at their conversion factors (CF), and the invoice amount for the futures (futures price * CF + accrued interest on the bond) will be equal to the dirty price of the bond on the delivery day for all of the bonds in the delivery basket. Assuming all of the bonds in the delivery basket rally in parallel from 6%, the bond with the lowest DVO1 will richen the least and be the CTD in a low yield environment. However, the key word here is parallel, meaning the bonds in the delivery basket should be flat to each other in yield terms. There is actually some steepness between the shortest maturity/DVO1 bond (FRTR Apr 21) and long maturity/high DVO1 bond (FRTR Apr 22) in the June delivery basket.
30 March 2012 22
However, this is similar to the steepness that the Bund delivery basket has between the shortest and longest maturity bonds (DBR Jan 21 and DBR Jan 22). Furthermore, while 10y OAT yields are c.100bp over Bund yields, absolute levels, ie 2.80-2.90%, are still far from the 6% notional coupon. This will most likely mean the steepness of the delivery basket will not be big enough to make the longest maturity bond in the basket become CTD. As such, FRTR 3.75% Apr 2021 should be the CTD. To health check the rule of thumb, we have derived a future price by setting one of the bonds in the delivery basket at zero and driving the net basis of the remaining bonds from the implied future price. The most sensible net basis table emerges when we derive the future price by setting the net basis of FRTR Apr 21 at zero (Figure 3). Moreover, even when we set the net basis of FRTR Oct 21 and FRTR Apr 22 separately at zero, the net basis on FRTR Apr 21 turns out the most negative, which implies it will be the CTD. Figure 3: Delivery basket with futures price derived from setting the net basis of FRTR Apr 21 at zero
Future price 125.71 Conversion factor 0.848510 0.806920 0.781200
Maturity FRTR 3.750% Apr 21 FRTR 3.250% Oct 21 FRTR 3.000% Apr 22
Spot yield 2.81% 2.86% 2.96%
Repo to contract date -0.05% -0.10% -0.10%
Gross Basis 72 174 211
Net Basis 0 111 152
25-Apr-21 25-Oct-21 25-Apr-22
Market implications
Assuming a successful launch, the new 10y OAT future is likely to be used as a hedging/risk-taking instrument for core EGB paper outside of Germany, as well as an instrument to position for spread moves between core and peripheral EGBs. The impact of the contract launch for the 10y part of the French curve versus other parts or the CTD bond versus other bonds in the basket is not necessarily clear at this stage. If we move in an environment in which there is further cross market spread consolidation, it would probably be beneficial to the 10y part of the curve, via boosting liquidity, as well as to the relative value of the CTD bond versus surrounding bonds. However, if we are still in a volatile, spread widening environment over the coming quarters and should the future be used for the purposes of shorting France versus other papers, then the CTD and the future could cheapen/trade would cheap versus the surrounding on the-run benchmarks. The repo activity for 10y French bonds is likely to improve as well. At the moment most investors looking to short France express this in the on-the-run benchmarks such as FRTR Apr 22 and FRTR Oct 21, keeping them special in repo. If the OAT future takes off successfully, these bonds are likely to be more available in the repo market as some shorts are more likely to be expressed via the future market, and this should help the repo activity. Furthermore, basis trade strategies (cash versus futures) are likely to be implemented, which should help the repo trading volumes for 10y OATs in general as well.
30 March 2012
23
EUROPE MONEY MARKETS
ECB: To exit or not?

Giuseppe Maraffino +44 (0) 20 3134 9938 giuseppe.maraffino@barcap.com
We expect the ECB to keep policy rates and liquidity measures on hold at the upcoming meeting. Extension of the full allotment is still a pending issue on which the ECB has been enigmatically silent over the last months. Over the last few days forward money markets rates have stabilized, having been quite volatile in the latter half of March. As we have stressed in the past, the initial sell-off (triggered by the upbeat comments by the Fed and the ECBs focus on inflation and an exit strategy) was overdone. Indeed, in the subsequent days, it was followed by a correction (owing to the disappointing economic data and rising concerns about the Spanish fiscal outlook). At present the forwards curve is pricing in the EONIA fixing at around 35/37bp until the end of the year, with some increase towards the 50bp area after January/February 2013 (when banks can start to exercise the option of exit from the 3y LTROs). The next two 3m Euribor futures have stabilized at around 67bp (June and September), close to the lowest level ever reached by the 3m Euribor fixing. At this weeks ECB refinancing operations (MRO and 3m LTRO) the demand for euro liquidity was broadly in line with the amount maturing (a 1.5bn increase at the MRO and a 4.5bn drop at the 3m LTRO). Due to the abundant and long liquidity in the system, we believe the refinancing operations will be used to fine tune the short-term liquidity of some banks, but not necessarily to meet funding needs. Interestingly, USD borrowing declined sharply at the 3m tenor (-USD19bn compared with the allotment at the January auction), probably reflecting deleveraging from USD assets and the improved market conditions for European banks USD funding.
ECB meeting: no new measures, probably some hints on its strategy

The most important event next week will be the ECB meeting (Wednesday). Following the recent shift in its rhetoric on inflation and the potential risks from abundant liquidity in the system, we expect the ECB to keep both policy rates and liquidity measures on hold. On the latter, the ECB could announce the extension of the full allotment beyond the current deadline of the end of the sixth reserve period (mid-July 2012), and probably to the end of the year. There is some risk on that side, though: the ECB has been enigmatically silent on the issue of full allotment over the last few months, and did not include the extension of the full allotment in the set of liquidity measures to support banks that it has announced since December last year (longer LTROs, wider collateral, drop in reserve requirements). The last time it prolonged the full allotment policy was in October 2011; at the same time it announced the introduction of two special 1y LTROs (one at the end of October and the other in December, which were replaced later by the first 3y LTRO) and the launch of the CBPP2. The fact that nothing has been said yet on full allotment, which expires in 2 to 3 months, raises the suspect that the ECB might consider dropping the unlimited funding at OMOs (or at some of them) as one of the key first steps of the exit strategy it has discussed recently. Indeed, as shown in the Figure 1, in 2010 and first part of 2011 the extension of the full allotment was decided on the month before its expiration and spanned only one quarter. This might be interpreted as a sign that there was an internal debate in the Governing Council (GC) on whether or not to extend the full allotment. In the second part of 2011 the tough conditions of the banking sector (in the context of a worsening of the sovereign crisis) eliminated any doubt on the necessity to extend the unlimited borrowing and the ECB
30 March 2012 24
Figure 1: ECBs announcement of the full allotment in the past

Date Oct-08 Dec-08 Mar-09 Dec-09 Mar-10 Launch Extension Extension Extension Drop only at the 3m LTRO Restore of full allotment at the 3m LTRO Full allotment at the 3m LTRO Extension for all operations Extension for all operations Extension for all operations Extension for all operations Extension for all operations Extension for all operations Meeting Press release Press release March meeting December meeting March meeting Maintenance period extension mid-January 2009 mid-April 2009 Beyond end 2009 mid-April 2010 mid-October 2010 (MRO and STRO) only for the May and June 3m LTRO extension to the end of Q3 mid-January 2011 mid-April 2011 mid-July 2011 mid-October 2011 mid-January 2012 mid-July 2012 Refi rate 3.75% 2.50% 1.50% 1.00% 1.00% Additional Measures taken on the day Reduce in the refi rate (by 50bp) and tightening of the corridor to 100 bp from 200bp Widening of the corridor to 200 bp from 100bp 50bp refi rate cut; extension of supplementary LTROs Refi rate unchanged Refi rate unchanged introduction of special 6m LTRO in May; reactivation of USD operations; activation of SMP purchases Refi rate unchanged Extension of the full allotment also for the 3m LTRO till end the year; rate at the 3m LTRO fixed at the average rate of the MROs over the life of the respective LTRO.
May-10
Press release
1.00%
Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Aug-11 Oct-11
June meeting September meeting December meeting March meeting June meeting August meeting October meeting
1.00% 1.00% 1.00% 1.00% 1.25% 1.50% 1.50%
Supplementary 6m LTRO Two supplementary 12m LTROs; launch of CBPP2
Source: ECB, Barclays Research
extended it for a longer period than one quarter and announced that well before the expiration. Therefore, in our view the fact that the ECB has not included the extension of the full allotment in the recent set of measures could be related to the fact that, similar to 2010, some GC members are likely contemplating the possibility of dropping it after its expiration date (mid-July 2012). Due to its importance, we believe the GC will take some time before announcing the final decision (probably, in May or June meeting). Clearly, full allotment still provides a very good backstop to banks funding, and therefore might be seen as discouraging the adjustment process necessary for business models. Due to high level of surplus liquidity and the increase in the average maturity of ECB borrowing, the liquidity is not an issue for banks (at least for the near term); this is also confirmed by the low demand at the current operations. Therefore, the ECB might expect that the drop of the full allotment at all or some of the operations (as it did in March 2010 on the 3m LTRO before moving back in May due to the beginning of the Greek crisis) in practice would have a limited impact on the liquidity conditions and on the EONIA fixing. However, there would likely be a strong signalling impact; it could cause sentiment on banks to deteriorate, and limit any further declines in euribors and money market rates in general (if anything, forwards should sell off on this), as well as reintroducing some volatility in term rates. In this respect, it is worth noting that even if the two successful 3y LTROs have eliminated the refinancing risks for banks, the interbank market is not working properly. The EONIA vs Euronia spread is still wide (at around 20bp) meaning that some credit risks is still priced in the market and the unsecured term interbank market is still very illiquid, in contrast to the ECP and CD markets (which involve transactions between Money Market Funds and banks) that have started working again following the general improvement in sentiment. Overall, we believe it would be quite a risk for the ECB to drop the full allotment so soon after doing the two 3y LTROs, and given the situation is still quite fragile. Our base case is thus that the full allotment procedure will be extended, by at least one quarter (as was the case in 2010 first part of 2011, before the worsening of the sovereign debt crisis).
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Withdrawal of liquidity: possible tools

In a recent speech, the President Draghi stressed the difference between different concepts of liquidity, pointing out that the impact on inflation and asset prices comes from a sustained and strong increase in money and credit and not from the central bank liquidity per se (i.e. liquidity borrowed at the refinancing operations). At the moment there is no strong evidence of the transfer of central banks liquidity in money and credit, as was also evidenced by the February M3 data on bank lending to the economy, which remained weak with only a moderate recovery in the monetary aggregate (although this did not capture the second 3y LTRO). Interestingly, he mentioned that, in the case of increase in inflation risks, the Eurosystem has several tools to withdraw the liquidity in excess, and in particular indicated: 1) the increase in the reserve requirement; and 2) term deposits with maturities longer than the current one (1-week) used to sterilize the SMP purchases. On the reserves requirement, it is worth remembering that at the December meeting, the ECB decided to reduce the reserve ratio from 2% to 1%, starting from the beginning of January reserve period. As noted in the press conference, the decision was aimed at increasing the available collateral for banks (as they need to borrow less to meet their reserve requirement) and not to boost the liquidity available for banks. It was also taken in the context of full allotment with a very large liquidity surplus and a reserve requirement-based system being less relevant. The success of the two 3y LTROs has provided banks with abundant and longterm liquidity, and the collateral issue has been addressed by the issuance of government guaranteed bonds as well as securitization programmes. Therefore, a possible decision to go back to increasing the reserve requirement would not necessarily mean a U-turn, The use of the long-term deposits (or the issuance of certificates of deposit) is an alternative tool for the ECB. It could work as the current weekly sterilization auctions through which the ECB drains on a weekly basis the amount of liquidity corresponding to the SMP outstanding. The ECB has never issued CDs as such, but some of the NCBs have in the past, and the CDs are expressly mentioned as one of the available tools for the ECB in the ECB General Documentation. While in aggregate terms the goal of the two tools is the same, at a micro perspective the impacts are different, as the increase in the reserve requirement would involve at the same time all banks in the eurosystem, while the term deposits would only affect the banks that take part in the auctions, stricto sensu (ie, mainly banks in the core countries or international banks, which are the main users of the deposit facility and the main buyers of the ECBs 1-week term deposit). Draining liquidity via auctions at the margin exposes the ECB more to market conditions (available liquidity, willingness of banks to bid, price, etc). Another important issue on the implementation of the liquidity absorbing tools will be the size of the drain, which has to be carefully calibrated in order to avoid a more-thannecessary tightening of the liquidity conditions. This holds true especially for the first tool (reserve requirement), while for the other tool (term deposit or certificates of deposit), we believe that they have some flexibility in terms of how to design the operation: one option could be to allow banks to buy unlimited amount of deposits ( a sort of full investment) at fixed rate (established in order to eliminate any possibility of carry trade using the ECB refinancing operations for funding), or the ECB could decide to auction fixed size of term deposit at different maturities.
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Conclusion
The fact that the ECBs rhetoric has shifted towards the potential inflation risks coming from the abundance of liquidity currently in the system, is probably a signal that it is preparing its gradual exit strategy. In the market, apart from an initial reaction, the curves are not pricing a drastic change in the liquidity conditions in c.2 years time (the forward on EONIA, see the fixing averaging 65bp in the January 2014, so about 30bp higher than the current level). We do not expect liquidity absorbing measures to be implemented soon, as the signalling impact would be dramatic given the still fragile situation in the banking system. Therefore, we expect money markets rates to remain broadly stable at the current historical low level in the near term. However, any further comments by the ECB officials on possible measures to withdraw liquidity would likely fuel volatility in the euro money markets
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EUROPE: SOVEREIGN SPREADS
Eurozone supply expectations for Q2 2012

Huw Worthington +44 (0)20 7773 1307 huw.worthington@barcap.com
We take a look at the eurozones issuance requirements in both gross and net terms for Q2 2012. In overall terms, the first three months of 2012 saw a slightly higher amount of gross funding vs. target as in the same period in 2011, with 32% of total estimated funding completed YTD, compared with c.31% a year ago. In gross issuance terms, c.255.5bn has been issued thus far in 2012, versus 255.8bn in the same period in 2011. There continues to be major differences in the progress of issuance by certain peripheral issuers, however, with Spain thus far having already issued 44% of its official 86bn target for the year. Given fiscal slippages and possible regional and other funding needs in Spain, some upside to this target seems likely and the new budget due to be delivered at end March may be a catalyst for this. However, even if this were revised as high as 100bn, Spain would still be more than one-third funded for the year. Italy has been somewhat slower off the mark, although last weeks BTP Italia retail-focused issue has improved this with c. 29% of its target achieved so far, which is slightly better than in 2011. We would not be surprised to see more retail-targeted deals as the year progresses, however any reduction in issuance would likely be targeted at BOT and CCT issuance rather than a reduction in bonds. There has been a more mixed picture among the core issuers. Belgium has easily had the fastest start to the year, with funding some 65% complete, however we suspect that this will not mean widespread cancelations in auctions later in the year and the 26bn target will likely be substantially exceeded. Finland has been notoriously slow to issue in the past, although following a new 15y in late January, it finds itself 26% funded for 2012. A Finnish tap auction was originally scheduled to take place in Q1, and we now expect this to come in early Q2 2012. Austria is just over 25% funded for the year as a whole.
Figure 1: Euro government supply YTD 2012

% of 2012 Net All isuance Maturities YTD bn 45.0 58.6 62.9 38.2 16.8 24.4 0.0 3.4 6.1 0.0 0.0 255.5 255.5 1.0 43.5 -1.1 36.2 12.0 10.1 NA 3.2 3.4 NA NA 108.2 Estimated gross issuance 25% 30% 29% 44% 65% 41% NA 26% 27% NA NA 32% Actual Estimated
Up to 31/03/12
2-3
7-10
15+ 3.0 7.7 0.0 0.0 5.6 5.5 0.0 3.0 2.0 0.0 0.0 26.7 10% -1%
YTD issuance/ Net Issuance Funding - '12 target for Difference Funding (inc. 2012 vs. 2011 '11 buybacks) 222% 60% 310% 106% NM 80% NA 56% 81% NA NA -3% -1% 1% 16% 29% 8% NA -13% -12% NA NA 1% 190 205 214 99 40 51 9 16 18 0 0 842 182 196 220 86 26 60 9 13 23 0 0 804
Germany 14.0 12.0 16.0 France (inc buybacks) 11.3 17.3 22.3 Italy 26.2 22.3 14.3 Spain 14.6 11.9 11.7 Belgium 0.5 1.0 9.8 Holland 5.9 7.0 6.0 Portugal 0.0 0.0 0.0 Finland 0.0 0.4 0.0 Austria 0.0 0.0 4.1 Greece 0.0 0.0 0.0 Ireland 0.0 0.0 0.0 Eurozone Aggregates 72.5 71.9 84.3 Eurozone ex-Greece, Ireland and Portugal Percentages 28% 28% 33% Difference vs. 2011 0% 0% 2%
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In terms of the larger issuers, Germany and France are 25% and 26% funded, respectively. Notably, Germany announced a 2bn increase to its original issuance schedule for Q2 2012 to reflect the capital it will eventually pay into the ESM in 2012. As a result, we may see further small revisions upwards in issuance needs by multiple other issuers reflecting the need for the first stage of payments of capital to the ESM.
Q2 gross and net issuance

Looking forward, we expect Italy to be the largest issuer in Q2, who we expect to issue up to 56bn gross after 63bn of supply in Q1. In net terms, however, the picture in Italy will be quite different QoQ. In this regard ,the actual net funding requirement in Italy was the lowest of any active EGB issuer in Q1 at -1.1bn; however, Q2 will see much less support from redemptions with only a 27.8bn redemption in April to support the market meaning net issuance will rise to around 23bn in the quarter. Domestic holders account for around half of BTP holdings, and we assume they will mostly roll this over. As such, the gross issuance will have less support from this source of demand. However, at the same time the low levels of redemptions mean that once the April redemption hump is over if market conditions are poor the flexibility for Italy to reduce issuance sizes is improved somewhat.. Thereafter, we expect France to be the next biggest issuer with up to 52.5bn in Q2. Redemptions of 18bn means this translates into net supply of 34bn leaving France with the highest net issuance needs of any issuer for the second quarter in a row. Germany has scheduled issuance of 47bn in Q1; however, 35bn of redemption flows mean this translates into net issuance of 12bn. Thereafter, we expect Spain to issue 25bn in gross terms. Spanish bond redemptions are 12.5bn as at end April and thus we expect net issuance needs of 14.5bn in the quarter. Elsewhere, the Netherlands has announced another quarter of heavy issuance with a forecast gross bond borrowing requirement of c.21.5bn in Q2, which could possibly be boosted if they deicide to issue a new 5y via DDA in June. Redemptions are zero however so gross issuance will translate directly into net issuance. Finally, Belgium has cancelled Aprils auction after two syndicated issuances in March, and thus gross borrowing will be low in the quarter at around 6bn we suspect (5.8bn net of bond redemptions). Figure 2: Forecast gross and net issuance by month and country Q2 2012 ( bn)
Germany Gross Issuance Apr-12 Total Redemptions Total Net Gross Issuance May-12 Total Redemptions Total Net Gross Issuance Jun-12 Total Redemptions Total Net Gross Issuance Q2 12 Total Redemptions Total Net
France 17.5 18.0 -0.5 17.5 0.0 17.5 17.5 0.0 17.5 52.5 18.0 34.5
Italy 18.0 27.8 -9.8 18.8 0.6 18.2 19.0 4.1 14.9 55.8 32.5 23.3
Spain Belgium Holland Portugal Finland Austria Greece Ireland 9.0 12.5 -3.5 9.0 0.0 9.0 9.0 0.0 9.0 27.0 12.5 14.5 0.0 0.0 0.0 3.0 0.0 3.0 3.0 0.2 2.8 6.0 0.2 5.8 5.5 0.0 5.5 6.0 0.0 6.0 10.0 0.0 10.0 21.5 0.0 21.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 10.2 -10.2 0.0 10.2 -10.2 1.0 0.0 1.0 0.0 0.0 0.0 0.0 0.0 0.0 1.0 0.0 1.0 1.3 0.1 1.1 1.1 0.3 0.8 2.2 0.0 2.2 4.6 0.5 4.1 0.0 0.0 0.0 0.0 4.1 -4.1 0.0 0.0 0.0 0.0 4.1 -4.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Total 69.3 74.5 -5.2 70.4 5.0 65.4 75.7 33.5 42.2 215.4 113.0 102.3
17.0 16.0 1.0 15.0 0.0 15.0 15.0 19.0 -4.0 47.0 35.0 12.0
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Next weeks cash flows

Wednesday sees Germany tap the 5y OBL for 4bn, while Spain will tap 3y, 5y and 8y bonds. The following day France will auction 7-8.5bn of 5y, 10y, 15y and 30y issues. Support for the market will be minimal in terms of coupon and redemption flows. Figure 3: Barclays Capitals cash flow expectations for week-beginning 2 April 2012
Beginning Weekly Net Cash flow Auction Date Issuance 4.00 8.00 0.00 4.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 16.00 Redemptions 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Coupons 0.00 0.00 0.25 0.01 0.00 0.07 0.00 0.00 0.00 0.00 0.00 0.328 Net Cash Flow 4.00 8.00 -0.25 3.99 0.00 -0.07 0.00 0.00 0.00 0.00 0.00 15.67
19-Mar 26-Mar
-1.74 3.30
Germany France Italy Spain Belgium Greece Finland Ireland Holland Austria Portugal Total
02-Apr
09-Apr 16-Apr
15.67
-4.06 -1.10
Net Cash Flow is issuance minus redemptions minus coupons. Negative number implies cash returned to the market.
Total issuance Total redemptions Total coupons Net cash flow

16.00 0.00 0.33 15.67
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UNITED KINGDOM: RATES STRATEGY
Institutional flows and long yields

Moyeen Islam +44 (0)20 7773 4675 moyeen.islam@barcap.com Henry Skeoch +44 (0)20 7773 7917 henry.skeoch@barcap.com
The latest data on domestic institutional flows in the gilt market suggest that demand for linkers remains healthy despite real yield levels. A bearish correction in both longdated nominal and real yields would likely see an increase in demand for both long ends. The final release of Q4 11 GDP has also seen the release of the latest available data on gilt holdings by sector. This gives us a fuller picture of flows across institutions. The aggregate data is outlined in Figure 1. This shows in absolute terms the aggregate size of holdings across investor classes. We can see that as the size of the market expanded as the fiscal deficit worsened and overall gilt issuance rose, there were big increases in gilt holdings from overseas buyers, MFIs, and the Bank of England under its QE programme. We can see this more clearly when we consider the changes in the composition of ownership (Figure 2). It shows how, aside from the BOEs asset purchase programme, key support has come from the overseas buyers of gilts who have preferred the UK to other sovereign bond markets as the combination of an accommodative monetary policy and credible fiscal policy has left the market well supported. But while there has been a great deal of scrutiny of the activities of overseas investors and the buying by banks for their liquidity portfolios, the one buying trend that has not attracted comment has been the share of the market from domestic institutional investors the domestic pension funds and insurance companies. All told, this sectors holdings of gilts have fallen from just over 50% of the market in Q4 06 to 25% at the end of Q4 11. The outright level has risen from 240bn to 312bn but more aggressive buying from other sectors has seen overall domestic institutional holdings as a share of the total market fall. One of the key channels by which the BOE has expected QE to influence the economy has been through the portfolio route. Simply, this is the idea that domestic holders of gilts would be willing to sell out of gilts as yields fell and replace their gilt holdings with investments in riskier (ie, higher-yielding) assets such as domestic equity or corporate paper so lowering the cost of funds for the wider economy. While in the abstract this sounds entirely plausible, it misses the point that gilts held by pension funds and insurance
Figure 1: Gilt market ownership Q107-Q411(mn)

1,200,000 1,000,000 800,000 600,000 400,000 200,000 0 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 PFs and InsCos BOE ROW MFIs ex BOE
Figure 2: Changes in composition of ownership (mn)

100,000 80,000 60,000 40,000 20,000 0 -20,000 -40,000 -60,000 Mar-08 Mar-09 Mar-10 MFIs ex BOE BOE ROW PFs and InsCos OFIs Mar-11
Source: National Statistics, Haver Analytics
Source: National Statistics, Haver Analytics
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companies are typically held against long-term liabilities. Hence, it cannot be assumed that other asset classes are perfect substitutes. It is widely assumed that one of the reasons why the BOE chose to alter the purchase bands for its reverse tenders in its February QE extension was because of a realisation that the rally in long-dated nominal and real gilt yields had increased the deficit for pension schemes. Indeed, the PPFs monthly 7800 Index shows that over 2011, the aggregate position of the DB schemes that come under its coverage has moved from largely being in surplus (+38.5bn in January 2011) to a deficit of 222bn at end February 2012. This measure looks at the Section 179 (s179) definition of the pension deficit. This measure calculates liabilities on the basis of paying out benefits subject to the regulatory cap, in this case the level of compensation paid out by the PPF (a range of between (22-38k pa depending on age of claimant). This deficit measure is thus not as conservative as the full buyout measure so underestimates the true size of the DB scheme deficit. The Bank has been quick to point out that when considering the pension deficit, it is important to note that the asset side of the balance sheet will have benefitted. And indeed, in aggregate, the PPF estimate that assets have risen from 970bn at end-2010 to 1.041trn at end Feb 2012. This greater sensitivity on the liability side to changes in rates compared to the asset side of valuation has been well-documented by The Pension Regulator. In the Purple Book 2011, it estimated that a 10bp fall in gilt yields raised scheme liabilities by 1.8% while increasing assets by only 0.4%. In cash terms, it estimated that a 10bp rise in yields would change the aggregate funding position by 12.1bn, roughly equivalent to a 2.5% rise in the equity market (9.2bn) (Figure 3). Hence, the sensitivity of the liability side to rates is far greater than the asset side. Additionally a 10bp rise in inflation assumptions increased liabilities by around 0.9% or 8bn. Figure 3: Effect of market movements on scheme funding levels, from a base aggregate deficit of 1.2bn
Assets less s179 liabilities (bn) Movement in equity prices 7.5% 5.0% 2.5% 0.0% -2.5% -5.0% -7.5% Movement in gilt yields -0.3pp -9.8 -20.1 -30.5 -40.9 -51.3 -61.6 -72.0 -0.2pp 3.4 -7.0 -17.3 -27.7 -38.1 -48.4 -58.8 -0.1pp 16.6 6.3 -4.1 -14.5 -24.8 -35.2 -45.6 0.0pp 29.9 19.5 9.2 -1.2 -11.6 -22.0 -32.3 0.1pp 43.2 32.8 22.4 12.1 1.7 -8.7 -19.0 0.2pp 56.5 46.1 35.8 25.4 15.0 4.6 -5.7 0.3pp 69.9 59.5 49.1 38.7 28.4 18.0 7.6
Source: PPF/The Pensions Regulator
The resumption of QE saw a richening of not only nominal gilt yields, but also real yields. Long-dated breakeven rates fell over the same period, in part as a consequence of QE purchases being conducted exclusively in conventional gilts. When linker real yields turned negative across the curve, this led to some concern that this might discourage pension fund demand for the asset class, as schemes would be unwilling to lock in a negative funding position. However, the release of the ONS MQ5 data for Q4 11 last week revealed that pension funds bought a record 7.3bn of gilt linkers in this period, with the previous largest aggregate quarterly purchases worth 5.6bn in Q3 09. Supply was heavy in both of these quarters, at 11.6bn and 12.4bn cash, respectively, and so is likely to account for some of these purchases, although other heavy episodes of linker supply have not seen
30 March 2012 32
commensurately high net investment from pension funds. It is salutary to note that both these periods coincided with a sharp richening in real yields (Figure 4). While correlation does not imply causation (in either direction), this does suggest that demand for linkers is a function of the availability and frequency of supply owing to probable pent-up demand that cannot be wholly satisfied via the regular auction programme. This does lend credence to the view that the DMOs increased use of syndications as a means to supply risk to the long end of the real yield curve is a pragmatic policy response to market need. Interestingly, the Q4 11 MQ5 data also reveals that pension funds were net sellers of 4bn conventional gilts, which supports anecdotal evidence of asset allocation-related demand for linkers when long breakevens touched lows of 3%. In aggregate, this also chimes with the overall view that in Q4 11 domestic institutional investment in the gilt market was only slightly positive, reflecting the stretched level of valuations. Nonetheless, the low levels of real yields has drawn complaints from the pensions industry with some citing an insufficient supply of index-linked gilts from the DMO for the richness of real yields. This point was argued in an FT article on Monday 8, UK pensions crying out for index-linked gilts. The article cites some 1.1trn of outstanding inflation-linked liabilities versus the c.300bn of gilt linkers in issuance. However, comparing these two figures is somewhat misleading, as there is no guarantee that these liabilities would be hedged and if they were, it does not also follow that it would be with index-linked gilts; for some inflationlinked liabilities inflation swaps are a more viable hedge as the market structure allows for a greater degree of precision in liability matching. But while it may be true that if supply was bigger and so likely would be real yields be higher, it cannot be taken as a given and indeed, the supply analysis does not support this view. The ongoing demand for linkers has not been lost on the Treasury or DMO. The minutes of the Treasurys annual consultation meetings with the market in January did reflect this as it was noted that demand for index-linked gilts from the pensions industry remained strong. Also, the Gilt Remit for FY2012/13 has planned linker sales of at least 36.1bn in FY12/13, plus any contribution from mini-tenders. While the share of total issuance in linkers at 20% is broadly similar to that seen in previous years, as there are no linker redemptions due until August 2013 this is likely to be the largest net issuance of linkers that the DMO has ever presided over. The low level of breakevens across the curve makes it hard to justify significantly increasing Figure 4: Real yield rallies correspond to PF linker buying
8000 6000 4000 2000 0 -2000 -4000 -6000 1999 Quarterly pension fund net investment in index-linked (bn) Quarterly change in >15y linker index real yield (rhs inv) -0.5 -0.4 -0.3 -0.2 -0.1 0.0 0.1 0.2 0.3 0.4 2001 2003 2005 2007 2009 2011 -0.6 2006 2007 2008 2009 2010 2011 0.2 -0.2 1.0 0.6
Figure 5: Long breakevens remain comparatively subdued

1.8 1.4 Barclays >15y linker index real yield >15y index breakeven (rhs) 4.5 4.3 4.1 3.9 3.7 3.5 3.3 3.1 2.9 2.7 2.5
Source: National Statistics, Haver Analytics and Barclays Research

8
http://www.ft.com/cms/s/0/eebdc9a8-736c-11e1-aab3-00144feab49a.html
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the proportion that linkers comprise in the gilt remit as when breakeven inflation rates are low, conventional gilts represent more cost effective funding for the exchequer. The compression of breakevens in 2011 was a consequence of the extension of QE, with longdated breakevens rebounding relatively strongly since then. In Q4 11, the average >15y index breakeven was 3.1%. Yet in Q3 09, when linker supply was higher both in cash and duration terms and the first round of QE was ongoing, the same index breakeven was 3.5% with slightly lower buying from pension funds (Figure 5). The key difference was that real yields were notably higher in that period at circa 62bp, although at that stage that level was fairly low for >15y linkers by historical standards. Nevertheless, a backdrop of accommodative monetary policy leaves low breakevens clearly encouraging allocations into linkers. The current structurally low level of breakevens is not consistent with the underlying significant supply/demand imbalance in long linkers. So while there may be pent-up demand, which should crystallise at higher real yields, it seems an exaggeration to suggest that this alone is responsible for the low level of real yields.
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COVERED BONDS
Depfa ACS covered bonds downgradedby six notches

(This is an extract from The AAA Investor, 29 March 2012)
Fritz Engelhard +49 69 7161 1725 fritz.engelhard@barcap.com Jussi Harju +49 69 7161 1781 jussi.harju@barcap.com
Rating volatility is something covered bond investors have become used to over the past years but multi-notch downgrades are still a painful and unexpected experience when they occur. This time around it was Depfa ACS public sector covered bonds that suffered a six-notch downgrade from S&P on Monday. The last major multi-notch downgrade of covered bonds from S&P was on 1 August 2011 when S&P downgraded 46 Spanish multi-cdulas between one and nine notches. This time around, the downgrade was less pronounced, but nevertheless it moved the rating two whole rating categories down from AA to BBB. Furthermore, the covered bond rating is currently levelled with the senior unsecured rating, ie from an investor perspective there is no rating benefit for investing in the covered bond over the senior unsecured. This warrants a discussion on the rationale of the downgrade and what does it really mean for investors. Depfas covered bond rating has been on CreditWatch Negative from S&P since 26 August 2011. Based on S&P quarterly Global Covered Bond Characteristics and Rating Summary reports, it appears that the over-collateralisation (OC) provided by Depfa has been below the OC required to support the rating since June 2011 reporting. However, based on Depfas reporting, it has complied with S&Ps OC requirement since June 2011. So, why is there a difference between the numbers? The difference stems from how S&P views zero-coupon covered bonds issued by Depfa. When determining the available OC, S&P calculates the outstanding principal balance on the zero-coupon covered bonds based on the final redemption amount (ie par of the bond) whereas Depfa calculates these based on their current principal amount (ie the intrinsic notional that grows to par value of the bond by maturity of the bond), which is allowed under the Irish Asset Covered Securities (ACS) Act. Consequently, the amount of liabilities issued under the programme, in S&Ps view, is higher and thus the available OC lower. Following S&Ps downgrade of European sovereigns on 13 January 2012 and the subsequent downgrades of number of European public-sector entities has in S&Ps view deteriorated the cover pool credit quality. In addition, S&P has lowered the ratings on selected U.S. student loan securitisations that are in the cover pool, which also has a negative impact on the required OC. Finally, S&P notes that a Spanish public sector exposure that according to their credit assessment is in the BB category represents an increased share of 6% of the cover pool. Although in S&Ps view the credit quality of the cover pool has deteriorated, we note that the average credit rating of the cover pool assets is considerably higher than the covered bond rating. In fact, 85% of the cover pool assets are rated higher than the covered bonds currently (see Figure 1). This highlights the fact that under S&Ps rating methodology, required OC is primarily driven by mismatches between asset and liability cash flows. Figure 1: Rating distribution of Depfa cover pool assets (February 2012)
Rating Category AAA AA A BBB BB and below
Source: Standard & Poors
Difference in reported overcollateralisation numbers is due to treatment of zero- coupon covered bonds
In S&Ps view the credit quality of the underlying assets has deteriorated
although the vast majority of the assets are still rated higher than the covered bond currently
% of the cover pool 26% 48% 11% 7% 8%
30 March 2012
35
Rating definitions matter
In order to understand the rationale for the downgrade, we must first understand S&Ps rating definition. To recap, S&Ps credit rating addresses the likelihood of an obligor receiving timely interest payments and ultimate payment of principal by maturity date. Consequently, even a one Euro of missed interest payment under its rating definitions classifies as a default. Given that covered bonds are issued primarily always in bullet format and the assets backing them tend to be amortising assets with longer maturities, this obviously creates a mismatch between the cash flows from the cover pool assets. In order for the cover pool administrator to bridge these gaps he/she is required to sell assets (likely at high discounts) or access liquidity in some other forms. Subsequent to their analysis, S&P indicated that Depfa should provide 11.67% of OC in order to maintain the AA covered bond rating. This obviously should be provided in the way S&P calculates the OC, ie calculating the zero-coupon bonds at final redemption value. Depfa decided not to comply with S&Ps OC requirement and, consequently, its covered bonds were downgraded. We note that even when using the issuers convention to calculate the liabilities, the provided OC is still at 8.81% below S&P required OC. However, levelling the rating at the level of issuer rating, ie giving no credit to the cover pool raises questions. Having the covered bond rating at the issuer rating level certainly raises questions of what the rating really means. This is exactly the question investors should ask as S&Ps rating, as explained above, addresses timely payment of interest and ultimate payment of principal only if mismatches in the cash flows of cover pool assets and liabilities are covered can the covered bond rating exceed the banks senior unsecured rating. However, if an investor considers it unlikely that they have to rely on the cover pool assets for repayment (and empirical evidence supports this strongly 9) and/or if they assume that if this were to occur the mismatches are bridged by other means (for example, by accessing central bank funding) then the quality of the underlying assets is of higher importance. Furthermore, investors still benefit on having a claim on a specific pool of assets after the insolvency of the issuer, which should make the covered bonds more attractive than senior unsecured debt. The next question for many investors is that will other rating agencies follow S&Ps lead and also downgrade Depfas covered bonds. The available OC (using Depfas convention to calculate the liabilities which we understand also Moodys and Fitch use) has remained the same since December 2011 at approximately 8.8%. Based on Moodys performance overview as of December 2011, the required OC to maintain the current Aa3 rating is 6.0%, which is less than the current available OC, so Depfas covered bond rating from Moodys should be safe. The highest rating on Depfas covered bonds is from Fitch, which currently rates them at AAA Watch Negative. The required OC to support the current rating is not disclosed on Fitchs website, but given that the OC has not changed based on the issuer calculation convention and the rating of Depfa ACS Bank has not changed, we do not expect immediate rating pressure from Fitch either, at least owing to the same reasons as those given by S&P. In addition, it is worth remembering that the deterioration in credit quality of the underlying assets is only in S&Ps view. In our view, the current covered bond rating of BBB from S&P, which is at same level as the senior unsecured rating of Depfa ACS Bank, is not justified from a fundamental perspective and is based solely on technical factors relating to the rating definition and the calculation of the available OC. While understandable from a rating agency perspective, this, in our view, ignores the claim investors have against the cover pool.
and the definition of available OC matters even more
Having no uplift in the covered bond rating above the issuer rating gives no credit to the cover pool assets
Will other rating agencies follow?
See The AAA Handbook 2011 A New Dimension: Covered Bond Rating Methodologies
30 March 2012
36
SUPRANATIONAL, EUROPEAN SUB-SOVEREIGN & AGENCIES
The National Loan Guarantee Scheme

Michaela Seimen +44 (0)20 3134 0134 michaela.seimen@barcap.com Zoso Davies +44 (0)20 7773 5815 zoso.davies@barcap.com
This is an extract from The NLGS and RMPP: Meaningful, but manageable, supply in sterling credit, dated 29 March 2012 The UK NLGS is expected to result in 20bn of UK Government guaranteed issuance over the next 24 months. Based on issuance under the previous guarantee scheme, we expect at about half of this to be sterling denominated. This therefore represents a significant upside risk to our FY12 GBP unsecured financial issuance of 12.5bn. In our view, the negative impact of this supply will be largely offset by two factors: participation of non-traditional credit investors; and displacement of other issuance. However, we believe NLGS issuance will erode demand for traditional corporate credit at the margin, raising the theoretical floor on credit spreads.
Scheme details
The NLGS was announced in November 2011 and launched on 20 March following State Aid approval by the European Commission. The purpose of the scheme is to ease credit conditions in the UK for businesses with less than 50mn in annual turnover. This will be achieved by lowering the cost of bank loans to these companies by 100bp. Banks will be compensated for the reduced lending rate on loans via a government guarantee scheme under which they will be able to issue unsecured debt, guaranteed by the UK government for a fee. Five banks have signed up to participate: Aldermore; Barclays; Lloyds/HBOS; RBS; and Santander UK. Over the life of the scheme, up to 20bn of guarantees will be available to banks, subject to the volume of qualifying loans made. These will allow banks to issue unsecured debt guaranteed by the UK government. In compliance with the ECs State Aid rules for government guaranteed issuance, banks will pay a fee based on the CDS spread of the bank and of the UK sovereign. The NLGS is expected to operate for up to two years and will guarantee debt of up to 5y in tenor, though no more than one third of total issuance can have an initial maturity beyond 3y. Debt issued under the scheme will be denominated in GBP, USD, EUR or JPY and will be eligible collateral at the Bank of England. It is likely to be eligible at the ECBs monetary operations. An initial 5bn tranche of guarantees has been allocated so far, with at least one bond already issued under the scheme. However, participating banks are required to offer or otherwise commit to credit facilities to eligible businesses to pass through the benefit they receive from the issuance within three months of NLGS issuance. Further, those facilities must be drawn down within six months. Thus SME loan-demand may prove to be a limiting factor on the pace of NLGS issuance beyond the initial round of supply.
How much and which currencies?

While an incremental 20bn of issuance would be relatively minor in both the USD and EUR markets, on paper the NLGS scheme is almost twice our FY12 forecast for unsecured bank debt in the GBP market (12.5bn). Based on the distribution of issuance in 2008/09, when ~50% of UK guaranteed bank issuance was GBP denominated, we believe that 8-12bn of NLGS issuance will be in sterling over the next two years with risks skewed to the upside. On the same basis, we expect the bulk of any non-sterling issuance to be USD denominated. Spread evenly over the two-year period, this suggests 4-6bn of additional supply this year, or a 30-50% upside risk to our FY12 forecasts. That said, NLGS issuance is likely to replace senior unsecured issuance in part, muting the overall impact somewhat.
30 March 2012 37
Who are the likely buyers?

The UK government has previously run a government guarantee scheme for unsecured bank issuance. The Credit Guarantee Scheme (CGS) resulted in 140bn of government guaranteed issuance, with the bulk done between October2008 and May 2009. As Figure 2 shows, this resulted in a sizeable uptick in AAA rated, non-Gilt -issuance. The initial buyers were a broad cross section of the UK investor community including banks, credit investors and traditional AAA desks. Over time, we believe most of this paper migrated to money market funds and treasury desks which now comprise a significant investor base. With this in mind, we have previously highlighted the ongoing CGS redemptions (Figure 3). These maturities have shrunk an already small pool of non-gilt AAA rated sterling assets by c.60bn over the past two quarters. The result has been a growing demand for replacement AAA rated -securities. This has been a key driver of short-dated -FRN covered bond and -SSA issuance, in our view. Indeed, AAA rated non-gilt issuance in Q1 was the highest on record, other than during the flurry of CGS issuance in Q1 09. Thus we believe that evidence points to a robust demand for short-dated, AAA rated sterling issuance which is likely to persist (or even grow). There is also evidence of rising demand for non-gilt, -AAA assets from Central Banks and Sovereign Wealth Funds looking to diversity their sterling assets. That said, we do not expect AAA focused investors to be the sole source of demand for NLGS paper. Benchmark-sized deals (which are likely to be favoured by investors), will likely end up in widely tracked non-gilt indices and therefore find demand from benchmarked credit managers. However, given the current spread on UK-guaranteed Network Rail bonds (and recent NLGS deals) NLGS paper appears likely to price around 50-60bp over gilts, in our view. At those levels NLGS bonds would likely be viewed as an alternative to gilts or -SSA debt, rather than corporate credit. The limit on issuance beyond 3y in tenor is likely to reinforce that attitude. Over time, the split between fixed and floating coupons will give some insight into the buyers of NLGS debt. Net-net, we anticipate that 8-12bn NLGS issuance would have a moderately deleterious effect on demand from UK RM credit investors. But we expect it to be significantly smaller than the headline figure would imply, and we do not believe that it will create negative technical pressure on spreads. However, the supply overhang should incrementally raise the floor on where spreads can go in a rally, in our view. Figure 2: AAA Sterling issuance by month
bn 14 12 10 8 6 4 2 0 06 07 08 09 10 11 12 5 0 07 08 09 10 11 12 13 15 2000-2007 Average 10 Sovereign Agency/SSA Covered Bond Unsecured Corporate Govt Guarantee
Figure 3: Maturing AAA Sterling credit

bn 25 20 Govt. Guarnateed Other 2011, 59bn 2012, 61bn
Note: Excludes FRN Covered bonds prior to 2010. Source: IMA, Barclays Research
Source: IMA, Barclays Research
30 March 2012
38
The long-term outlook for non-bank credit in the UK

The NLGS is just one part of the UK governments efforts to ease the flow of credit into the economy, the unspoken assumption being that lacklustre domestic credit growth has been due to supply-side constraints. Over the past three years, the UK government has engaged in a number of other schemes aimed at easing credit conditions in the economy: The Enterprise Finance Guarantee: Launched in 2009, the EFG was aimed at helping SMEs access up to 1.5bn in credit over three years. The fund sought to support lending to viable businesses with an annual turnover of up to 41mn that were seeking loans between 1,000 and 1mn, but which lacked sufficient security. The EFG provided a government guarantee for up to 75% of the loans face value. Project Merlin: Launched in 2010, Project Merlin was an initiative in which UK banks agreed soft targets on lending volumes in the UK. The Business Finance Partnership: Launched in November 2011, the BFP is a co-investment scheme in which HMRT will look to invest up to 1bn in managed funds that lend directly to mid-sized businesses and/or SMEs in the UK. This scheme is targeted at businesses with up to c.500mn consolidated annual turnover. Further, the UK government remains open to exploring other avenues of non-bank lending. For example, in its Request for Proposals, the Business Finance Partnership comments that The government is also considering other non-bank lending channels through which BFP may invest. This leads us to note that the UK is currently one of the few large, Western governments without an associated Agency issuer. A government-sponsored task force set up by UK Business Secretary Vince Cable has looked into alternative sources of SME lending in the UK along these lines. A report published by the task force in March 10 recommends that the government explore the creation of an aggregation agency to lend directly to and/or pool SME loans. In its response, the current UK government has said that it will support the feasibility study and recognises it may have a role to play in supporting the initial development of these markets. However, it also emphasised private sector participation. We believe that the establishment of a permanent agency in the UK for the financing of SMEs could be beneficial. Successful models already exist, for example, KfW in Germany and ICO in Spain, and allow governments to integrate lending business of these entities into their respective industrial policies. From a policy perspective an agency can be beneficial, as the government can adjust business targets in line with changing stimulus needs. Further, a permanent and stable financing approach, involving a specialised funding entity, would ease the loan application process for SMEs and would make it easier for them to secure follow-up financing over longer periods of time - essential for businesses with longer start-up periods. From a capital market perspective, government guaranteed issuance from one agency would also have a positive impact on funding costs. With a permanent presence in the market, debt issuance should become cheaper as a well established investor base values the ongoing issuance and complete maturity structures provided by single issuers. Clustered, smaller issuance from several issuers leads to inefficient cost structures. These market inefficiencies were observed during 2008 and 2009 with the establishment of national government guarantee schemes. The French model of an established single issuing agency benefited from cheaper funding levels than in fragmented schemes in other countries.
10
Boosting Finance Options for Business, http://www.bis.gov.uk/businessfinance
30 March 2012
39
While we see many benefits of a single agency issuer, we note that the political response to such a suggestion remains tepid. Chancellor Osborne made a series of comments to the Treasury select committee on the matter this week. In particular, he noted that the coalition was prepared to increase the capacity of the NLGS scheme beyond 20bn if there was evidence that it was helping to ease credit conditions for SMEs. Further, he intimated that ways to (re)start the market for securitising small business loans are actively being looked at while emphasising that a new national Agency would take longer to implement than schemes utilising the existing network of UK banks. While several consultation exercises are possible (probable even), the establishment of a UK agency before the next elections seems unlikely at the moment. Along similar lines, we also note that the UK governments stance towards debt issuance by Local Authorities appears to have softened on the margin. Following the successful deal by COMFIN (for the GLA), a number of stories emerged suggesting that other Local Authorities were looking at bond issuance. However, given the price ceiling imposed by PWLB borrowing, credit spreads will need to tighten markedly before this becomes economically attractive to potential issuers.
30 March 2012
40
EURO INFLATION-LINKED MARKETS
Positioning for the carry upswing

Khrishnamoorthy Sooben +44 (0)20 7773 7514 khrishnamoorthy.sooben@ barcap.com
The OATi15 breakeven still appears attractive ahead of the positive carry season. Marchs very negative carry is behind us, leaving the market to focus on the very positive seasonals that should accrete on i linkers in the coming months. Carry is not a de facto driver of returns, as the market has become more efficient over the years in pricing out extreme inflation accretion as it erodes, but extreme seasonals do typically increase tactical investors confidence in initiating short-term positions. As Figure 1 shows, the market is currently trading at the lowest point of the year in terms of seasonal accrual, with the highest point to be reached at the end of June. At this time of the year, it is therefore essential to look beyond spot valuations when gauging short-dated linkers. At the very front end, ie the 2012 linkers, we use our economists euro HICPx forecast profile to project the remaining cash flows and back-out a nominal yield measure. On that basis, the OATi12 appears about 50p cheap to the nominal BTAN July 2012, while we find the BTPi12 to be in line with the nominal market. With our economists euro HICPx forecasts stretching out to the end of 2013, we can assess the fair value of the OBLi13 using the above methodology; and we find the bond to be about 15bp cheap. Although the OBLi13 may appear a suitable bond for those wishing to position for the very positive carry ahead, the fact that it will fall out of 1y+ indices at the end of the month means that it is likely to be subject to strong selling pressures in the near term. We highlight that many index-based investors who have been reducing their exposure to BTPis over the past two years have structurally allocated the proceeds to German linkers. Index-related selling in the OBLi13 may therefore be significant. However, longer on the curve, we continue to find value in the OATi15 in breakeven. We strip out any seasonal bias by looking at its forward breakeven to the 25 July 2012 settlement date, here again using our economists euro HICPx forecasts. On that date, the bond will have an exact residual maturity of three years, and at just above 1.4%, the forward breakeven looks economically cheap to us. Tactically, the risk to a long position in the OATi15 breakeven is a correction in energy prices, but more structurally, we believe that higher indirect taxation may become a recurrent theme in the coming years. A 3y breakeven at just above 1.4% does not appear to be pricing that possibility, in our view. Figure 2: OATi15 still pricing a very low inflation scenario
2.8 2.4 2.0 1.6 1.2 0.8 Current seasonals 0.4 0.0 Jan-10 OATi15 breakeven Forwards up to 25 July settlement date Lowest point in rolling 3y annualised euro HICPx Highest point in rolling 3y annualised euro HICPx Jul-10 Jan-11 Jul-11 Jan-12 Jul-12
OATi15 breakeven appears economically cheap
Figure 1: Market currently trading at lowest seasonal point

0.6% 0.4% 0.2% 0.0% -0.2% -0.4% -0.6% -0.8% -1.0% Jan Mar May Jul Sep Nov Cummulative seasonal accrual over a year
30 March 2012
41
EUROPE: VOLATILITY
Buy EUR mid-curve, sell US mid-curve

Piyush Goyal +1 212 412 6793 piyush.goyal@barcap.com Hitendra Rohra +44 (0)20 7773 4817 hitendra.rohra@barcap.com
Buy EUR vs US 1y*2y1y mid-curve payer as the market is more likely to re-price hike expectations from the ECB than from the Federal Reserve. The recent price action in EUR and US vol has been strikingly similar in that investors are more cautious about expecting the central banks to remain on hold for a long time. While there is little uncertainty about inactivity from the Fed and the ECB for the next couple of years, expectations further out out can change quickly. Thus, as Figure 1 shows, gamma on 2y in both US and EUR has been unchanged since March 9, but gamma on 5y tails has yet to retrace recent moves. These rate and vol moves are not surprising, as any exit from the dovish Fed/ECB stance could be volatile. Investors tend to own short-term Treasuries, curve steepeners, etc, as these carry well in a low short-rate environment. The positioning then becomes crowded, eventually resulting in a nasty unwind. The last hike episodes are a testimony to such vicious price action. In the Fed case, the US 2y swap rate rose by about 150bp in the three months leading up to the first hike in June 2004. In EUR, the 2y swap rate rose ~80bp in the three months leading up to the first ECB hike in April 2011.
Dont fight the Fed

Looking ahead, we think the market is more likely to re-price action from the ECB than from the Fed. This is because the recent gyration in USD rates highlights the lengths to which the Fed will go to ensure that rates remain low for a long time. First, based on communication at the March FOMC meeting, the market thought the Fed would not implement a third round of asset purchases and started pushing rates higher. However, less than two weeks later, Fed communications dampened expectations of higher rates. Clearly, the Fed is dovish and will do whatever it takes to ensure that the economy does not fall prey to deflation. More importantly, market participants are aware of this tendency. On the other hand, the ECB has not implemented any form of unsterilized balance sheet expansion. If anything, it has shown enthusiasm to hike the main refinancing-rate as soon as data warrant. Accordingly, the probability of a market expecting ECB hikes a few years out is more than that of a market expecting hikes from the Fed. Figure 1: Gamma on 5y tails rose the most for US and EUR
10
Figure 2: EUR 1y*2y1y payer has best carry/ realized vol ratio
Expiry Realized Vol carry / realized vol 3m carry (ct) (60d, bp/d) (ct / dbpv) 1y1y 2y1y 1yf 1y1y 2y1y -9 -10 -9 -10 3.8 4.6 4.3 5.1 -2.4 -2.2 -2.1 -2.0
6mf
6 4 2 0 -2 -4 3m2y 3m5y 3m10y EUR 3m30y USD 5y5y 10y10y
Note: Changes since 9 March 2012. Source: Barclays Research
30 March 2012
42
Mid-curve options likely the best choice

Generally, a long position in mid-expiry short-tail payer swaptions, such as 3y*2y, can allow an investor to position for hikes a few years out. However, a mid-curve options such as 1y*2y1y is better, for two reasons. 1. The longer expiry swaption requires more premium outlay as it has more time value. This means rates would need to rise more for a favourable P&L. 2. The mid-curve option allows an investor to benefit from a market expecting hikes, not necessarily actual hikes, from the central bank. As highlighted by the price action of the past three years, several bouts of hike expectations have eventually fizzled out. To determine preferred positioning, we evaluate a variety of mid-curve options (Figure 2) for the best carry/realized vol ratio. In general, all mid-curve payers carry negatively, primarily because the forward rates are higher than the spot rates. But the one with higher realized vol has more chances of fighting the negative carry. We like 1y*2y1y because it has the highest carry/realized vol ratio (Figure 2). An investor could buy the mid-curve standalone or fund with a similar option in US. Buy EUR 100mn 1y*2y1y payer @ 1.75% Sell $130mn 1y*2y1y payer @ 1.75% Depending on bid-offers, the above trade may not require a premium outlay. So if investors did not re-price the Fed and the ECB, both options would expire worthless and the trade would incur no P&L. Furthermore, in this way the trade carries positively as the EUR payer decays more slowly as a result of less onerous forwards and vol. Thus, it is easier to hold the trade. But the main reason we like the trade is that it could do well if the market re-prices action from the ECB. Both options are struck at the same strike, so the trade would incur gains if the 2y forward 1y swap rate in EUR is even slightly higher than the US rate . Clearly, as the recent history shows, a higher EUR short rate should not be hard to achieve (Figure 3).
Risk alleviation of funding worries

The main risk to the trade arises from further alleviation of funding worry for banks in the Eurozone. Generally, short-end swap spreads have widened more in EUR than in US. 2y and 5y swap spreads are still 40-60bp wider in EUR than in US. Further compression, possibly as Eurozone worry is pushed further onto the backburner, may cause the EUR short swap rate to fall more than the US short swap rate, delivering mark-to-market losses to the trade. However, both options would drift away from the strike and could eventually expire worthless. So an investor could hold the trade to expiry and incur no losses.
30 March 2012
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Figure 3: EUR 2y fwd 1y rate has been as high or higher than US rate for a few years
4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0
Nov-09 Nov-10 Nov-11 Sep-09 Sep-10 Sep-11 Jan-09 Jan-10 Jan-11 Mar-09 May-09 Mar-10 May-10 Mar-11 May-11 Jan-12 Mar-12
44
EUR 2y1y rate
US 2y1y rate
Jul-09
Jul-10
Note: Last point as of 3/29/12. Source: Barclays Research
30 March 2012
Jul-11
AUSTRALIA: RATES STRATEGY
A 40bp gain in three days. Can we expect more?

This article was originally published on 30 March 2012.
Gavin Stacey +61 2 9334 6128 gavin.stacey@barcap.com
Bottom line
After a 40bp rally, we believe investors who entered a receive AU 1y1y earlier in the week should lock in their gains. Moreover, depending on how things play out over the coming week, there may be an opportunity to pay AU 1y1y.
Global manufacturing PMI weakness in March could spark an AU 1y1y rally

On Monday, we recommended a tactical receive AU 1y1y trade on a pullback to 4.25% (see Australia: March global PMI weakness would likely drive AU 1y1y to bottom of 4.00-4.40% range, 26 March 2012). The AU 1y1y was trading around 4.20% at that time, but rose to 4.25% on Tuesday. The rationale for the recommendation can be summarised using the "Bottom line" section of the above-mentioned report: Since early February the AU 1y1y has been basically trading on the assumption that the GMPMI troughed in November 2011. The sideways shift in the GMPMI in February (released on 1 March) initially created a bit of ambiguity about that trough call, but the market eventually shrugged it off given the extension of the "risk on" trade. Following the China and EU flash PMIs, we believe the best-case scenario is a flat print for the GMPMI in March. Given that such an outcome would come on the back of February's disappointment, our suspicion is that the market's mindset, as well as the RBA's, about the possibility of higher rates is likely to soften. Accordingly, we believe the risk/return going into the upcoming PMI round suggests a more cautious stance towards expectations for higher AU short-end rates, despite our relatively sanguine global economic outlook. Indeed, at around 4.25% a tactical receive AU 1y1y position looks potentially attractive, in our view. Three days later we find the AU 1y1y around 3.85%, 40bp lower than Tuesday's level and through the bottom of its recent 4.00-4.40% trading range. In light of that, the obvious question is what to do? The prudent trader would of course lock in their three-day profit of 40bp. Prudence aside, are there compelling reasons to close out a position that has performed so well? Our report yesterday (Australia: Likely decline in index of non-rural commodity prices should mean a more dovish RBA, 29 March 2012) suggested that there is merit in holding the receive AU 1y1y position through the release of the Reserve Bank of Australia's (RBA's) index of commodity prices (ICP) and the April RBA board meeting. First, we believe investors should expect a decline of about 2.0% in the March non-rural ICP; and Second, we expect the RBA statement accompanying the April rate decision to strike a more dovish tone than March on a lower ICP and likely weakness in the global manufacturing PMI.
30 March 2012
45
With the market pricing a 50:50 probability for an April ease and a near 100% probability for a May move, however, it is far from clear that a dovish shift in RBA commentary alone will be enough to spark a further rally. Moreover, with respect to our global manufacturing PMI (GMPMI) measure, our modelling now suggests the market has gone from being too sanguine following the weakness in the EU and China "flash" PMIs, to being too pessimistic. Indeed, the 1m change in the AU 1y1y now appears consistent with declines of similar magnitude in the Japan and US PMIs. Figure 1 highlights the 1m change in the AU 1y1y versus model fair value based on the GMPMI. It suggests a significant overshoot in the AU 1y1y rally for anything other than a disastrous GMPMI. Interestingly, these overshoots, when they occur, tend to unwind just as quickly as they arise (Figure 2).
Figure 1: 1m change in AU 1y1y (%) vs model

1.0 0.5 0.0 -0.5 -1.0 -1.5 Mar-06
Mar-07
Mar-08
Mar-09
Mar-10 Model
Mar-11
Mar-12
1m change in AU 1y1y
Figure 2: 1m change in AU 1y1y model residual

0.8 0.6 0.4 0.2 0.0 -0.2 -0.4 -0.6 -0.8 -1.0 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12
30 March 2012
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JAPAN: RATES STRATEGY
Seasonality and fundamentals

Chotaro Morita +81 3 4530 1717 chotaro.morita@barcap.com Reiko Tokukatsu, CFA +81 3 4530 1532 reiko.tokukatsu@barcap.com Noriatsu Tanji +81 3 4530 1346 noriatsu.tanji@barcap.com
The markets may try to move based on the pattern of the past two years, in which yields hit their peak for the fiscal year in April. However, JGBs, which would normally cheapen relative to USTs during this period, are, in fact, rich currently and could enter a bear steepening trend in the coming weeks. We think 10y richness is best captured via butterflies, such as 5s7s10s and 7s10s20s. There is a perennial debate at this time of year over an alleged anomaly at the start of the fiscal year and in the Apr-Jun quarter. In fact, no consistent seasonal pattern exists, and mechanical trades can produce big losses. Still, this year, market participants are likely to recall the pattern that has held over the past two years, and their activity at the start of the new fiscal year could be based on that. In both 2010 and 2011, yields hit their peak for the fiscal year in April, the very first month. Moreover, the high was reached in the first 10 days of the month and was followed by a clear downtrend, especially in the fiscal years first half (Figure 1). Of course, this was not limited to JGB markets, the same phenomenon occurred in US Treasuries and German Bunds. In Japans case, though, the timing ie, the turn of the fiscal year suggests that the investment decisions made at that time helped determine the performance for the year. We suspect current yield levels will not be attractive to major JGB investors, such as banks and life insurers, relative to the cost of debt. In that sense, they may prefer to wait as long as possible until yields rise. That is, the start of the fiscal year could see a battle between a focus on an anomaly and the desire to delay investments, and investors can easily swing one way or the other depending on the external environment at that time. Let us look again at trends around the start of the fiscal year under the assumption that there is no such perfect anomaly. We find that JGBs tend to underperform USTs from the second half of March through the first half of April (Figure 2). Because UST yields often turn upward during this period, JGB yields are also relatively prone to rise higher at this time than during the rest of the year. On the other hand, the JGB yield uptrend in June and July, which
Figure 1: Fiscal year pattern of 10y JGB yields (bp)

60 50 40 30 20 10 0 -10 -20 -30 -40 -50 -60 Apr Jun 2007 Aug 2008 Oct 2009 Dec 2010 Feb 2011
Figure 2: Seasonality in richness/cheapness of JGBs vs USTs (bp)

JGB richness/cheapness (average) JGB richness/cheapness (2012) 10y UST yield (average, RHS) 50 10y UST yield (2012, RHS) 40 JGB rich 30 20 10 0 -10 -20 -30 -40 -50
12 10 8 6 4 2 0 -2 -4 -6 -8 -10 -12 Jan Mar May
JGB cheap
Jul
Sep
Nov
Note: Movement from April. Source: Barclays Research
Note: Richness/cheapness is 60-day residual for 10y JGBs and USTs. Average is 2002-11 excluding 2008. Source: Barclays Research
30 March 2012
47
had been an anomaly up to FY 09, took place when the direction of USTs tended to be flat. Cheapness against USTs would propel JGB yields higher during that period. One distinctive feature this year has been that while UST yields have climbed since early March, there was no corresponding cheapness in JGBs. Based on the experience of the previous two years, this may reflect investors desire to concentrate their investments early in the fiscal year despite the unattractive level of yields. If this pattern more firmly entrenched, we expect the curve to have a bull-flattening bias from early next week. However, the external environment may point in the opposite direction, and we should not make any firm assertions. If the external environment turns to a rise in yields and a steepening bias, JGBs could cheapen rapidly to historical average levels, leading to a sudden 7-8bp increase in 10y yields. Assuming flat UST yields, we see room for a correction of this scale. If the climate encourages bear steepening, UST yields could come under upward pressure, which could mean 10-20bp of cheapening ahead.
Best way to capture 10y JGB richness

Last week, we recommended going long the 5s7s10s JGB butterfly. Although it was a weighted fly and was short delta on a net basis, it performed by 1bp despite the rally this week (Figure 3). It is worth noting that almost all of the move was caused by 5-7y portion. The 10y sector, hence, is trading close to its richest level since October 2010 in terms of the 7s10s20s fly (Figure 4). While this makes a 7y10y steepener look more attractive within the 5s7s10s butterfly, we advise caution One similarity in the 10y richness between in October 2010 and now appears to be investor caution toward extending duration to the 20y level. We see efforts to keep duration risk at the 10y level due to: 1) a painful rebound to bull flattening in 2010; and 2) concerns about higher 20y JGB issuance from April and weaker demand from life insurers currently. However, the 2010 experience offers a reason to be careful with a 7y10y steepener as a way to capture 10y richness. After October 2010, although the 10y richness was corrected in terms of the 7s10s20s, 7s10s did not change (Figure 5, circled). It steepened temporarily at the end of November 2010 and in mid-February 2011, although these adjustments were linked to yield dips triggered by nationalization of Irish banks and the turmoil in Libyan, respectively (shadowed in Figure 5). Figure 3: Weighted 5s7s10s and its breakdown, bp
-28 entry -30 -32 -34 -36 -38 -40 1-Mar 38 36 34 32 -38 30 28 5s7s10s with -1:2:-1.3 (LHS) 26 5s7s (RHS) 24 7s10s (RHS) 15-Mar 22-Mar 29-Mar -43 7s10s20s Mar-11 Sep-11 Mar-12 -33 -28 40
Figure 4: JGB 7s10s20s,bp
8-Mar
-48 Sep-10
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48
Figure 5: JGB 7s10s and 7s10s20s during 2010,bp
Figure 6: Examples of bull flattening followed by bear steepening

-30
Changes (bp) period
day1 4/4/03 12/11/08 6/1/10 12/1/11 day2 6/18/03 12/29/08 8/23/10 3/29/12 day3 7/3/03 1/14/09 9/3/10 ?
49 47 45 43 41 39 37 35 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 7s10s (LHS)

-32 -34 -36 -38 -40 -42 -44 -46 -48
7s10s
day1 2 -9.3 -12.4 -8.5 -1.9 day2 3 15.3 10.9 6.1 ? day1 2 -17.6 -21.3 -32.0 -8.2
10s
day2 3 56.9 6.5 16.6 ?
7s10s20s
These movements remind us that 7s10s steepening is not a standard pattern in our bearish scenario. However, there are cases when the 10y sector encounters bear steepening after trading rich due to bull flattening good examples are July 2003, January 2009 and August 2010 (Figure 6). However, the recent bull flattening has advanced at a slower pace than in these periods, and this may weaken prospects for bear steepening. On the other hand, in the sense that only a partial correction of the sharp 7y cheapening from mid-March is achieved, the probability of 7s10s bear steepening is high. We conclude that it is better to express view to 10y richness through flies, such as long the 5s7s10s or short the 7s10s20s, from a risk/return perspective. While 7s10s20s carry is normally negative, it has become flat due to recent 7y cheapening. Therefore, we advise investors to build short 7s10s20s positions at a level richer than -40bp (constant maturity base). Figure 7: Recommendation updates (bp)
Year end/ Entry level -31.1 -41.0 -2.0 0.1 36.0 -15.7 -92.0 Current (incl carry) -32.4 -41.5 -1.3 -3.4 24.7 -16.5 -53.0 Weekly P&L (JPY mn) 16.0 -2.5 -2.0 1.0 -6.0 -5.0 0.0 Risk (DV01, JPY mn) 20 (body) 10 (body) 10 10 10 15 10 Target (incl carry) -35.0 -35.0 2.0 -5.0 25.0 -13.0 -50.0
Entry date JGB 5-7-10y long (JS101JBM2-JB320 at -1:2:-1.3) JGB 7-10-20 short (JBM2-JB320-JL125) Tibor/Libor 5-10y steepener 10Y ASW (JB318) Swap spread 20Y ASW vs. 3month (JL129) 5Y ASW short (JS100) Pay 1yx1y Xccy basis swap 23-Mar 30-Mar 09-Dec 25-Nov 28-Oct 02-Mar 02-Dec
Stop -25.0 -25.0 -4.0 8.0 42.0 -18.0 -100.0
Horizon medium medium by March end long long medium medium
Action hold New (0.5bp bid/offer) Close Hold Hold but look to take profit Hold Hold (CM=-60bp, the difference owes rolldown) Hold Hold with view to further sell-off in April
JGB
Swap
Rec 20yx10y 3mx10Y swaption long (K=1.12% )
27-Jan 20-Jan
38.0 43.0
39.9 17.0
6.3 -20.0
3 JPY10bn face
20.0 90.0
45.0 20.0
mediumlong till expiry
Swaption
Weekly P/L = -12.2; Total P/L since 2012: 789; Balance sheet 80.1; 1 day VaR (x2.33 std) 65.9. Note: Current levels based on the absolute maturity to capture rolldown correctly; therefore, it is different from the constant-maturity spread. Source: Barclays Research
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GLOBAL TRADERS GUIDE
Key data and events

US
We look for Mar. nonfarm payrolls to expand 200k (Fri.; consensus: 213k, previous: 227k) and private payrolls to increase 215k (consensus: 230k, previous: 233k). Underlying our forecast are improved jobless claims data and a downward move in parttime employment for economic reasons. We look for the Mar. manufacturing ISM to increase to 53.0 (Mon.; consensus: 53.5, previous: 52.4), reflecting the increases seen in both the Empire State and Philadelphia Fed manufacturing indices. We project the Mar. non-manufacturing ISM to decrease to 57.0 (Wed.; consensus: 56.7, previous: 57.3), which would be consistent with solid growth in Q1 service sector activity. We look for the minutes of the Mar. FOMC meeting (Tue.) to provide additional insight about how strongly the committee upgraded its view on the economic outlook. We believe the minutes will offset the upgraded outlook found in the statement with a balance of risks skewed to the downside.
Europe
In the euro area, the main focus next week is the ECB policy announcement (Wed.) - we do not expect any change. The message from the press conference is likely to be that the economy is showing signs of stabilisation and that it is now up to national governments and other institutions, such as banks, to pursue consolidation and reform strategies. One key issue is whether the ECB will move away from fixed rate full allotment, an issue it must resolve by the end of June, but we do not expect a comment on that this time. Also next week in the euro area, we look for the Feb. unemployment rate to be unchanged at 10.7% (Mon.; consensus: 10.8%) and we expect Feb. retail sales to have edged down 0.5% m/m (Wed.; consensus: -0.1%, last: +0.3%). In Germany, we forecast Feb. industrial production to inch up by 0.3% m/m (Thurs.; consensus: -0.5%, last: 1.6%). In the UK, the main event next week is the MPC meeting (Thurs.) and we are in line with consensus in expecting it to keep monetary policy on hold, with Bank Rate at 0.5% and QE at 325bn. We forecast Mar. manufacturing PMI to decrease to 51.0 (Mon.; consensus: 50.7, last: 51.2) and construction PMI to fall to 53.0 (Tues.; consensus: 53.5, last: 54.3). We expect services PMI to edge down to 53.5 (Wed.; consensus: 53.4, last: 53.8). We forecast Feb. industrial production to have increased by 0.3% m/m (Thurs.; consensus: 0.5%, last: -0.4%) and manufacturing output to have increased by 0.2% m/m (consensus: 0.2%, last: 0.1%).
Japan
We expect the Mar. Tankan DI to improve for both large manufacturers/nonmanufacturers to -0/+5 (Sun.; consensus: -1/+5, last: -4/+4), with further gains in the outlook for June.
30 March 2012
50
GLOBAL WEEKLY CALENDAR

Saturday 31 March Period Italy: PM Monti visits Japan and China (final Day) E27: EC President Barroso meets Finnish PM Katainen in Helsinki 10:30 E27: ECOFIN meeting (final day) 22:30 US: Minneapolis Fed President Kocherlakota (FOMC non-voter) speaks in Illinois Sunday 01 April 01:00 China: PMI manufacturing, index 11:00 Peru: CPI, % m/m 23:00 Korea: CPI, % y/y Japan: Tankan DI for mftg/non-mftg, index 23:50 Period Mar Mar Mar Q1 Prev 2 Prev 1 Latest Forecast Consensus
Prev 2 50.3 0.27 4.2 -9/-5
Prev 1 50.5 -0.10 3.4 2/1 Prev 1 4.00 5.25
Latest 51.0 0.32 3.1 -4/4 Latest 4.00 5.25
Forecast Consensus 50.8 0.63 3.1 3.2 -0/5 -1/5 Forecast Consensus 4.00 5.25 -
Monday 2 April Period Prev 2 Apr 4.00 Russia: Overnight deposit rate, % Apr 5.25 Russia: Overnight repo rate, % 09:30 E17: ECB Governing Council member Mersch presents CB's annual report in Luxembourg 14:00 US: St.Louis Fed President Bullard (FOMC non-voter) speaks in China 16:35 US: Cleveland Fed President Pianalto (FOMC voter) speaks in Marietta Mar 7.4 Kazakhstan: CPI, % y/y 00:30 Australia: Inflation expectations, % m/m Mar 0.5 04:00 Indonesia: CPI, % y/y Mar 3.8 Japan: Auto sales, % y/y Mar 23.5 05:00 Q4 12.0 07:00 Turkey: GDP, % y/y Mar -1.0 (-1.3) 07:00 UK: Halifax house price index, % m/m (3m/y) (to 5/04) 07:13 Spain: Manufacturing PMI, Index Mar 43.7 07:15 Swi: Retail sales, % y/y Feb 1.8 Mar 49.1 07:30 Swi: Manufacturing PMI, index Mar 44.3 07:43 Italy: Manufacturing PMI, index 07:48 France: Final manufacturing PMI, index Mar 48.5 07:53 Germany: Final manufacturing PMI, index Mar 51.0 Mar 48.8 07:58 E17: Final manufacturing PMI, index Mar 49.7 08:28 UK: Manufacturing PMI, index Feb 10.5 09:00 E17: Unemployment rate, % 14:00 US: Construction spending, % m/m Feb 1.9 14:00 US: ISM manufacturing, index Mar 53.1 Mar -15.3 16:00 Italy: New car registrations, % y/y Mar -61.5 17:00 Italy: Budget, year-to date, bn 02:30 Korea: 3y Bonds Auction 04:00 Malaysia: 91d/191d/210d Notes Auction 09:00 Germany: New 6m Bubill (10 Oct12) 09:00 Holland: DTC 29Jun12 & 27Dec12 09:30 UK: 3-7y Reverse Gilt Auctions 12:50 France: BTFs 5Jul12, 23Aug12, 4Apr13 Tuesday 3 April Period Germany: Chancellor Merkel visits Czech Republic Spain: 2012 Budget presented to Parliament Apr 04:30 Australia: RBA cash target, % Q1 15:00 Chile: Monetary policy report (IPOM) Apr 18:00 US: Minutes of FOMC meeting released 20:05 US: San Francisco Fed President Williams (FOMC voter) speaks in San Diego E17: Publication of the MFI Interest rate statistics Venezuela: CPI, % m/m (to 12/04) Mar Japan: Wages per worker, % y/y Feb 01:30 Mar 04:00 Thailand: CPI, % y/y 07:00 Turkey: CPI, % y/y Mar 08:30 UK: Construction PMI, index Mar Feb 09:00 E17 : PPI, % m/m (y/y) 14:00 US: Factory orders, %m/m Feb 21:00 US: Vehicle sales, mn saar Mar 23:01 UK: BRC shop price index Mar Japan: 10y JGB Auction 02:00 09:30 EFSF: T bill 05 Jul12 09:30 Belgium: 19Jul12, 20Sep12 09:30 UK: 15y+ Reverse Gilt Auctions Prev 2
5.9 0.2 3.7 40.7 8.8 0.6 (-1.8) 45.1 1.7 47.3 46.8 50.0 50.2 49.0 52.0 10.6 1.4 54.1 -16.9 -3.3
4.7 0.1 3.6 31.9 8.2 -0.5 (-1.9) 44.9 4.4 49.0 47.8 47.6 P 48.1 P 47.7 P 51.2 10.7 -0.1 52.4 -18.9 -10.7
4.6 4.7 4.0 4.0 5.4 - -0.4 (-1.7) 44.5 44.9 2.0 50.0 47.2 47.5 47.6 47.6 48.1 48.1 47.7 47.7 51.0 50.7 10.7 10.8 0.5 0.8 53.0 53.5 KRW 1400 bn MYR 1 bn/MYR 1 bn/MYR 1 bn 4 bn 1/2-1/2 bn 1.5 bn 3.6/4-1/1.4-1.6/2 bn Forecast Consensus
Prev 1
Latest
4.25
4.25
4.25
4.25
4.25
0.1 3.20 53.5 0.5 (3.5) 1.4 14.7 1.5 2300 bn 0/2 bn 4 bn 1.5 bn Note: All times reported in GMT. Some data or events are boxed to indicate their importance to financial markets. Market events are highlighted in light blue.
1.80 -0.2 3.53 10.5 53.2 0.3 (5.4) 2.2 13.5 1.7
1.50 0.1 3.38 10.6 51.4 -0.2 (4.3) 1.4 14.1 1.4
1.10 0.0 3.35 10.4 54.3 0.7 (3.7) -1.0 15.0 1.2
1.30 0.1 3.4 10.6 53.0 1.5 14.5 -
30 March 2012
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Wednesday 4 April Period Prev 2 4.50 Poland: Base rate announcement, % Apr 11:45 E17: ECB Interest rate announcement, % Apr 1.00 12:30 E17: ECB Press Conference 15:00 US: San Francisco Fed President Williams (FOMC voter) speaks in San Francisco Russia: CPI, % y/y Mar 6.1 01:00 Philippines: CPI, % y/y Mar 4.1 Mar 42.1 07:13 Spain: Services PMI, index Feb 0.0 (3.8) 07:30 Sweden: Service production, % m/m (y/y) Mar 44.5 07:43 Italy: Services PMI, index 07:48 France: Final services PMI, index Mar 52.3 07:53 Germany: Final services PMI, index Mar 53.7 07:58 E17: Final services PMI, index Mar 50.4 Mar 50.4 07:58 E17: Final composite PMI, index 08:00 Italy: Deficit, % of GDP Q4 7.1 08:28 UK: Services PMI, index Mar 54.0 Feb -0.3 (-1.4) 09:00 E17: Retail sales, % m/m (y/y) 10:00 Germany: Factory orders, %m/m (y/y) Feb -4.9 (-4.3) 12:15 US: ADP private payrolls, chg, thous Mar 267.0 14:00 US: ISM non-manufacturing, index Mar 53.0 04:00 Malaysia: 54d/89d/124d Notes Auction 08:30 Spain: 3y, 4y & 8y SPGB Auctions 09:30 Germany: 5y OBL Auction 09:30 UK: 7-15y Reverse Gilt Auctions 09:30 Portugal: BT 19Oct12 & 18Oct13 Thursday 5 April Period 11:00 UK: BoE Bank rate decision, % Apr Apr 11:00 UK: BoE asset purchase decision 13:10 US: St. Louis Fed President Bullard (FOMC non-voter) speaks in St. Louis 00:00 Colombia: CPI, % m/m Mar 07:15 Swi: CPI, % m/m (y/y) Mar 07:30 Neth: HICP, % m/m (y/y) Mar 08:00 Mar Taiwan: CPI, % y/y Feb 08:30 UK: Industrial output, % m/m (y/y) 08:30 UK: Manufacturing output, % m/m (y/y) Feb 10:00 Germany: Industrial production, % m/m (y/y) Feb 11:00 Chile: CPI, % m/m Mar 11:30 Chile: Economic activity index, % y/y Feb 12:00 Brazil: IPCA inflation, % m/m Mar 12:30 US: Initial jobless claims, thous (4wma) 31-Mar 02:00 Japan: Liquidity Enhancement Auction 04:00 Malaysia: 3.5y Bonds Auction 04:00 Malaysia: 364d Bills Auction 08:50 France: 5y, 10y, 15y & 30y OAT Auctions Prev 2 0.50 275 0.42 -0.2 (-0.7) -0.3 (2.5) 2.01 -0.4 (-3.3) -0.1 (-1.0) 0.0 (4.4) 0.6 4.0 0.50 353 (356) Prev 1 4.50 1.00 Latest 4.50 1.00 Forecast Consensus 4.50 4.50 1.00 1.00
4.2 4.0 46.1 -0.3 (3.6) 44.8 50.0 52.8 48.8 49.3 5.2 56.0 -0.5 (-1.3) 1.6 (0.0) 173.0 56.8
3.7 3.6 3.6 2.7 2.8 2.8 41.9 43.5 42.0 -0.8 (1.2) (0.9) 44.1 44.6 47.5 50.0 P 50.0 50.0 51.8 P 51.8 51.8 48.7 P 48.7 48.7 48.7 P 48.7 48.7 4.3 53.8 53.5 53.4 0.3 (0.0) -0.5 (-2.0) -0.1 (-0.3) -2.7 (-4.9) 0.2 (-1.2) 1.4 (-5.7) 200.0 216.0 57.0 56.7 57.3 MYR 1 bn/MYR 1 bn/MYR 1 bn 4.5 bn 4 bn 1.5 bn 1.25/1.5 bn Latest 0.50 325 0.61 0.3 (-0.9) 1.0 (2.9) 0.25 -0.4 (-3.8) 0.1 (0.3) 1.6 (1.8) 0.4 5.5 0.45 359 (365) Forecast Consensus 0.50 0.50 325 325 0.37 1.4 (2.9) 1.3 0.3 (-2.2) 0.2 (0.2) 0.3 (-0.2) 0.4 6.3 0.40 355 (360) 0.33 0.4 (-1.0) 1.3 0.5 (-2.1) 0.2 (0.2) -0.5 (0.3) 0.5 6.2 0.35 300 bn MYR 3 bn MYR 0.1 bn 8.25 bn
Prev 1 0.50 275 0.73 -0.4 (-0.8) 0.1 (2.9) 2.37 0.4 (-3.1) 1.2 (0.8) -2.6 (1.3) 0.1 5.3 0.56 364 (369)
Friday 6 April Period Prev 2 Prev 1 Latest Forecast Consensus US, UK and Germany: Markets closed in observance of Good Friday holiday Ukraine: CPI, % y/y Mar 4.6 3.7 3.0 2.8 06:45 France: Budget, year-to date, bn Feb -97.2 -90.8 -12.5 06:45 France: Trade balance, bn Feb -4.2 -5.1 -5.3 -4.5 -5.2 12:30 US: Nonfarm payrolls, chg, thous Mar 223 284 227 200 213 12:30 US: Private nonfarm payrolls, chg, thous Mar 234 285 233 215 230 12:30 US: Unemployment rate, % Mar 8.3 8.3 8.3 8.2 8.3 12:30 US: Average hourly earnings, % m/m (y/y) Mar 0.1 (2.1) 0.1 (1.8) 0.1 (1.9) 0.1 0.2 12:30 US: Average weekly hours Mar 34.5 34.5 34.5 34.5 34.5 19:00 Feb 20.0 16.3 17.8 16.0 12.0 US: Consumer credit, chg, $ bn Note: All times reported in GMT. Some data or events are boxed to indicate their importance to financial markets. Market events are highlighted in light blue.
30 March 2012
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GLOBAL KEY EVENTS

Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Forthcoming central bank announcement dates North America FOMC meeting 13 24-25 19-20 31 12 23-24 FOMC minutes 2 16 11 21 3 Jul Congressional testimony Fed's Beige Book 11 6 18 30 10 Bank of Canada 8 17 5 17 5 23 Europe ECB "policy" meeting 8 4 3 6 5 2 6 4 ECB monthly bulletin 15 11 10 13 12 9 13 11 ECB "non-policy" meeting 22 19 16 21 19 20 18 Bank of England 7-8 4-5 9-10 6-7 4-5 1-2 5-6 3-4 BoE Inflation Report 16 8 BoE minutes 21 18 23 20 18 15 19 17 Riksbank 19 30 4 6 25 SNB 15 14 13 Norges Bank 14 10 20 29 31 Asia/RoW Bank of Japan 12-13 9-10,27 22-23 14-15 11-12 8-9 18-19 4-5, 30 BoJ minutes 16 13 7, 28 20 18 14 24 11 Reserve Bank of Australia 6 3 1 5 3 7 4 2 RBNZ 8 14 13 Key international meetings ECOFIN 13,31 15 22 n/a n/a n/a n/a G20 15-16 19-20 10-11 15-17 13-14 n/a Elections Finland (Presidential) Russia (Presidential) 4 Greece (Parliamentary) Apr France (Presidential) 22 6 France (Legislative) 10-17 Jul India (Presidential) 1 Mexico (Presidential/Legislative) Hong-Kong (Legislative) Sep US (Presidential/Legislative) Source: Central banks, IMF, European Commission, Reuters, Bloomberg, Market News, Barclays Capital
Nov-12
Dec-12
Jan-13 Feb-13
14 28 8 15 22 7-8 14 21 29 19-20 2,28 6 n/a n/a 6
11 4 6 13 20 5-6 19 18 13 19 19-20 26 4 6 n/a n/a -
n/a n/a n/a n/a n/a 10 17 24 11-12 25 n/a n/a n/a n/a n/a n/a n/a n/a -
n/a n/a n/a n/a n/a 7 14 21 8-9 15 22 n/a n/a n/a n/a n/a n/a n/a n/a -
30 March 2012
53
GLOBAL SUPPLY CALENDAR

S pr ead to Co u ntry Eu ro Are a 04 -A pr -12 04 -A pr -12 04 -A pr -12 0 4-A pr- 12 05 -A pr -12 05 -A pr -12 05 -A pr -12 05 -A pr -12 1 0-A pr- 12 1 0-A pr- 12 1 0-A pr- 12 1 1-A pr- 12 1 2-A pr- 12 1 2-A pr- 12 1 2-A pr- 12 1 8-A pr- 12 19 -A pr -12 19 -A pr -12 19 -A pr -12 19 -A pr -12 19 -A pr -12 19 -A pr -12 19 -A pr -12 23 -A pr -12 2 4-A pr- 12 2 4-A pr- 12 24 -A pr -12 24 -A pr -12 2 5-A pr- 12 27 -A pr -12 27 -A pr -12 27 -A pr -12 27 -A pr -12 Jap an 0 3-A pr- 12 0 5-A pr- 12 1 2-A pr- 12 1 7-A pr- 12 1 9-A pr- 12 2 4-A pr- 12 2 6-A pr- 12 UK 0 2-A pr- 12 0 3-A pr- 12 0 3-A pr- 12 0 4-A pr- 12 1 0-A pr- 12 1 1-A pr- 12 1 1-A pr- 12 1 2-A pr- 12 1 6-A pr- 12 1 7-A pr- 12 1 8-A pr- 12 1 9-A pr- 12 2 3-A pr- 12 2 4-A pr- 12 2 5-A pr- 12 3 0-A pr- 12 US 1 0-A pr- 12 1 1-A pr- 12 1 2-A pr- 12 1 9-A pr- 12 2 4-A pr- 12 2 5-A pr- 12 2 6-A pr- 12 Sp ain Sp ain Sp ain G erm an y F ran ce F ran ce F ran ce F ran ce H ollan d Au s tria Au s tria G erm an y Italy Italy Italy G erm an y Sp ain Sp ain Sp ain F ran ce F ran ce F ran ce F ran ce B elgiu m H ollan d H ollan d Italy Italy G erm an y Italy Italy Italy Italy Jap an Jap an Jap an Jap an Jap an Jap an Jap an UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK US US US US US US US B on d 3y S PG B 4y S PG B 8y S PG B 5y O B L A uction 5 yr O A T (total ra ng e 7-8 .5b n ) 10 yr O A T (tota l ran ge 7- 8.5 bn ) 15 yr O A T (to ta l ran ge 7- 8.5 bn ) 30 yr O A T (to ta l ran ge 7- 8.5 bn ) 5y DSL Au ctio n 5y R A GB A uction 15 y R AG B A uctio n New 10 y Bu n d A uction 3yr B T P A uction 1 5 yr B T P A u ctio n 2yr B T P A uction 2y S chatz A u ctio n 7 y SP GB A uctio n 1 5y S PG B A u cti on 1 0y S PG B A u cti on 2 yr B T AN 3 yr B T AN 5 yr B T AN O A T i/ei A uctio n s B GB Au ction s C a ncelled 2y D SL A u ctio n (total ran ge 1.5 -2 .5b n) 2 5y D SL Au ctio n (to ta l ran g e 1 .5-2 .5b n) N ew C T Z A u cti on BT P ei Lin ker Au ction N ew 3 0y Bu n d A u ctio n CC T A u cti on C ance lle d 5y BT P Au ction 9y BT P Au ction 10 y BT P A uctio n 10 y JG B A uction Liq uid ity En h ancem ent A uction 30 y JG B A uction 5 y JGB Au ction 20 y JGB A uctio n Liq uid ity E nh an cem en t Au ction 2y J GB Au ction 3-7 y R evers e G ilt A u ctio ns Co n ve ntion al Gilt Au ctio n 1 5y + R evers e Gilt Au ction s 7-1 5y R evers e Gilt Au ctio n s 1 5y + R evers e Gilt Au ction s Co n ve ntion al Gilt Au ctio n 7-1 5y R evers e Gilt Au ctio n s Co n ve ntion al Gilt Au ctio n 3-7 y R evers e G ilt A u ctio ns 1 5y + R evers e Gilt Au ction s 7-1 5y R evers e Gilt Au ctio n s Linker A uc tio n 3-7 y R evers e G ilt A u ctio ns 1 5y + R evers e Gilt Au ction s 7-1 5y R evers e Gilt Au ctio n s 3-7 y R evers e G ilt A u ctio ns 3y N ote A uction 10 y No te A u ctio n 30 y Bo n d A uction 5y T IP s A uctio n 2y N ote A uction 5y N ote A uction Co u po n 4 .40 % 3 .30 % 4 .85 % 0 .75 % 4 .25 % 3 .00 % 3 .50 % 3 .75 % 0 .75 % 4 .30 % 4 .85 % 4 .00 % 4 .00 % 4 .25 % 0 .25 % 4 .10 % 4 .30 % 5 .85 % 4 .00 % 2 .50 % 2 .25 % M atur ity 3 1- Jan- 15 3 0 -O ct- 16 3 1 -O ct- 20 2 4 -Feb- 17 2 5 -O ct- 17 2 5-A p r-22 2 5-A p r-26 2 5-A p r-41 1 5- Jan- 17 1 5-S ep -17 15 -M ar-2 6 04 -Ju l- 22 01 -M ar-1 5 01 -M ar-2 6 0 1 -Au g- 14 14 -M ar-1 4 3 0 -O ct- 19 30 -Ju l- 26 3 1- Jan- 22 2 5-A p r-14 1 5- Jan- 15 2 5- Feb -17 Si ze - b n 1.2 5 1.5 0 1.2 5 4.0 0 1.2 5 3.5 0 1.7 5 1.7 5 3 .00 0 0 .62 5 0 .62 5 5.0 0 3.0 0 2.0 0 1.0 0 5.0 0 1.5 0 1.5 0 1.5 0 2.0 0 2.0 0 4.0 0 1.5 0 1.2 5 1.2 5 4.5 0 1.0 0 3.0 0 0.0 0 2.5 0 1.0 0 2.5 0 2 30 0 30 0 70 0 2 50 0 1 20 0 30 0 2 80 0 1.5 0 1.5 0 1.5 0 1.5 0 1.5 0 1.5 0 1.5 0 1.5 0 1.5 0 1.5 0 1.5 0 1.5 0 35 21 13 16 35 35 29 G erm a n S p lin e 3 m th Z S co re to Ger m an y 5 00 .00 1.1 0 1.4 2 5 00 .00 -0 .46 0.6 6 -0 .03 2.1 0 5 00 .00 -0 .66 -0 .33 5 00 .00 -0 .56 5 00 .00 5 00 .00 2.0 0 1.0 0 1.0 1 -0 .73 -0 .86 0.4 0 5 00 .00 5 00 .00 0.4 4 3.0 6 5 00 .00 5 00 .00 5 00 .00 5 00 .00 1.0 3 -0 .44 0.7 1 Sp re ad to Sw ap s 3 m th Z S cor e to S wa ps 50 0.0 0 1 .22 1 .53 50 0.0 0 -0 .7 4 0 .02 -0 .2 0 0 .74 50 0.0 0 -0 .8 3 -0 .4 4 50 0.0 0 -0 .6 0 50 0.0 0 50 0.0 0 2 .05 1 .09 1 .01 -1 .1 3 -1 .2 3 -0 .1 0 50 0.0 0 50 0.0 0 0 .88 2 .23 50 0.0 0 50 0.0 0 50 0.0 0 50 0.0 0 0 .93 -0 .5 0 0 .71
31 6.6 35 0.9 10 3.9 10 8.7 12 0.5 45 .1 10 0.7 93 .1 32 4.6
23 7.2 27 4.4 34 .1 69 .0 11 3.6 8 .0 28 .1 75 .8 30 7.4
36 0.5 36 2.8 36 9.1 47 .7 58 .4 94 .2
29 9.1 34 4.6 32 4.1 -4 0.8 -2 5.7 19 .9
3 .75 % 4 .00 %
15 -Ju l- 14 1 5- Jan- 37
23 .9 25 .0
-6 3.1 19 .7
4 .75 % 4 .75 % 3 .75 % 5 .50 %
0 4- Jul- 44 1 5-A p r-18 0 1-M a y-17 01 -M ar-2 1 0 1-S ep -22
36 3.3 33 5.5 35 3.2
28 6.3 28 5.2 30 6.1
7y N ote A uction Un co nf irm ed B arclays Cap ita l Es tim ate R ich Ch eap
30 March 2012
54
GLOBAL BOND YIELD FORECASTS

US Treasuries Fed funds Q2 12 Q3 12 Q4 12 Q1 13 0.00-0.25 0.00-0.25 0.00-0.25 0.00-0.25 3m Libor 0.40 0.35 0.35 0.35 2y 0.30 0.30 0.30 0.30 5y 1.10 1.00 1.00 1.00 10y 2.25 2.00 2.00 2.00 30y 3.40 3.40 3.40 3.40 10y RY -0.20 -0.40 -0.35 -0.35 Q2 12 Q3 12 Q4 12 Q1 13 US swap spreads 2y 35 35 30 30 5y 30 30 25 25 10y 10 10 5 5 30y -30 -35 -40 -40
Euro government Refi rate Q2 12 Q3 12 Q4 12 Q1 13 1.0 1.0 1.0 1.0 3m 0.65 0.65 0.65 0.80 2y 0.40 0.45 0.50 0.65 5y 1.10 1.20 1.25 1.40 10y 2.10 2.20 2.25 2.40 30y 2.70 2.80 2.90 3.05 10y RY 0.15 0.15 0.20 0.35 Q2 12 Q3 12 Q4 12 Q1 13
Euro area swap spreads 2y 65 60 60 60 5y 55 50 50 50 10y 40 35 35 35 30y 0 -5 -5 -5
UK government Bank rate Q2 12 Q3 12 Q4 12 Q1 13 0.5 0.5 0.5 0.5 3m 0.95 0.95 0.95 0.95 2y 0.50 0.55 0.60 0.70 5y 1.45 1.60 1.75 1.95 10y 2.50 2.70 2.90 3.10 30y 3.50 3.55 3.60 3.65 10y RY -0.50 -0.30 -0.10 0.00 Q2 12 Q3 12 Q4 12 Q1 13
UK swap spreads 2y 80 75 75 70 5y 45 40 35 30 10y 15 10 10 10 30y -15 -15 -10 -10
Japan government Official rate Q2 12 Q3 12 Q4 12 Q1 13 0.10 0.10 0.10 0.10 3m 0. 20 0. 20 0. 20 0. 20 2y 0.10 0.10 0.10 0.10 5y 0.40 0.35 0.35 0.35 10y 1.20 1.15 1.10 1.00 30y 2.10 2.05 2.00 2.00 10y RY 0.85 0.85 0.85 0.85 Q2 12 Q3 12 Q4 12 Q1 13
Japan swap spreads 2y 15 15 15 15 5y 15 15 15 15 10y 10 10 10 10 30y 0 0 0 0
Australia government Official Rate Q2 12 Q3 12 Q4 12 Q1 13 3.75 3.75 3.75 3.75 3y 3.95 4.15 3.95 3.95 5y 4.05 4.20 4.05 4.05 10y 4.15 4.25 4.15 4.15 AU-US 10y 2.15 2.25 2.15 2.15
30 March 2012
55
GLOBAL RATES RESEARCH

US
Ajay Rajadhyaksha Head of US Fixed Income and Securitised Products Strategy +1 212 412 7669 ajay.rajadhyaksha@barclays.com Chirag Mirani Fixed Income Strategy +1 212 412 6819 chirag.mirani@barclays.com Joseph Abate Fixed Income Strategy +1 212 412 6810 joseph.abate@barclays.com Piyush Goyal Fixed Income Strategy +1 212 412 6793 piyush.goyal@barclays.com James Ma Fixed Income Strategy +1 212 412 2563 james.ma@barclays.com
Amrut Nashikkar Fixed Income Strategy +1 212 412 1848 amrut.nashikkar@barclays.com
Michael Pond Treasury and Inflation-linked Strategy +1 212 412 5051 michael.pond@barclays.com Igor Zoubarev Fixed Income Strategy +1 212 526 5518 igor.zoubarev @barclays.com
Anshul Pradhan Treasury and Inflation-linked Strategy +1 212 412 3681 anshul.pradhan@barclays.com
Rajiv Setia Fixed Income Strategy +1 212 412 5507 rajiv.setia@barclays.com
Vivek Shukla Fixed Income Strategy +1 212 412 2532 vivek.shukla@barclays.com
Europe
Laurent Fransolet Head of European Fixed Income Strategy +44 (0)20 7773 8385 laurent.fransolet@barclays.com Jussi Harju European Strategy +49 69 7161 1781 jussi.harju@barclays.com Mikael Nilsson Fixed Income Strategy +44 (0)20 7773 6057 mikael.nilsson@barclays.com Khrishnamoorthy Sooben Inflation-Linked Strategy +44 (0)20 7773 7514 khrishnamoorthy.sooben@ barclays.com Alan James Global Inflation-Linked Strategy +44 (0)20 7773 2238 alan.james@barclays.com Cagdas Aksu European Strategy +44 (0)20 7773 5788 cagdas.aksu@barclays.com Fritz Engelhard German Head of Strategy +49 69-7161 1725 fritz.engelhard@barclays.com
Moyeen Islam Fixed Income Strategy +44 (0)20 777 34675 moyeen.islam@barclays.com Hitendra Rohra Fixed Income Strategy +44 (0)20 7773 4817 hitendra.rohra@barclays.com Stuart Urquhart European Strategy +44 (0)20 7773 8410 stuart.urquhart@barclays.com
Sreekala Kochugovindan Asset Allocation Strategy +44 (0)20 7773 2234 sreekala.kochugovindan@barclays.com Michaela Seimen SSA & Covered Bond Strategy +44 (0) 20 3134 0134 michaela.seimen@barclays.com Marcus Widen Fixed Income Strategy +44 (0)20 3134 5632 marcus.widen@barclays.com
Giuseppe Maraffino Fixed Income Strategy +44 (0)20 313 49938 giuseppe.maraffino@barclays.com Henry Skeoch Inflation-Linked Strategy +44 (0)20 777 37917 henry.skeoch@barclays.com Huw Worthington European Strategy +44 (0)20 7773 1307 huw.worthington@barclays.com
Asia Pacific
Chotaro Morita Head of Fixed Income Strategy Research, Japan +81 3 4530 1717 chotaro.morita@barclays.com Ju Wang Fixed Income Strategist, Emerging Asia +65 6308 2801 ju.wang@barclays.com Reiko Tokukatsu Senior Fixed Income Strategist, Japan +81 3 4530 1532 reiko.tokukatsu@barclays.com Gavin Stacey Fixed Income Strategist, Australia and New Zealand +61 2 933 46128 gavin.stacey@barclays.com Rohit Arora Fixed Income Strategist, Emerging Asia +65 6308 2092 rohit.arora3@barclays.com Kumar Rachapudi Fixed Income Strategist, Emerging Asia +65 6308 3383 kumar.rachapudi@barclays.com
30 March 2012
56
Analyst Certification(s) We, Vivek Shukla, Anshul Pradhan, James Ma, Rajiv Setia, Amrut Nashikkar, Joseph Abate, Chirag Mirani, Michael Pond, Piyush Goyal, Cagdas Aksu, Giuseppe Maraffino, Huw Worthington, Moyeen Islam, Henry Skeoch, Fritz Engelhard, Jussi Harju, Zoso Davies, Michaela Seimen, Khrishnamoorthy Sooben, Hitendra Rohra, Gavin Stacey, Chotaro Morita, Noriatsu Tanji, Reiko Tokukatsu, CFA and Marion Laboure, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report. Important Disclosures Barclays Research is a part of the Corporate and Investment Banking division of Barclays Bank PLC and its affiliates (collectively and each individually, "Barclays"). For current important disclosures regarding companies that are the subject of this research report, please send a written request to: Barclays Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer to http://publicresearch.barcap.com or call 212-526-1072. Barclays Capital Inc. and/or one of its affiliates does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Barclays may have a conflict of interest that could affect the objectivity of this report. Barclays Capital Inc. and/or one of its affiliates regularly trades, generally deals as principal and generally provides liquidity (as market maker or otherwise) in the debt securities that are the subject of this research report (and related derivatives thereof). Barclays trading desks may have either a long and / or short position in such securities and / or derivative instruments, which may pose a conflict with the interests of investing customers. Where permitted and subject to appropriate information barrier restrictions, Barclays fixed income research analyst(s) regularly interact with its trading desk personnel to determine current prices of fixed income securities. Barclays fixed income research analyst(s) receive compensation based on various factors including, but not limited to, the quality of their work, the overall performance of the firm (including the profitability of the investment banking department), the profitability and revenues of the Fixed Income, Currencies & Commodities Division ("FICC") and the outstanding principal amount and trading value of, the profitability of, and the potential interest of the firms investing clients in research with respect to, the asset class covered by the analyst. To the extent that any historical pricing information was obtained from Barclays trading desks, the firm makes no representation that it is accurate or complete. All levels, prices and spreads are historical and do not represent current market levels, prices or spreads, some or all of which may have changed since the publication of this document. The Corporate and Investment Banking division of Barclays produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in other types of research products, whether as a result of differing time horizons, methodologies, or otherwise. In order to access Barclays Statement regarding Research Dissemination Policies and Procedures, please refer to https://live.barcap.com/publiccp/RSR/nyfipubs/disclaimer/disclaimer-research-dissemination.html.
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INTEREST RATES RESEARCH

Global Rates Strategy | 30 March 2012

GLOBAL RATES WEEKLY The (w)ides of March?

Global Supply Calendar Global Bond Yield Forecasts

Barclays | Title of Document Goes Here

Other spread sectors

Take profit on long BEI.

Long 3mx10y volatility.

Source: Barclays Research

Barclays | Global Rates Weekly

UNITED STATES: TREASURIES

10y real yields, bp, lhs

Barclays | Global Rates Weekly

Figure 3: Fed fund expectations have become more realistic

Figure 4: More room to go in the front end

25 5 0 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 2y OIS Rates, bp

Effective Fed Funds Rate, bp

0 Apr-12 Oct-12 Apr-13 Oct-13 Fed Fund Futures,bp, As of Mar 29

Apr-14 Oct-14 As of Jan 31, bp

Maintain the long 2y Treasuries recommendation

Barclays | Global Rates Weekly

Recommend 10s30s curve steepeners ahead of the bond auction

120 100 80 60 40 20 (20) (40) (60)

Barclays | Global Rates Weekly

110 90 70 50 Sep-09 Reaction to Operation Twist

10s30s Treasury Curve

Barclays | Global Rates Weekly

UNITED STATES: AGENCIES

Own callables to position for a continued reversal in rates/vol

Agency bellwether outperformance hits turbulence

Figure 2: Agency-Treasury spreads leak wider

04-Mar-12 25-Mar-12 5y Agy-T 10y Agy-T

Barclays | Global Rates Weekly

Figure 3: MTN pickup in the front end

Figure 4: USD covered bond issuance accelerates

2012 Outlook: US Agencies, 14 December 2011

Barclays | Global Rates Weekly

Legislative developments underwhelm

Figure 5: But valuations do not necessarily suffer

Figure 6: Supras outperform, remain behind agencies

CS 2.6 5/16 SPNTAB 2.125 8/16

BNS 2.15 8/16 ANZ 2.4 11/16

Source: Barclays Research

Barclays | Global Rates Weekly

UNITED STATES: SWAPS

Tightening risks remain

10y swap spd, LHS

MBS Index duration, RHS

Source: Barclays Research

Barclays | Global Rates Weekly

19-Jan-12 09-Feb-12 01-Mar-12 22-Mar-12 3s-FV-5s spread fly (bp)

mom chg in $SSA idx (LHS)

Barclays | Global Rates Weekly

UNITED STATES: MONEY MARKETS

Too much cash

Barclays | Global Rates Weekly

Precautionary liquidity motive

Figure 1: Non-financial corporate cash and non-cash assets (2007=100)

Mar-04 Mar-06 Mar-08

Source: Federal Reserve, Barclays Research

Barclays | Global Rates Weekly

Rock and a hard place?

Figure 4: Money fund 7d net yields (%)