3/27/2014

10y US/Bund and 10y Gilt/Bund Aiming at High Spreads From 2005
US and UK 10 year yields are rivaling high spreads relative to German 10 year yields last seen in September 2005. We have been searching for reasons to expect reversion narrower from these old highs, however we see key indicators as supportive of further widening:

Key Indicators Include:

Front-end yields Dec 2015 Euribors continue their deviation from Dec 2015 Short Sterling and Eurodollars, which are marching to higher yields. Normalized Swaption Volatility EUR volatility remains at subdued levels as USD and GBP volatility surges are emblematic of fears over higher yields. Economic Data GDP forecasts show stronger growth in the UK and US versus the Eurozone. Recent positive economic surprises in the UK and US are shifting their Citigroup Economic Surprise Indices higher while the Eurozones falls. Technical Picture US/Bund 10 year and Gilt/Bund 10 year spreads maintain widening trends until AQAs Monthly Supports (held 20 consecutive months) give way.

Copyright 2014 Arbor Research & Trading, Inc. All rights reserved. This material is for your private information, and we are not soliciting any action based upon it. This material should not be redistributed or replicated in any form without the prior consent of Arbor. The material is based upon information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied upon as such.

Front-yield yields and Central Bank Policy A hawkish tone roiled the belly of the US interest rate curve this March after Yellens comments pulled rate hike expectations into 2015. All eyes are squarely on economic data improvements, or lack thereof, after this winters weather related issues. The Bank of England maintains its Official Bank Rate at 0.5%, which it has been stuck at since 2009, however stronger data and growth forecasts have some looking higher. Earlier this month the central banks quarterly Inflation Attitudes Survey saw predictions for a higher benchmark rate rise from 34 to 40% of respondents. On the flip side, the European Central Bank looks more inclined to bolster a slow economic recovery. To illustrate the short-ends correlation to longer dated rates we look to Dec 15 Eurodollar vs Euribor and Dec 15 Short Sterling vs Euribor. The main driver for 10 year spreads appears to fall on the reassessment of front-end yields.

Normalized Swaption Volatility Higher volatility is showing floating rate payors heightened anxiety levels over rising interest rates. USD and GBP normalized swaption volatility in 1-2 year tenors with 1 year or less expiry are shifting towards highs seen in the summer of 2013 when taper became a major buzzword. The Eurozones volatility has failed to follow suit and fallen back to early 2013 lows. Lower fear over higher rates in the Eurozone is not supportive of narrower spreads to US and UK yields.

Copyright 2014 Arbor Research & Trading, Inc. All rights reserved. This material is for your private information, and we are not soliciting any action based upon it. This material should not be redistributed or replicated in any form without the prior consent of Arbor. The material is based upon information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied upon as such.

Economic Data: While unemployment rates have converged, QoQ GDP forecasts show stronger growth in the US and UK through the end of 2014.

The UKs Citigroup Economic Surprise Index (CESI) shot higher today on the back of better than expected retail sales (1.7% MoM, 0.5% expected). Its index is seeing renewed widening versus the Eurozones. Additionally, the gap between US and Eurozone indices is narrowing as data has slowly improved in the US in recent weeks. Note CESI indices show moderately positive correlation to respective 50-day changes in 10 year yields. Therefore, further negative economic surprises in the Eurozone may not be supportive of higher 10 year Bund yields.

Copyright 2014 Arbor Research & Trading, Inc. All rights reserved. This material is for your private information, and we are not soliciting any action based upon it. This material should not be redistributed or replicated in any form without the prior consent of Arbor. The material is based upon information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied upon as such.

Technical Picture: The US/Bund 10 year and Gilt/Bund 10 year spreads continue their long-term widening trends until AQAs Monthly Supports give way. Note that Monthly Supports for these spreads are to hold for their 21st consecutive month.

Copyright 2014 Arbor Research & Trading, Inc. All rights reserved. This material is for your private information, and we are not soliciting any action based upon it. This material should not be redistributed or replicated in any form without the prior consent of Arbor. The material is based upon information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied upon as such.