EFTA01362010.pdf

4 September 2015 US Fixed Income Weekly United States Dominic. NoIiIchm Gov. Bonds & Swaps Research Analyst Rates Volatility (+11212 250-9753 [email protected] Ainstandm Koctr US Overview Research Analyst 1+1)212 250-0376 aleicsandar.kocio@decom • Markets are fixated on the potential for Fed normalization to start earlier Alec than currently priced and whether China's recent FX adjustment is the beginning or the end. Research Analyst 1+11212 250-5483 • At a superficial level there appears to be conflicting influences on rates. [email protected] The Fed and China may undermine risk asset performance but the consensus is that if risk assets find support, fewer FX reserves are likely to Spntkr; pressure rates higher. Research Analyst 1+11212 250-0332 On the contrary, we think the most important thing is that both the Fed stuart.sparksaide.com and China's FX (ongoing?) unwind represent a tightening of global liquidity that clearly is negative for risk assets and clearly, at least for the last DarnEd decade, has been positive for real rates and the curve. 5y5y is well Research Analyst correlated with changes in global liquidity and based on recent trends 1+11212250-1407 should be closer to 2 percent. dankti.soridedb.com • This reinforces our view that the Fed is in danger of committing policy error. Not because one and done is a non issue but because the market iNteven /se CFA will initially struggle to price "done" after "one". And the Fed's gatemen Analyst communication skills hardly lend themselves to over achievement. More 1+11212 250-9373 likely in our view, is that one in September will lead to a December pricing [email protected] and additional hikes in 2016, suggesting 2s could easily trade to 1 1/4 percent. This may well be an overshoot but it could imply another leg Adityb Eltiatits lower for risk assets and a sharp reflattening of the yield curve. Economist 1+11212 250-0584 • We think risk/reward has shifted toward paying spreads in the front end. aclitya.bhaveaklb.com Financing is challenging with term GC trading high relative to LIBOR, but we think rolling the position overnight should allow investors to average in financing better than LIBOR, providing some backstop against tightening if significant additional intervention-related selling does not materialize. • We like being long front end breakevens in forwards. e.g., one-year breakevens implied by short maturity TIPS, such as the 7/2016s and the 7/2017s. One can also hedge out energy prices in that trade to create a synthetic exposure to core CPI. A simpler version of the implied front end forward breakevens is to be long front end breakevens outright. They have lagged oil prices. 5-year inflation basis has recovered, while 30-year inflation basis has done less well, and remains in the low end of the long term trading range. Investors should consider inflation basis steepeners by being long 30-year inflation basis against 5-year inflation basis. The case for mote liquidity Investors are rightly concerned about the impact of both a possible early start to Fed normalization and the probably yet-to-be-resolved Chinese FX adjustment. There is a reasonable consensus that both encourage further downside to risk assets. There is more uncertainty around bond yields. Potential FX intervention might imply selling of Treasuries, especially the front end where most reserves are held. But if higher short rates from either those sales or Fed tightening, undermine equities, bond yields might actually fall. Page 6 Deutsche Sank Securities Inc. CONFIDENTIAL - PURSUANT TO FED. R. CRIM. P. 6(e) DB-SDNY-0051307 CONFIDENTIAL SDNY_GM_00197491 EFTA01362010