JPM Global Fixed Income 2012-03-17 810381

European Rates Strategy
J.P. Morgan Securities Ltd. March 16, 2012
Global Fixed Income Markets Weekly

Overview Pavan Wadhwa, Kedran Panageas We analyse two distinct strategies for investors wishing to hold out from the Greek foreign-law bond exchange. Although tendering is the best strategy in our view, holding out has reasonable chance of success for the handful of bonds that mature early, have small outstanding size, and carry strong creditor protections. Triggering cross-default clauses with railway and public transport bonds is more risky as it could create a political backlash and would likely produce an outright Greek default if bondholders accelerate en masse. New Greek bonds do not cross-default with old Greek bonds, limiting the fallout from a default on holdouts. Euro Pavan Wadhwa, Fabio Bassi, Gianluca Salford Stay short duration, although yields are likely capped given sky-high liquidity and already short positions; we target 2.20% in 10Y Bunds. Stay positioned for tighter intra-EMU spreads, but favour Italy over Spain and Finland over the Netherlands. Hold 2Y Belgium longs and 4s/10s BTP flatteners. If other peripherals restructured debt along Greek lines, their debt/GDP ratio would also fail to decline appreciably. Initiate weighted reds/blues EONIA steepeners. Close Jun12/Jun13 Euribor bear flatteners since the curve is now positively directional. Buy Jun12 midcurve put spreads funded by selling call spreads as a short duration trade. Hold weighted greens/10s steepeners and initiate 5s/30s bear flatteners. Hold 2Y Schatz narrowers with a 75bp target on b/m spreads. Exit short 3Mx10Y gamma; instead sell proxy gamma by shorting 3Mx10Y vs. 3Mx5Y gamma. Sell Schatz vs. swaption gamma. UK Francis Diamond Negative technicals and continued risk-on dynamic makes us bearish on gilts; sell 10Y duration with a tight stop loss. Take profit on 5s/10s steepener and enter 10s/30s gilt curve flattener. Stay long belly of 10s/30s/50s gilt fly. Initiate tactical 5Y swap spread narrower. We think investor demand for 100Y gilts will be limited. US Terry Belton, Srini Ramaswamy Stay bearish on duration and neutral on yield curve. Turn neutral on intermediate swap spreads but hold 30Y swap spread widener. Stay short gamma in 10Y. Japan Takafumi Yamawaki, Yuya Yamashita Stay neutral on duration. Unwind the 5s/8s JGB flattener while maintaining long 7Y via weighted 5s/7s/10s butterfly. We recommend selling 3Mx10Y payers swaption with the strike of ATMF + 20bp. Australia and New Zealand Sally Auld Take profit on tactical shorts in AUD 3Y bonds and AUD 3M/12M OIS steepeners. Enter AUD 1Yx(2s/9s) swap curve steepener. Hold AUSUS 10Y bond spread contraction trades.
www.morganmarkets.com
Pavan WadhwaAC
(44-20) 7777-3370 pavan.wadhwa@jpmorgan.com
Fabio Bassi
(44-20) 7325-8615 fabio.bassi@jpmorgan.com
Contents
Overview Euro Cash European Derivatives United Kingdom US Cross Sector US Treasuries US Interest Rate Derivatives Japan 2 10 16 25 31 34 43 52
Australia & New Zealand 57 . Interest rate forecasts Recent curve movements Recent sov cash spread movements Recent sov CDS spread movements Sov & bank redemptions Event risk calendar Euro-area fact sheet / SMP Purchases Global Market Movers 63 64 65 66 67 68 69 72
J.P. Morgan Securities Ltd.
See page 70 for analyst certification and important disclosures.
European Rates Strategy Global Fixed Income Markets Weekly March 16, 2012 Pavan WadhwaAC (44-20) 7777-3370 Kedran Panageas (44-20) 7777-0326 J.P. Morgan Securities Ltd.
Overview
Stay positioned for risk-on: we see potential follow-through to this weeks sharp move higher in yields We analyse two distinct strategies for investors wishing to hold out from the Greek foreign-law bond exchange in late March Greece has limited ability and willingness to pay holdouts; the vast majority of foreign-law investors would be better served by tendering into the exchange, which should boost participation and potentially create opportunities for small investors The quiet holdout strategy has the most chance of success. The handful of bonds which mature early, have small outstanding size, and carry strong creditor protections, may be able to slip through the cracks Indeed, we estimate that each 1-month reduction in maturity adds about 5-10, 2-3, and 1-2 to bond prices, respectively, for bonds maturing from 1-2, 3-5, and 6-12 months out, while each 1bn reduction in outstanding bond size boosts bond price by around 2 points, and each 10% increase in the CAC voting threshold boosts bond price by around 8 Some Greek foreign-law bonds may be able to accelerate principal payment based on crossdefault clauses with railway and public transport bonds however, this loud holdout strategy is more risky as it could create a political backlash and would likely produce an outright Greek default if bondholders accelerate en masse Note that new Greek bonds do not cross-default with old Greek bonds, limiting the fallout from any default on holdouts We also review financial covenants in Portuguese foreign-law bonds; the 2016 Loan Stock has particularly strong covenants including a restructuring EOD
Stay positioned for risk-on

The main newsflow this week was the conclusion of the US bank stress tests on Tuesday, which led to a 2% rally in the S&P500 and a 4.5% boost to US bank stocks (up over 8% on the week). European yields reacted with a lag: the 10Y Bund and Gilt yield rose 14bp and 16bp on Wednesday, respectively. This move single-handedly retraced the last two weeks of yield compression and, along with some follow-through on Friday, brings yields to three-month highs. We hold short duration trades in Bunds, and enter short duration trades in Gilts, as we see the potential for further follow-through. However, we dont necessarily expect a large or sustained move higher in yields given the implication of high excess liquidity for positive carry, long-duration trades, as well as the still-mixed economic backdrop and ongoing fiscal consolidation. We also hold risk-on peripheral spread trades (see Euro Cash). Below, we provide an update of the Greek PSI process as it relates to foreign-law bonds, review financial covenants in existing and new Greek bonds, and estimate how various foreign-law bond characteristics (maturity, size, and voting thresholds) affect bond price. The Greek domestic-law bond exchange settled on Monday but the foreign-law exchange extends through late March. Some creditors are reportedly seeking ways to hold out, and we review the potential avenues by which they could seek to accelerate Greek bonds. This could potentially force Greece into a hard default over the next few weeks although ultimately we think this is more a source of headline risk than actual market implications. Importantly, the new Greek bonds granted in the recent debt exchange do not cross-default with existing Greek bonds (Appendix-1). This means that Greece can default on existing Greek bonds without causing its newly-issued bonds to become immediately due and payable. We also review the financial covenants in Portuguese foreign-law bonds (Appendix-2).
The outlook for holdouts in Greek foreign-law bonds

The 2nd Greek bailout was formally approved by the EU and IMF on Monday 12 March and Thursday 15 March, respectively. The domestic-law exchange officially settled on Monday, but the foreign-law exchange extends through late March. The official deadline to send in participation instructions is Friday 23 March, but bondholders can also vote at their respective bondholders meetings which occur from Tuesday
Exhibit 1: Maturity is by far the most important variable in Greek foreign-law bond pricing;
Greek foreign-law bond prices* regressed against months to maturity;
potentially seeking ways to hold out. Broadly speaking, we see two possible ways for foreign-law bonds to hold out: 1) The quiet way: that is, accumulating a blocking stake in a particular issue, holding out of the exchange, and hoping that Greece continues to pay interest and principal up to the point at which ones bond comes due; or 2) The loud way: attempting to accelerate payments on bonds which have experienced events-of-default, and hoping that Greece chooses to pay principal (or some fraction thereof) rather than default outright.
100 80 60 40 20 0 0 50 100 150 200 months to mat
y = -8.9Ln(x ) + 67.3 R 2 = 44.6%
250
300
* Includes Hellenic Railways and Athens Urban Transport bonds. We caveat that available bond pricing for existing Greek foreign-law bonds is extremely unreliable. We clean the data to some extent as follows. First, we use Bloomberg pricing if it appears reasonable. If not, we take the average of the best bid and offer prices from actual (and reasonable) screen quotes. If no reasonable quotes are available, we discard the bond. Source: Bloomberg, J.P.Morgan
Exhibit 2: indeed, we estimate that each 1M reduction in maturity adds about 5-10, 2-3, and 1-2 to bond prices, respectively, for bonds maturing from 1-2, 3-5, and 6-12 months out
Price beta* to a 1M reduction in maturity for Greek foreign-law bonds**;
10 8 6 4 2 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 months to maturity
* Beta defined as 9.2/maturity, where 9.2 is the partial regression beta shown in Exhibit 3 below. ** See footnote in Exhibit 1. Source: Bloomberg, J.P.Morgan
Below we review the best bonds for each type of holdouts, and their likelihood of success. Overall we think the outlook for holdouts is poor given Greeces motivations to default. First, Greece has limited ability to pay holdouts given the severity of its financial challenges. This primarily impacts large bond issues (or a large acceleration effort). Any principal that comes due in size is likely to be defaulted on or settled on worse terms than offered now. Second, Greece has limited willingness to pay: EU politicians will support Greece in not paying holdouts, especially as policymakers can argue that doing so would be unfair to voluntary participants. Third, Greece has already triggered CDS, so has little to lose on that front. Fourth, the new Greek bonds granted in the exchange do not cross-default with old Greek bonds, limiting the fallout of a default on holdouts (see Appendix-1). Fifth, rewarding holdouts sets a bad precedent in case the EU ever proceeds with PSI in Portugal or Ireland. In short, neither the economics nor the politics support the holdout trade, and we think the vast majority of foreign-law investors would be better served by tendering. However, there may be some opportunities for small investors to slip through the cracks, which we discuss below.
1) The best foreign-law bonds for (quiet) holdouts

Bonds with the best chance of getting out whole are those that a) mature as soon as possible, b) have small outstanding face value, and c) have strong minority protections. For instance, the smaller the face value, the more likely that Greece can afford to close its eyes and pay out par. Similarly, the higher the voting threshold required to employ collective action clauses (CACs), the less likely that minority holdouts will be roped into the exchange. Based on current foreign-law bond pricing
3
Thursday 27-29 March (see Overview, Global Fixed Income Markets Weekly, 9 Mar 2012). According to the Greek Finance Ministry, 61% of foreign-law bondholders had already sent in positive participation instructions as of 8 March (the original deadline). The remainder are either abstaining (roughly 90% of bondholders responded to the domestic-law exchange), or are still evaluating their strategy and
(admittedly an illiquid and low visibility market)1, we find that maturity is by far the most important variable. The price/maturity curve starts to kink at around the 9 month maturity, or December 2012 (Exhibit 1). Size and minority protections have a more modest but still intuitive impact. For instance, based on a cross-sectional regression we estimate that: For 1-2, 3-5, and 6-12 months to maturity, each 1M reduction in maturity adds about 5-10, 2-3, and 1-2 points to bond price, respectively (Exhibit 2); Each 1bn reduction in outstanding bond size boosts bond price by around 2 points; and Each 10% increase in the CAC voting threshold2 boosts bond price by around 8 (Exhibit 3).
Exhibit 3: Size and minority protections have more modest but still intuitive impact; each 10% increase in CAC voting threshold boosts bond price by around 8
Regression statistics* for Greek foreign-law bonds**; in price terms () Beta T-stat
Intercept LN(months to maturity ) Face v alue (bn) Voting threshold (%)***
10.1 -9.2 -2.1 81.7
0.5 -5.3 -1.2 2.9
* Cross-sectional regression on current bond prices. Adj R-squared = 57%, SE = 10. ** See footnote in Exhibit 1. *** We use the percentage of principal required to invoke collective action clauses assuming a 100% response rate. Source: Bloomberg, J.P.Morgan
Overall, there are just a handful of bonds that meet multiple criteria. Exhibit 4 illustrates bonds that have less than 12 months to maturity and either 1) small size (defined as less than 500mn outstanding), or 2) strong creditor rights (defined as requiring at least 75% of
principal to change bond terms via CACs). The OASA Mar2013 has extremely strong minority protections, with a 100% approval threshold for changing bond terms; however it matures a year from now which is longer than ideal. The highlighted bonds tally about 1.5bn in notional terms, which is small enough that Greece can likely
Exhibit 4: Only a handful of Greek bonds are potentially attractive to holdouts on multiple fronts
Greek foreign-law bonds that meet multiple holdout criteria*; number in parentheses is the voting threshold required to employ CACs**;
STRONG MINORITY RIGHTS 240mn OASA Mar 2013 (100%) 450mn Greece May 2012 (75%) EARLY MATURITY
190mn OSE Sep 2012 (66%) 250mn OSE Dec 2012 (66%) 413mn OSE Apr 2013 (66%) SMALL SIZE
* Defined as having 12M or less to maturity and either 1) less than 500mn outstanding face value, or 2) a 75% voting threshold for CACs** ** CAC voting threshold as a % of principal, assuming a 100% response rate to any bondholder proposals. Source: Bloomberg, bond prospecti.
1 We caveat that available bond pricing for existing Greek foreign-law bonds is extremely unreliable. We clean the data to some extent as follows. First, we use Bloomberg pricing if it appears reasonable. If not, we take the average of the best bid and offer prices from actual (and reasonable) screen quotes. If no reasonable quotes are available, we discard the price. 2 We use the percentage of principal required to invoke collective action clauses assuming a 100% response rate.
Exhibit 5: we believe the vast majority of Greek foreign-law investors would be better served by tendering into the exchange
Bond characteristics Exchange High (>80%) Low (<80%) Acceleration Limited Limited Large Matures early Small size Hold out Hold out or Tender Tender Large size Tender Tender Tender Matures medium/late Small size Accelerate Tender or Accelerate Tender Large size Tender Tender Tender participation tactics
JPMorgan estimate of optimal exchange strategy for Greek foreign-law bondholders in various exchange scenarios; most likely outcome highlighted in blue
afford to pay out. Whether Greece chooses to do so depends in part on other creditor strategies. For instance, we think that voluntary participation is the optimal strategy for all medium to large bond issues, as discussed above. If exchange participation is high, there is a reasonable chance that Greece is willing and able to pay out on this small group of bonds. We would ballpark the probability at somewhere between 1/3 and 1/2, depending on maturity. This is also true, albeit less so, if other bonds dont participate, but also dont force the issue by attempting to accelerate in large size. On the other hand, if a large group of bonds attempt to accelerate their payment, it will likely lead Greece to default or pursue a more severe restructuring which involves all holdouts (discussed below). In this eventuality, we think the optimal strategy for other bondholders would be to participate voluntarily, regardless of maturity. These optimal strategies for different bondholders, as we estimate them, are summarized in Exhibit 5. Finally, regulated investors who are susceptible to moral suasion should look to sell bonds with attractive holdout features to less regulated investors who are more able to take advantage of such features.
Office of Athens Urban Transport) include a restructuring of the guarantors debt as an event-ofdefault (EOD).4 Following an EOD, any bondholder can choose to accelerate the bond. This means that principal becomes immediately due and payable. If each such bond has this clause, or can cross-default with each other, it means that around 3bn of debt has the ability to accelerate already, due to the domestic-law PSI exercise which just went through (Exhibit 6). Greek government foreign-law bonds do not include this restructuring language. However, the majority do have cross-default clauses. Cross-default means that when Bond A is not paid its interest or principal, Bond B also suffers an EOD. Then Bond B principal can also be accelerated. As far as we can tell by looking at available bond prospecti, the Greek cross-default clauses are all defined with respect to External Debt. This category of debt is defined in various ways, but most commonly includes the following: o Foreign-currency (FX) debt, o Foreign-law debt issued to foreign holders (FL/FH), and o Guarantees of other issuers debt that meet either of the above conditions5. Thus, if a government-guaranteed state agency bond gets accelerated, and it can be demonstrated that this foreign-law bond was placed initially with a non-
2) The (mostly empty) threat of acceleration

Theres also an avenue by which creditors could attempt to force the issue by accelerating Greek foreign-law debt. The bet is that Greece would choose to settle on more favorable terms rather than default outright.3 This is most attractive to small issues which mature late (it moves them up in the queue, but Greece is likely to default if too many pursue this strategy). The chain is as follows: A number of government-guaranteed state agency bonds (OSE, or Hellenic Railways, and OASA, or
3 For example, see Hedge funds find loophole to trigger Greek default, 8 March 2012, Bloomberg
4 For example, from the OSE Oct2015 list of EODs: A general moratorium is declared by the Guarantor in respect of its External Indebtedness or the Guarantor announces its inability to pay its External Indebtedness as it matures or the Guarantor otherwise commences negotiations with one or more of its respective creditors with a view to a general readjustment or rescheduling of its respective indebtedness." 5 OSE and OASA bonds are -denominated, so do not meet the foreigncurrency criterium.
Exhibit 6: Some Greek international bonds may be able to accelerate principal payment based on cross-default clauses with railway and public transport bonds. This loud holdout strategy is more risky as it could create a political backlash and would likely produce an outright Greek default if bondholders accelerate en masse
Estimated terms of financial covenants in existing Greek foreign-law bonds, weighted by principal amount outstanding*;
Acceleratable in an EOD by ** Amt Ty pe Greek International Hellenic Railw ay s Urban Transport Total (bn) 17.4 2.4 0.6 20.4 w / Neg w / Cross- EOD: includes pledge 93% 100% 100% 94% Def 93% 100% 100% 94% Greek Restruc? Any Holder No Yes Yes 15% 7% 100% 100% 21% >25% of Prin 86% 0% 0% 73% Neg Pledge / Cross-Default pertains to: Ex ternal Indebtedness Relev ant Debt for issuer / Ex ternal Indebtedness for guarantor Relev ant Debt for issuer / Ex ternal Indebtedness for guarantor -FX 1% 0% 0% 1% Ex ternal debt defined as**,***: FX and FL/FH 7% 0% 0% 6% FX or FL/FH 85% 100% 100% 87%
* Based on sampling of available prospectus. We sample around 85% of Greek international bonds, 60% of Greek railway bonds, and 33% of public transport bonds by principal amount. ** Only shown for bonds which have cross-default clauses. *** FX (foreign-currency) generally means any currency other than that of the Greek Republic, i.e. the euro. FL/FH generally means foreign-law bonds initially issued to foreign holders. Both categories include guarantees of another issuers debt which meet the applicable criteria. We use cross-default criteria for debt issued from early2000s onwards since the relevant railway and public transport bonds were all issued post-2002. Note: The above summary is based on our reading of available bond documents and is not intended to represent legal advice. Investors should consult their own counsel. Source: Bloomberg, bond prospecti.
Greek investor, then other foreign-law bonds can potentially accelerate as well. We reckon about 85% of Greek government foreignlaw bonds have the most relaxed version of crossdefault clauses which would allow them to pursue this strategy (Exhibit 6). However, government bonds are more difficult to accelerate than state agency bonds, requiring 25% of principal rather than a single holder. This is not a trivial hurdle to meet given that 61% of principal is already reported to have been tendered into the exchange. In fact, it is probably preferable to wait until after 11 April, when the foreign-law exchange settles, so that one may own a higher proportion of existing debt. (Delaying has the risk of getting roped into CACs however).
As discussed above, we think that the vast majority of Greek foreign-law bondholders would be better served by tendering. In particular, the optimal strategy for investors in medium to large bond issues (which we define as anything over 500mn) is to tender into the exchange. This, plus moral suasion applied to highly regulated investors, should cause exchange participation to be high, which in turn might allow some small bonds which mature early to hold out, or some small bonds which mature late to accelerate. If many investors attempt to accelerate, or participation looks to be on the low side, it becomes more preferential to tender in order to avoid potentially more severe treatment (Exhibit 5). This implies that holdout attempts are likely to be fairly small in size, which should limit the amount of headline risk posed over the near term.
The acceleration strategy is more risky than the quiet holdout strategy. First, it is more aggressive and as such is more likely to prompt a political backlash, which increases the odds that Greece chooses to default rather than pay out. Second, in this strategy twos company, threes a crowd: one acceleration is likely to encourage others to accelerate as well (for defensive reasons), which if it snowballs is likely to lead Greece to default outright. For this reason, as well as for need to control 25% of the outstanding principal, it is probably better to wait until after the 11 April foreign-law exchange settlement, which should reduce the outstanding principal considerably. Overall we ballpark the odds of an acceleration strategy working at something like 1/5.
6
Trade recommendations
Duration In Euro, hold short duration in 10Y Bunds; In UK, turn bearish on duration and sell 10Y Gilts. Curve In Euro, have a steepening bias on curve; In UK, take profits on 5s/10s gilt steepeners and enter 10s/30s flatteners.
Exhibit 7: Birds eye view of our major trade recommendations by currency

Duration Curve Euro area Short 10Y Steepening bias Weighted greens/10s steepener 5s/30s bear flattener Jun12 Schatz narrower UK Short 10Y Pay 12Mx6M in swaps Reds/greens steepener 10s/30s flattener Long 10s/30s/50s gilts fly 5Y narrowers US Bearish bias Neutral Japan Neutral 8s/30s steepener Long 7Y JGB in 5s/7s/10s wtd. fly Pay 10Y in 5s/10s/20s swap wtd fly 1s/5s FX basis steepener 20s/30s wtd. steepener Sell 3Mx10Y Sell OTM 3Mx10Y payers
Swap spreads
30Y widener
Jun12 Schatz narrower hedged with Jun12 FRA/OIS widener Swap spread curve Neutral Neutral Gamma Short Schatz unhedged strangle Short 3Mx10Y vs. 3Mx5Y straddle Short Schatz vs. maturity matched swaption gamma Neutral Pay 5Yx10Y HICP (rec. fixed) Rec. 10Y French CPI vs. Euro HICP swaps Long BTANi16, OBLi13 & OATei15 b/e Long 9Y Finland vs. Germany 4s/10s Italy flattener Long 2Y Belgium vs. Germany Long 5Y Italy vs. France Sell protection in 3Y Spain CDS Short 2Y Italy CDS-cash basis Neutral
Vega Inflation
Neutral Long ILG16 b/e
Bearish Bullish bias
Neutral Neutral
Cross-market
Appendix 1: Financial covenants in new Greek bonds

Here we summarize the financial covenants in the new Greek bonds granted in the exchange. We caveat that the following is not intended to represent legal advice; investors should consult their own counsel. Based on our reading, the new Greek bonds can be characterized as offering more protection to bondholders than Greeces prior bonds did (whether domestic or foreign-law), but less minority bondholder rights. First, the new Greek bonds are foreign-law, so terms cannot be changed by Greece at will, which is a material advantage. Second, they contain a co-financing arrangement between payments due to the EFSF and to the new Greek bonds: Greece pays interest and principal into a common vehicle, and these funds are distributed pro-rata to the EFSF and to new Greek bonds. This makes private creditors closer to pari passu with the official sector. Third, the new bonds cross-default with all Greek debt issued after the exchange date (not just external debt). Note that these cross-default clauses do not trigger for payment disruptions to old Greek bonds. Fourth, they carry both individual and aggregate CACs. The former operate across the series of 20 new Greek bonds whilst the latter can include other Greek debt series as well. This means that Greece can pursue a bond modification to the new Greek bonds alone, or could elect to pursue a bond modification across its entire stock of debt securities. The voting thresholds are somewhat lower than in existing Greek foreign-law bonds and have shorter notice periods (effectively, one day). Bond terms are summarized in the gray box at right (Exhibit A1).
Exhibit A1: Financial covenants in Greeces new bonds offer more protection to bondholders than Greeces prior bonds did (whether domestic or foreign-law), but less minority bondholder rights
Summary of financial covenants in New Greek bonds* (1) Governing Law = ENGLISH --- Sovereign immunity is waived, but nevertheless, diplomatic properties, noncommercial properties, central bank assets, military assets, cultural heritage assets, and all assets residing in Greece are not liable for attachment. (2) Negative pledge clauses: YES --- Pertains to all Relevant Indebtedness, which includes all Greek debt or guarantees issued on or after 12 March 2012 (the exchange date). (3) Events of Default: cross-default does NOT extend to existing Greek bonds --- Non-payment of interest on the new Greek bonds* or GDP warrants, with a 30D grace period --- Non-payment or acceleration of principal on any Greek debt that is issued on or after 12 March 2012 (the exchange date), subject to a 250mn minimum, and subject to applicable grace periods --- Any other covenant failure on the New Greek bonds*, with a 30D grace period --- Acceleration of the 1Y/2Y EFSF sweeteners --- Moratorium declared w/respect to the New Greek bonds* --- Repudiation/expropriation of the New Greek bonds* or of the co-financing agreement --- Legal decree prevents Greece from fulfilling its obligations to the New Greek bonds* or to the co-financing agreement (4) Acceleration by 25% of principal --- Can be rescinded by holders of 50% of principal, without curing of the EOD (5) CACs: both individual and aggregate CACs, either can be pursued --- Individual CAC: operates across the New Greek bonds* --- Quorum = 2/3 for Reserved Matters and 1/2 for other matters --- Voting threshold = 75% for Reserved Matters and 50% for other matters, as a % of those voting --- Modifications can also be passed by written resolution with signatures from 67% of total principal --- Aggregate CAC: operates across the New Greek bonds* + any other series of Greek debt securities --- Two voting thresholds, both must be met --- Aggregate threshold = 75% of those voting, by principal, taken across all affected series, subject to meeting proper quorums at the separate meetings --- Individual threshold = 67% of those voting, by principal, for each affected series separately, subject to meeting proper quorums at the separate meetings --- For written resolutions, aggregate threshold = 67% of total principal amount taken across all affected series; individual threshold = 50% of total principal amount of each affected series --- Bonds controlled by Greece or Greek state agencies cannot vote --- Notice period = 1D (day of first publication in major Greek & Englishlanguage newspapers) (6) Co-financing arrangement --- Principal and interest on 1) the New Greek Bonds* and 2) the EFSF loan which covers the 30bn PSI sweeteners, is paid to a "common paying agent" each payment period --- This paying agent pays each class of creditors pro-rata, including shortfalls --- Any creditor who recovers any past due amounts must turn funds over for pro-rata distribution to all creditors --- Paying agent = Bank of Greece --- Governed by laws of England *Note: The New Greek bonds are the 20 new bonds granted on 12 March 2012 in the debt exchange. The above summary is based on our reading of available bond documents and is not intended to represent legal advice. Investors should consult their own counsel. Source: Greek Finance Ministry, J.P.Morgan
Appendix 2: Financial covenants in Portuguese foreign-law bonds

Amongst the peripherals, Portugal has the 2nd highest proportion of foreign-law bonds (Greece has the 1st; see Overview, Global Fixed Income Markets Weekly, 3 Feb 2012). Most are issued out of a common MTN platform and have one overarching bond prospectus. These bonds have the following characteristics: Negative pledge clauses with respect to External Debt, which is defined as debt placed with investors outside the Republic of Portugal Cross-default clauses with respect to notes issued out of the MTN platform, but not with respect any other debt securities
Fairly circumscribed EODs: only failure to pay principal/interest and failure to meet other MTN conditions (all with a 30-day grace period) CACs which operate across the MTN platform: at least 2 noteholders holding >75% of the principal are necessary to form a quorum to modify key bond terms.6
Exhibit A2: Financial covenants in most of Portugals foreign-law bonds are fairly limited, except for in the 2016 Loan Stock
Summary of financial covenants in Portuguese MTN program* (1) Governing Law = ENGLISH --- Sovereign immunity is waived, but public property used for public purposes or assets in the public domain are not liable for attachment. (2) Negative pledge clauses: YES --- Pertains to all External debt or debt guarantees, which is defined as debt placed with investors outside the Republic of Portugal (3) Events of Default: cross-default ONLY with other MTNs --- Non-payment of interest on any MTN note, with a 30D grace period --- Non-payment of principal on any MTN note, with a 30D grace period --- Any other covenant failure on any MTN note, with a 30D grace period (4) Acceleration by any holder --- Any holder of Bearer or Registered notes can accelerate --- Interbolsa notes (a small Portuguese-law subset of the MTN platform) may require 20% of principal to accelerate if a common representative has been appointed (5) CACs: aggregate across the MTN platform --- Collective action clause operates across the MTN platform --- Quorum = at least 2 holders holding >75% of total principal --- Voting threshold not clear --- Notice period = 1D (day of first publication in major newspaper) or 7D if the entirety of notes are held by Euroclear/Clearstream and notice is disseminated via Euroclear/Clearstream Summary of financial covenants in 2016 Portuguese Loan Stock* (1) Governing Law = ENGLISH --- Sovereign immunity is waived, but public property used for public purposes or assets in the public domain are not liable for attachment. (2) Negative pledge clauses: YES --- Pertains to all External Debt --- External Debt is defined as debt or debt guarantees, that are either 1) not in escudo currency or 2) placed with investors outside the Republic of Portugal (3) Events of Default: Includes Cross-default and Restructuring --- Non-payment of interest, with a 30D grace period --- Any other covenant failure, with a 30D grace period --- Non-payment of interest or principal on any External Debt (including loans), with a 30D grace period, where External Debt is defined as above --- Any event that could lead to acceleration of any External Debt (including loans), even if the EOD is not acted upon (but remains uncured); External Debt is defined as above --- Moratorium --- Portugal enters into debt restructuring with or for the benefit of any creditor (4) Acceleration by any holder (5) CACs exist, terms NA *The above summary is based on our reading of available bond documents and is not intended to represent legal advice. Investors should consult their own counsel. Source: Bloomberg, J.P.Morgan
Another bond, the Portuguese Loan Stock maturing in 2016, is a small issue that has relatively strong investor protections. It has negative pledge and crossdefault clauses which apply to External Debt, and because the bond was issued in 1986, the definition of External Debt is somewhat antiquated: it includes any debt not denominated in Portuguese escudos (meaning that even -denominated domestic-law bonds would apply). It also has a restructuring EOD (albeit somewhat ambiguously written). Exhibit A2 summarizes these bond terms. We caveat that the above is based on our interpretation of available bond documents and is not intended to represent legal advice; investors should consult their own counsel.
The voting threshold to implement a bond modification is not clear, but is likely to be either a) 75% of total principal outstanding, or b) 75% of those voting at a bondholders meeting.
9
European Rates Strategy Global Fixed Income Markets Weekly March 16, 2012 Gianluca SalfordAC (44-20) 7325-4334 Aditya Chordia (44-20) 7777-9841 J.P. Morgan Securities Ltd.
Euro Cash
German yields finally caught up with the risk-on mood resulting in a significant sell-off Mentions of ECB exit from non-standard measures and a spillover from the US may explain part of the move We remain short duration, targeting 2.20% in 10Y Bunds; we see little room for a sharp move beyond that level as excess liquidity is exceptionally high and positions are already skewed towards the short side Most RV opportunities on the German curve have corrected, with the exception of 2019 expensiveness We remain positioned for tighter intra-EMU spreads, but favour Italy over Spain and Finland over the Netherlands, given the newsflow We still recommend 2Y Belgium duration longs, 4s/10s BTP flatteners, and selling protection in short-dated peripheral CDS Light bond supply over the next two weeks, with only Germany and Italy tapping the market Special focus: De facto subordination of peripheral bond holders in peripheral bond markets
Exhibit 1: The shift in tone by ECB members has hurt safe assets
Recent comments from ECB members discussing the ECBs exit strategies from crisis mode
Date Speaker Comment "It is too early to decide on ex it strategy We hav e to prepare for future ex it, but I w ould say that time is not ripe now ." "We as central banks must dev elop an idea of how w e w ill 13-Mar Weidmann organize and ex ecute an ex it from the special measures, how w e w ill limit the risks that w e hav e taken during the crisis." "ECB discussing strategy to ex it crisis mode, has arsenal of 15-Mar Now otny options, process w ill be gradual. Ex it w ill depend on price stability , efficient functioning of capital and money markets." "Euro crisis solution requires controlled, timely ex it from recent 15-Mar Liikanen central bank steps. Long term refinancing ops had "decisiv e impact on market", pose no threat to price stability ." "It is v ery important on the one hand that gov ernments commit 16-Mar Liikanen and implement policies w hich consolidate their public finances and create a basis for grow th and on the other hand w e must also decide how and w hen w e ex it in a controlled and timely matter." 11-Mar Benot Cur
Source: Media articles
Exhibit 2: but we would be cautious about extrapolating too much from current conditions; therefore we do not expect the 10Y Bund yields to sell-off beyond the 2.20% level
Global composite PMI vs. consensus on 1Y ahead global real GDP growth index %
58 56 54
Global consensus
3.60
3.20
2.80 52 50 Global PMI 2.40
Pressure for higher yields, but not the beginning of a bear market
The risk-on trade gained traction on the week, finally hurting AAA fixed income markets across the globe. In GFIMs, we have been highlighting for a while that valuations for Bunds and US Treasuries were stretched, and we believe the current adjustment should not be faded. The ECB chatter about the need to be ready to exit non-standard measures increased in volume (Exhibit 1), hurting the short end of the curve, adding a domestic component to the US-driven sell-off. How far can the sell-off go? Our fair value target is 2.20% (see GFIMs, 2 March 2012) and a round of convexity hedging in the US might also help (see US sections for details). We put a stop at 1.95%. As discussed at length in the past, we remain sceptical about the possibility of a meaningful sell-off beyond the 2.20% level, as the conditions for a more restrictive monetary policy are not in place. We
10
48 Jan-10 May -10 Sep-10 Jan-11 May -11 Sep-11 Jan-12
2.00
argue against extrapolating too much into the future the recent strength in the data, as for the past two years, consensus on 1Y forward growth has lagged the message of contemporaneous activity indicators (Exhibit 2). In addition, we believe most investors are already positioned on the short side, albeit with limited risk. In the sell-off, the 5Y part of the curve suffered the most, as 2s/5s steepened 13bp and 5s/10s flattened 4bp. We believe recent market moves have corrected many of the RV themes we have been highlighting since the beginning of the year. The 5Y underperformance looks excessive and now leaves 5Y around 3bp cheap on the
Exhibit 3: After the recent sell-off, the 5Y is no longer dear and the 10Y is no longer cheap on the German curve
Residual from regressing 50:50 2s/5s/10s against curve and level and 50:50 2s/10s/30s against 1s/2s OIS and 2s/30s*; past 1Y; bp
curve, after months of expensiveness (Exhibit 3). At the same time, most of the cheapness of the 10Y sector has been eroded. In addition, 20Y has outperformed 10Y and 30Y after we highlighted its cheapness a week ago. The only remaining theme is the 3bp expensiveness of 2019 Bunds.
30 20 10 0 -10 -20 -30 Mar11 May 11 Jul11 Sep11 Nov 11 Jan12 Mar12 5Y 10Y
Intra-EMU
Despite higher yields in many countries, intra-EMU spreads were generally tighter. In line with the theme of the past few weeks, Italy was a relative outperformer and Spain a relative underperformer. Belgium warrants an honourable mention: OLOs were the best performers despite the pricing of 4bn of a new 20Y bond. As discussed above, we believe spreads can tighten further from here. In our country selection, we focus on valuations and newsflow. We favour countries like Italy and Finland against Spain and the Netherlands, respectively, and we continue to highlight the cheapness of the short end of Belgium. Increased risk appetite has prompted some investors to reconsider their consensus on France underweight. However, we do not find any domestic reasons to change our cautious stance on French bonds: in our view, any tightening will be driven by Italys performance and find better value in BTPs at around 300bp over Bunds than OATs at around 100bp over. We provide a country-by-country update on our favourite themes for the most liquid markets. Selling protection in short-dated CDS remains another very interesting theme, given the market segmentation accentuated by the 3Y LTROs. Austria We continue to believe that Austrias fundamentals did not warrant S&Ps downgrade and the risk of banking sector exposure to Eastern Europe is overblown. 2018 and 2019 RAGBs remain stubbornly cheap on the Austrian curve and vs. France. The Sep21 remains the most expensive bond. Belgium Belgiums recent outperformance was concentrated in the 5-10Y part of the curve. We believe the best value can be found at the short end of the curve, given attractive valuations, around 20bp cheap (Exhibit 4), whereas at these levels, we are neutral on the rest of the curve.
* 50:50 2s/5s/10s = 0.13*5Y 0.06*2s/10s -0.20, R-squared: 87%; * 50:50 2s/10s/30s = 0.58*1s/2s OIS + 0.43*2s/30s -0.58, R-squared: 69%;
Exhibit 4: We find value in the short end of the Belgian curve, given attractive valuations: stay long 2Y Belgium vs. Germany
2Y spread to Germany as % of 10Y spread to Germany regressed against 10Y spread to Germany; %
80% BEF 60% NLG 40% FIM 20% 0 50 100 150 200 250 10Y spread to Germany ; bp 300 350 ITL ESP FRF y = 0.14*Ln(x ) - 0.11 R 2 = 63%
ATS
Exhibit 5: The 8-10Y sector of the Finnish curve has failed to tighten vs. Germany since the beginning of the year despite the risk-on mood
RFGB Apr21-Bund Jan21, OAT Apr21-Bund Jan21 and KFW Jan21-Bund Jan21 yield spread evolution since 1 January 2012; 1 January 2012 level indexed at 100; index
120 110 100 90 80 70 60 Jan-12
FIM-DEM KFW-DEM
FRF-DEM
Feb-12
Mar-12
11
Finland We recommend overweight in Finnish bonds, especially in 2020 and 2021 maturities as 1) the countrys fundamentals remain very solid, and 2) 2020 and 2021 RFGBs have failed to tighten vs. Germany since the beginning of the year despite the risk-on mood (Exhibit 5). We therefore recommend investors to open longs in RFGBs Apr21 vs. Bund Jan21. France We recommend a token underweight in France: we believe fundamentals require wider spreads than Austrias, but the election risk is well flagged, and France underweight remains fairly consensus. We find the best value in the 3Y part of the curve, whereas in longer maturities, the Oct21 is around 3.5bp expensive vs. the Apr21 and the Apr22, but it has been trading special in repo, so we do not recommend short-selling. Italy We are positive on a continuation of spread compression in BTPs. Our favourite sectors are 3Y as it is not pricing any LTRO premium (in contrast with the Spanish curve) and 10Y, which looks cheap vs. both 4-5Y and 15Y (Exhibit 6). We stick to 4s/10s flatteners and plan to reopen 10s/15s steepeners after the month-end 10Y auction. The Netherlands A combination of poor growth prospects, higher-thanexpected deficit and political noise do not justify relative valuations vs. Finland. We recommend underweight. Spain As discussed last week, we believe Spains underperformance vs. Italy can continue in the short term. Indeed, recent data was not favourable: the January budget balance number was -9.3bn (vs. -4.7bn in 2011) and house prices declined by a record amount in 4Q11 (-11% on the year). Our favourite play on the Spanish curve is to sell the high price Bono 2032 vs. the low price 2037. We also find 5Y fairly cheap after the auction-induced cheapening.
Exhibit 6: 10Y part of the BTP curve looks cheap vs. both 4-5Y and 15Y
5Y par Italian government rates; %
12
5Y spot
5Y 5Y fw d
5Y 10Y fw d
SMP2
3Y LTRO
Jul11 Aug11 Sep11 Oct11 Nov 11 Dec11 Jan12 Feb12 Mar12

Note: SMP2 started on 8 Aug 2011 and first 3Y LTRO took place on 21 Dec 2011.
Exhibit 7: Euro area conventional bond issuance calendar for the next two weeks
Euro area conventional bond issuance calendar; official announcements and J.P. Morgan forecast; peripheral supply highlighted in grey; bn
Date Issuer Short Mar14 5.0 3.0 3.0 Medium Long Ultralong
21-Mar Germany 29-Mar Italy
Exhibit 8: 1Q12 supply came in marginally higher than expected, mainly due to aggressive front-loading by Spain
Gross conventional bond issuance in 1Q12* vs. J.P. Morgan Q1 supply forecast made at the starting of the year; bn 1Q12 JPM 1Q12 Country Diff. realised* forecast
Germany France Italy Spain Netherlands Belgium Austria Greece Finland Portugal Ireland Total
43 52 40 38 22 12 8 0 3 0 0 219
43 55 45 27 23 9 7 0 1 0 0 209
0 -3 -5 11 0 3 1 0 2 0 0 10
Issuance/News
Next week will be very light in terms of supply, with only Germany tapping the conventional market for 5bn (Exhibit 7). Germany also plans to issue around 2bn of a new 10Y linker maturing in April 2023 (on Wednesday). On the T-bill side, peripheral supply will come from Spain and Greece (on Tuesday) and Portugal
12
* We assume that Germany will issue 5bn at the 21 March auction and Italy will issue 6.0bn at the 29 March auction.
(on Wednesday). Also, on Monday, ISDA will hold an auction in respect of outstanding Greek sovereign CDS transactions.
On Wednesday, Germany will tap the 2Y benchmark Schatz Mar14 for 5bn, bringing the total outstanding size to 10bn. The bond will be tapped again in April. The bond is the dominant CTD for the June Schatz future contract. As 1Q12 comes close to an end, we take the opportunity to review the issuance dynamics of the Euro area countries during the quarter. Based on the supply so far and official announcements/J.P. Morgan projections of the sizes of the upcoming auctions, the total supply by Euro area countries will be around 219bn, marginally higher than our start-of-the-year forecast of 209bn (Exhibit 8). The upside surprise came mainly from Spain, which engaged in aggressive issuance frontloading, issuing around 38bn of conventional bonds (the highest ever in one quarter) vs. our forecast of 27bn. Belgium also issued more than expected, as it took advantage of the improved market sentiment and launched two syndicated deals in 1Q12 (in the 10Y and 20Y sectors). On the other hand, Italy has been lagging in terms of issuance, issuing only 40bn over the quarter vs. our forecast of 45bn. Italy started the year on a cautious note and issued in small sizes, but the supply has gained momentum since the second 3Y LTRO at the end of February. We will publish a new quarterly update on supply in the coming days. Germany announced an upward revision to net new borrowing in 2012 from 26bn to 35bn (due to early ESM payments), but a downward revision to borrowing needs in the following years. Italy has set a 2.25% coupon for its retail BTPi Mar16 bond that will be sold next week.
Exhibit 9: A Greek-style debt restructuring provided little relief to Greeces debt to GDP ratio due to: 1) the decision to restrict haircuts to bonds, 2) to safeguard official bond holdings, 3) to recapitalise the domestic banking sector, and 4) technical issues linked to general government consolidation;
Estimate of the impact of a Greek-style debt restructuring* for Greece, Ireland, Italy, Portugal and Spain; estimates of current values based on publicly available sources; bn
General govt debt (Maastricth def.) Bonds Eurosystem bond holdings Bank bond holdings General govt consolidation Debt reduction due to haircut on all debt 1) Impact of haircut on bonds only 2) Impact of central bank seniority 3) Impact of fin. sector recapitalisation 4) Impact of gen. govt consolidation Total debt reduction after Greek-style PSI Total reduction as % of GDP Greece Ireland Italy Portugal Spain 355 169 1,911 175 736 280 80 1,450 108 550 62 19 186 17 66 50 14 240 16 175 25 1 8 0 62 190 -40 -33 -30 -13 73 34% 90 -47 -10 -9 0 24 15% 1,023 -247 -99 -144 -4 528 33% 93 -36 -9 -10 0 39 23% 394 -100 -35 -105 -33 121 11%
* Assumptions: 1) A 53.5% reduction in principal to the stock of government bonds. 2) A 75% NPV reduction in the value of government bonds. 3) Recapitalisation needs for the domestic banking sector equivalent to 80% of the NPV loss.
Exhibit 10: and our calculations suggest that debt/GDP relief would be even more modest for other peripheral countries
Estimate of the impact of a Greek-style debt restructuring* for Greece, Ireland, Italy, Portugal and Spain; estimates of current values based on publicly available sources; % of GDP
General govt debt (Maastricth def.) Bonds Eurosystem bond holdings Bank bond holdings General govt consolidation Debt reduction due to haircut on all debt 1) Impact of haircut on bonds only 2) Impact of central bank seniority 3) Impact of fin. sector recapitalisation 4) Impact of gen. govt consolidation Total debt reduction after Greek-style PSI Greece Ireland Italy Portugal Spain 163% 108% 121% 102% 69% 129% 51% 91% 63% 51% 28% 12% 12% 10% 6% 23% 9% 15% 9% 16% 11% 1% 1% 0% 6% 87% -18% -15% -14% -6% 34% 58% -30% -6% -5% 0% 15% 64% -16% -6% -9% 0% 33% 54% -21% -5% -6% 0% 23% Avg. 112% 77% 14% 15% 4%
37% 60% -9% -19% -3% -7% -10% -9% -3% -2% 11% 23%
Special focus: De facto subordination of private bond holders in peripheral bond markets
Our sister publication (Flows and Liquidity, 9 March 2012) discussed how the Greek PSI provided more disadvantages than advantages for the stability of the region. Greeces debt restructuring provided only limited relief to the country (around 30% of GDP) and highlighted the issue of de facto private bond investor subordination. We show, in a theoretical simulation, that applying the same debt restructuring format to other peripheral countries would achieve even more limited improvement in the debt/GDP ratio, with the least impact in Ireland and Spain.
* Assumptions: 1) A 53.5% reduction in principal to the stock of government bonds. 2) A 75% NPV reduction in the value of government bonds. 3) Recapitalisation needs for the domestic banking sector equivalent to 80% of the NPV loss.
The conclusions of our analysis are two-fold: on the one hand it suggests that the balance between the pros and cons of applying a PSI-style medicine to other countries is even more skewed towards cons, but on the other hand, reinforces private investors fears that in case a Greek-style PSI were decided, very harsh haircuts would be needed even for countries with a much lower debt/GDP ratio than Greece. Greeces limited reduction in debt/GDP after the debt restructuring is attributable to four factors:
13
1) Only one type of debt was involved bonds whereas T-bills, private and official loans were spared a notional reduction (keeping in mind that official loans have seen maturity extension and interest-rate reductions). 2) Among bond holders, European public institutions such as the ECB, national central banks, and the EIB were spared from the PSI. 3) Part of the savings from the debt restructuring was offset by the need to recapitalise the domestic banking sector. 4) Finally, the general government debt/GDP ratio consolidates between different sectors of the public administration. Therefore, a restructuring of securities held by the public social security fund has no impact on the debt/GDP ratio. To gauge the relative importance of these factors for Greece and other peripheral countries, we assume: 1) A 53.5% reduction in principal to the stock of government bonds. 2) A 75% NPV reduction in the value of government bonds. 3) Recapitalisation needs for the domestic banking sector equivalent to 80% of the NPV loss. Arguably, recapitalisation needs might be necessary for other financial institutions like insurance companies, further reducing the improvement in the debt/GDP ratio, but we do not want to further complicate the analysis. Exhibits 9 and 10 show our estimates based on various public sources. For Greece, a 53.5% notional reduction on all debt would have reduced the debt/GDP ratio by almost 90%; however, the decision to focus only on bonds meant that the decline was reduced by 18% of GDP. SMP purchases and previous bonds held by the Euro system in investment portfolios were not subject to the haircut, reducing the decline by a further 15%. The need to recapitalise the domestic banking sector subtracted another 14%, whereas the impact of the consolidation of the social security funds holdings was lower, at 6%. Once the four factors are taken into account, the reduction in the debt/GDP ratio drops dramatically to 34% of GDP. For the other countries, the eventual decision to target only government bonds would be the most important factor reducing the effectiveness of a Greek-style debt restructuring. The impact of preserving Euro system bond holdings and the required
14
recapitalisation of the banking system would be similar in most cases, with the exception of Spain, where central bank holdings are considerably less important than domestic bank holdings. Spain is also peculiar in its significant bond holdings by the social security fund. A Greek-style debt restructuring would have an impact on the debt/GDP ratio of around 30% in Italy, in line with Greece, more than 20% in Portugal, but much less in Ireland, and especially so in Spain. We make a final additional observation. If, as has been the case recently, a reduction in international investor support will continue to be offset by domestic bank purchases, SMP purchases or official lending, the problem of de facto subordination of private bond holders will grow with time. In conclusion, the role of international investors is therefore key: the more they disengage from peripheral countries, the more they tend to create effective subordination for the remaining investors.
Open long 9Y Finland vs. Germany Open long 25mn RFGB Apr21 vs. short 25.5mn Bund Jan21 @ 57bp. 3M carry and slide: 0bp. Keep 4s/10s BTP flattener Keep long 25mn of BTP Sep22 vs short 50mn of BTP Aug16 @ 158bp. 3M carry and slide: -6bp. P&L since inception (9 March): 7bp. Keep Bono Jul32-Jan37 flattener Keep long 25mn of Bono Jan37 and short 23.5mn of Bono Jul32 @ 1.5bp. 3M carry and slide: -2bp. P&L since inception (2 March): -0bp. Keep short 10Y Bund Keep short 100mn of Bund Jan22 @ 2.05%. 3M carry and slide: -10bp. P&L since inception (24 February): 16bp. Keep long 5Y Italy vs. France Keep long 25mn BTP May17 vs. short 19.8mn OAT Oct17 @ 188bp. 3M carry and slide: 14bp. P&L since inception (24 February): 62bp. Keep long 2Y Belgium vs. Germany Keep long 25mn OLO Mar14 vs. short 26mn Schatz Mar14 @ 95bp. 3M carry and slide: 21bp. P&L since inception (2 March): 19bp.
Keep short protection on 3Y Spain CDS Keep short protection on $25mn Spain 3Y CDS protection @ 371bp. 3M carry and slide: 30bp. P&L since inception (3 February): -36bp. Keep BTP Dec13 vs. selling maturity-matched CDS protection Keep short 25mn of BTP Dec13 @ 2.10% and short $32mn of Dec13 CDS protection on Italy @ 300bp. 3M carry and slide: +5bp. P&L since inception (20 January): -49bp.
Trades closed in 2012

TRADE DURATION Short 10Y Bund Jan22 CURVE 5s/10s flattener v s. beta adj. 2s/30s steepener 3s/10s flattener COUNTRY SELECTION/RELATIVE VALUE Short 25Y Italy v s. Spain Long 8Y Austria v s. Germany and Spain Short 3Y Spain v s. Germany Italy 5s/10s flattener Long Bund Jan21 v s. RFGB Apr21 Long BTP Nov 23 v s. Aug23 Long 10Y Spain v s. Italy Short BTP May 31 v s/ BTP Aug23 and Sep40 Bono Jul19-Jul26 flattener Long Italy 5Yx 5Y 10s/15s Italy steepener CDS Sell protection on 2Y Italy CDS Spain 5s/10s CDS flattener 20-Jan-12 03-Feb-12 105 10-Feb-12 24-Feb-12 0 11-Nov -11 06-Jan-12 06-Jan-12 20-Jan-12 21 9 09-Dec-11 20-Jan-12 03-Feb-12 10-Feb-12 3 -2 27-Jan-12 10-Feb-12 6 ENTRY EXIT P&L
09-Dec-11 20-Jan-12 -132 06-Jan-12 03-Feb-12 -56 06-Jan-12 03-Feb-12 03-Feb-12 10-Feb-12 10-Feb-12 24-Feb-12 03-Feb-12 02-Mar-12 27-Jan-12 02-Mar-12 02-Mar-12 09-Mar-12 02-Mar-12 09-Mar-12 -5 14 11 7 20 27 5
15
European Rates Strategy Global Fixed Income Markets Weekly March 16, 2012 Pavan WadhwaAC (44-20) 7777-3370 Fabio Bassi (44-20) 7325-8615 Khagendra Gupta (44-20) 7777-1980 J.P. Morgan Securities Ltd.
European Derivatives
The EONIA curve bear steepened, taking late 2012/early 2013 ECB OIS rates to their highest level since the beginning of the year; turn mildly bearish on the EONIA curve with a steepening bias The risk-adjusted carry on long EONIA positions has improved for fronts and reds EONIA The reds/blues EONIA curve appears too flat vs. the level of yields; we recommend weighted steepeners as relative-value trade The volatility of the EONIA curve has increased relative to the volatility to the FRA/OIS curve, making the Euribor curve positively directional in yield and we recommend closing Jun12/Jun13 Euribor bear flattener We refrain from recommending conditional bear steepeners on the Euribor curve as implied directionality is rich to delivered directionality; however, investors sharing our bearish view should consider buying Jun12 mid-curve put spreads funded by selling call spreads Hold weighted greens/10s steepeners 5s/30s is trading too steep vs. the level of 5Y and is expected to remain directional; implement 5s/30s bear flatteners Close longs in 5Y in the 1s/5s/12s level-neutral fly, but hold 2s/5s/10s bull-belly richeners Excess liquidity, risk-on sentiment and higher yields will continue to put narrowing pressure on front-end swap spreads and we recommend holding 2Y Schatz narrowers both outright and hedged with FRA/OIS wideners with a target of 75bp on b/m spreads Seasonally adjusted swapped issuance is running close to its lifetime high and we retain our bias for narrower 10Y swap spreads in the near term while expecting them to trade in a 20-40bp range in the intermediate term
Exhibit 1: The EONIA curve bear steepened, taking late 2012/early 2013 ECB OIS rates to their highest level since the beginning of the year
ECB OIS rate; %
Change since 9 March 2012; bp
0.50
Change
16-Mar-12
12 10
0.45
8 6
0.40
4 2
0.35 Apr12 Jun12 Aug12 Oct12 Dec12 Feb13
We reduce our conviction on outright short gamma positions and recommend low-risk alternatives to short gamma positions. Exit short 3Mx10Y gamma at a loss; instead, sell 3Mx10Y gamma vs. buying 3Mx5Y gamma Sell Schatz gamma vs. buying maturity matched swaption gamma
Swap Curve
Since our last publication, the EONIA curve bear steepened, taking late 2012/early 2013 ECB OIS rates to their highest level since the beginning of the year (Exhibit 1). Dec12 EONIA sold off 10bp from its lows and is currently trading around 0.43%. With the refi rate likely to remain on hold for the rest of 2012 and excess liquidity expected to stay sky high for at least 1 year, investors may be tempted to fade the recent sell-off and implement longs on the EONIA curve to earn carry. However, with our bearish duration view and ECB members discussing an early exit strategy from emergency liquidity measures (see Euro Cash), we do not recommend this and instead, turn mildly bearish on the EONIA curve with a steepening bias. The recent bear steepening of the EONIA curve has clearly increased the carry of long positions; however, on a risk-adjusted basis, the improvement occurred only in
16
Exhibit 2: The steepening of the EONIA curve has increased the risk-adjusted carry in fronts and reds EONIA
6M carry (bp) and annualised risk*-adjusted carry across the EONIA curve (unitless) and changes since 9 March 2012; Lev el 6M Carry Risk* Annualized risk- Change in Change in 6M Change in
(bp) 6M 6Mx 6M 1Yx 6M 1Y6Mx 6M 2Yx 6M 2Y6Mx 6M 3Yx 6M 3Y6Mx 6M 4Yx 6M 4Y6Mx 6M 5Yx 6M 36 41 56 77 100 125 151 176 201 223 242 (bp) 0 4 12 18 21 23 28 26 25 22 19 (bp) 0.5 1.3 2.2 2.9 3.6 3.9 4.4 4.7 4.8 4.6 4.1 adjusted carry -0.1 0.4 0.7 0.8 0.7 0.7 0.8 0.7 0.7 0.6 0.6 lev el (bp) 2 7 15 25 31 32 30 29 29 26 21 carry (bp) 2 5 5 7 4 0 -1 -1 0 -2 -5 risk-adj. carry 0.4 0.4 0.2 0.1 -0.1 -0.2 -0.2 -0.2 -0.1 -0.2 -0.3
* Risk is defined as 1M standard deviation of daily changes of the underlying EONIA rate.
fronts and reds EONIA due to the large increase in volatility further out the curve (Exhibit 2). The reds/blues EONIA curve appears too flat vs. the level of yields since the announcement of the 3Y LTRO in December 2011 (Exhibit 3). On RV, we therefore recommend weighted reds/blues EONIA curve steepeners, which offer about 12bp of upside. Given that tail risks have dissipated, FRA/OIS is no longer a significant driver of the Euribor curve, making the Euribor curve positively directional, steepening in a sell-off and flattening in a rally (Exhibit 4). This clearly challenges our long-standing Euribor bear flatteners, which we recommended in December 2011 as a hedge for a flare-up in the peripheral crisis. Thus, we close Jun12/Jun13 Euribor bear-flatteners. Investors wishing to position for a continuation of the positive directionality of the Euribor curve may consider conditional bear steepeners. However, the implied directionality on the money-market curve is expensive relative to the delivered directionality (Exhibit 5), limiting the attractiveness of these conditional structures. We favour bearish positions on the Euribor curve, expressed via option structures; for example, we recommend buying Jun12 mid-curve put spreads (on Jun13 Euribor) funded by selling call spreads, as we see limited upside in Jun13 Euribor. With EONIA likely to stabilise in the 35-40bp range for the first year of the EONIA curve, we expect some term premium to remain in the Euribor strip; therefore, we do not expect Jun13 Euribor to rally above 99.25. Our recommendation is to
Exhibit 3: Reds/blues EONIA curve is too flat adjusted for the level of yields; we recommend weighted steepeners as relative-value trade
Reds/blues EONIA curve regressed against blues EONIA; since 1 December 2011; bp
140 130 120 110 100 90 80 1.20
y = 67.9x - 1.4 R 2 = 92%
16-Mar-12
1.40
1.60 1.80 Blues EONIA; %
2.00
2.20
Exhibit 4: Given that risks have dissipated, the FRA/OIS is no longer a significant driver of the Euribor curve, making the Euribor curve positively directional; close Jun12/Jun13 Euribor bear flatteners
2nd/6th Euribor curve regressed against 6th Euribor contract; past 2W; bp
25 20 15 10 5 0 0.65
y = 77.5x - 52.1 R 2 = 95%
0.70
0.75 0.80 0.85 6th Euribor futures y ield; %
0.90
0.95
17
Exhibit 5: Although the Euribor curve is positively directional in yield, we refrain from recommending bear steepeners, as implied directionality is rich to delivered directionality;
Current implied* and delivered** directionality for various Euribor curve trades; %
Exhibit 6: however, investors sharing our bearish view should consider option structures on Jun13 Euribor via Jun12 mid-curve options such as buying 99.00/98.75 put spread funded via selling 99.25/99.50 call spread
Projected P&L profile at expiry on long 99.00/98.75 put spread vs. short 99.25/99.50 call spread on Jun12 Euribor mid-curve options; cents
Euribor curv e 2nd/6th 3rd/7th 4th/8th
Implied directionality 59% 61% 61%
Deliv ered directionality 49% 42% 36%
Implied Deliv ered 10% 19% 25%
30 20 10 0
* Implied directionality for the Euribor curve calculated as a ratio of implied volatility of mid-curve/front option-1. ** Delivered directionality for the swap curve calculated as 1 - 3M beta of daily changes in front contract regressed against daily changes in 1Y forward Euribor contract.
98.000
98.125 98.250
98.375
98.500 98.625
98.750
98.875
99.000 99.125
99.250
99.375 99.500
99.625
99.750 99.875
-10 -20
buy the 99.00/98.75 Jun12 mid-curve put spread funded by selling the 99.25/99.50 call spread (Exhibit 6). Over the past week, the swap curve bear steepened, with significant underperformance of the 5Y sector. Since last Friday, 2s/5s steepened about 10bp, with both 5s/10s and 5s/30s flattening about 2bp. Last week, we highlighted the cheapness of 5Y on the curve and recommended structures such as long 5Y in the 1s/5s/12s level-neutral fly to exploit the relative value. Going forward, we have less conviction that relative value will be a driver of curve moves, given the risk of further intermediates under-performance, compelling us to stop out of 1s/5s/12s level-neutral fly. However, we hold 2s/5s10s bull-belly richeners, which are likely to expire worthless if the sell-off continues. The weighted greens/10s steepeners have underperformed 2s/10s steepeners over the past week (Exhibit 7), while the weighted greens/Bunds performed better and benefited from a narrowing of the swap spread. We still find steepeners attractive and hold weighted greens/10s steepeners. Going forward, we believe the intermediates will drive the sell-off, exerting flattening pressure on 5s/30s. A historical analysis shows that 5s/30s is trading too steep vs. the level of 5Y yields and has a decent negative directionality. With options on 30Y tails trading more expensive than option on 5Y tails, we find it attractive to implement 5s/30s bear flatteners (Exhibit 8), which can be initiated at zero cost via 3M payers at a level close to spot (see Trade Recommendations). We also hold
-30
Exhibit 7: Weighted greens/10s curve has lagged the 2s/10s steepening; hold weighted greens/10s steepeners, which remain attractive on RV
Weighted greens/10s curve and 2s/10s EUR swap curve; bp
130 120
2s/10s
110 100 90 Sep 11 Oct 11 Nov 11 Jan 12 Feb 12
Wtd Greens/10s
Mar 12
Exhibit 8: 5s/30s is trading too steep vs. the level of 5Y and is expected to remain directional; implement 5s/30s bear flatteners
5s/30s EUR swap curve regressed against 5Y EUR swap yield and isopremium* line; past 6M; bp
110 Spot 100 3M Forw ard 90 80 70 60 1.40 1.60 1.80 2.00 5Y EUR sw ap y ield; % 2.20 y = -39.0x + 155.6 R 2 = 55%
18
* Isopremium indicates the breakeven level for entering conditional fly trades at zero cost. This is based on COB 15/3/2012.
100.000
155 150 145 140 135 130 125
Exhibit 9: Despite recent narrowing, front-end swap spreads appear too wide; hold 2Y Schatz swap spread narrowers both outright and hedged with FRA/OIS basis wideners
Rolling front* 2Y Schatz swap spread regressed against back Euribor FRA/OIS basis; past 1Y; bp
Exhibit 10: In the past, significant widening of front-end swap spreads has been followed by dramatic increase in liquidity provision by the ECB, which has put narrowing pressure on 2Y swap spreads; we retain our near-term target of 75bp for 2Y b/m swap spreads
2Y German b/m swap spreads vs. 21-day MA of NSA excess liquidity; past 5Y; bp bn
110 90 70 50
y = 1.0x + 28.4 R 2 = 86% 09-Mar-12 16-Mar-12
2Y benchmark b/m sw ap spread 110 90 70 50
700 600 500 400 300 200 100
30 10 20 30 40 50 60 70 80 90 Back FRA/OIS basis; bp

* Contract rolled 20D before option expiry.
30 10 Mar 07 Mar 08 Mar 09
Ex cess liquidity Mar 10 Mar 11
0 -100 Mar 12
bearish conditional structures such as 3s/7s/15s conditional belly cheapeners.
Exhibit 11: Seasonally adjusted swapped issuance is running at very high levels as corporations and financial institutions take advantage of the reopening of debt capital markets
J.P. Morgan estimate of seasonally adjusted swapped issuance*; bn/day
Swap Spreads
The sharp sell-off in fixed income markets left its mark on swap spreads, which narrowed across the curve. On the week, 2Y, 10Y and 30Y German b/m swap spreads narrowed 7bp, 9bp and 7bp, respectively. Despite the recent narrowing, 2Y swap spreads continue to appear too wide, both on an outright basis and on an adjusted-for-the-FRA/OIS basis. In fact, regressing the front 2Y Schatz swap spread against the back Euribor FRA/OIS basis suggests that spreads are trading about 10bp too wide (Exhibit 9). In past crises when 2Y swap spreads have widened dramatically, the ECB has introduced considerable liquidity into the banking system, leading to narrowing pressure on front-end spreads (Exhibit 10). For example, full-allotment tenders were introduced in October 2008 when 2Y swap spreads peaked at 120bp due to the Lehman crisis. Subsequent improvement in risk sentiment allowed 2Y swap spreads to narrow almost 100bp over the next 6-9 months. 2Y swap spreads peaked again in mid-2010 at 85bp in response to the Greek crisis, before narrowing 20bp as liquidity improved. This time around, 2Y swap spreads have narrowed around 30bp from their peak of 115bp. Given the
2 Av g: 0.8bn/day 1
-1 Mar 07 Mar 08 Mar 09 Mar 10 Mar 11 Mar 12
* We use the 60-day MA of swapped issuance and seasonally adjust the data by subtracting the 60-day MA of swapped issuance averaged over the past 5 years on a rolling basis. We use fixed-rate, -denominated issuance by financial institutions (including covered bonds) and supras/agencies, plus one half of corporate bond issuance, as an estimate of swapped issuance
unprecedented amount of excess liquidity that exists in the banking system, we believe 2Y swap spreads can narrow significantly more, and retain our 75bp near-term target on 2Y b/m swap spreads. We recommend investors hold 2Y swap spread narrowers on both an outright basis and on a hedged-against-FRA/OISwidening basis.
19
Swapped issuance continues to run at very high levels. For example, the 20-day MA of swapped issuance is currently at 5.7bn/day, which is exactly twice the 5Y average of 2.85bn/day. One could argue that this may merely be a reflection of the fact that January and February are good months for swapped issuance since debt capital markets take a hiatus in December. We note, however, that swapped issuance is running at high levels even after adjusting for this seasonality. Exhibit 11 shows the J.P. Morgan estimate of seasonally adjusted swapped issuance. To smoothen the data series, we use the 60-day MA of swapped issuance and seasonally adjust it by subtracting the 60-day MA of swapped issuance averaged over the past 5 years on a rolling basis. The chart suggests that seasonally adjusted swapped issuance is running close to its lifetime high as corporations and financial institutions take advantage of the reopening of debt capital markets after a long hiatus in 2H11. Additionally, the risk-on sentiment that has prevailed over the past 3 months has resulted in increased appetite for spread products. Indeed, each 10-pt increase in the S&P500 index has resulted in seasonally adjusted swapped issuance increasing by around 0.2bn (Exhibit 12). We expect markets to remain in risk-on mode and therefore expect swapped issuance to stay high, thereby putting narrowing pressure on swap spreads, especially in the belly of the curve. Despite the recent narrowing, 10Y swap spreads appear to be trading a tad wide (Exhibit 13). We believe they can narrow further in the short term and retain our narrowing bias. In the intermediate term, we continue to expect 10Y spreads to trade in a 2040bp range.
Exhibit 12: and the risk-on sentiment that has prevailed over the past 3 months; we expect markets to remain in risk-on mode and therefore expect swapped issuance to stay high, thereby putting a narrowing pressure on swap spreads
J.P. Morgan estimate of seasonally adjusted swapped issuance* regressed against S&P500 index; past 6M; bn/day
2.5 2.0 1.5 1.0 0.5 0.0 -0.5 1050
y = 0.00001x 2 - 0.12x + 68.93 R 2 = 89% 16-Mar-12
1150
1250 S&P500 index ; points
1350
1450
* See Exhibit 11 for definition of swapped issuance.
Exhibit 13: especially in the belly of the curve where spreads are trading a tad wide and are most susceptible to swapping activity; we continue to expect 10Y swap spreads to trade in a 2040bp range in the intermediate term
10Y German b/m swap spreads regressed against 10Y German b/m yield and 3Mx10Y swaption implieds; past 6M; bp
140
y = 8.7*(3Mx 10Y Vol) - 34.7*(10Y Yld) + 63.2 R 2 = 87%
130 120 16-Mar-12 110 100 4 5 6 7 3Mx 10Y implied v ol; bp/day 8 9
Euro Volatility
Implieds had a roller-coaster week. After having dropped to the lows since the start of the Greek crisis in May 2010 during the early part of the week, they rebounded over the following three days. This reversal was driven by the increase in delivered volatility with rates selling off 10+bp across the curve on increased positive sentiment after the results of the US stress tests were announced on Tuesday. Net, implieds on shortdated options are up between 0.2-0.5bp/day over the week (Exhibit 14). 1M delivered volatility also increased between 0.2bp/day and 0.7bp/day on the back of the jump in yields on Wednesday. Implieds on govie options also followed a similar pattern; Schatz implieds
Exhibit 14: Shorter-dated implied volatility increased over the past week as yields shot higher
Change since 9 March 2012 in implied volatility on EUR swaptions; 3M, 2Y and 5Y expiries; bp/day
0.6 0.4 0.2 0.0 -0.2 1Y 2Y
3M
2Y
5Y
20
5Y Tails
10Y
30Y
Note: Implieds on 1Y tails are based on the 3s curve.
Number of days of carry lost from selling 3Mx10Y gamma for various one-day jump in 10Y swap rate; # days
Exhibit 15: Short gamma positions are susceptible to jump risk. At current levels, a 10bp jump in 10Y swap yields would cost 9 days of carry to short gamma positions. Exit short 3Mx10Y gamma as jump risk is high
3Mx10Y implied volatility regressed against 3Mx10Y swap yield; past 3M; bp/day
Exhibit 16: and implieds are trading cheap relative to yield levels
7.5 7.0 6.5 6.0 5.5 5.0 4.5 4.0 2.25
y = 5.78x - 8.35 R 2 = 51%
25 20 15 10 5 0 6 7 8 9 10 11 12 13 1D mov e in 10Y sw ap y ield; bp 1 3 5 9 7 15 12 18
21
24
16-Mar-12
2.30
2.35 2.40 2.45 3Mx 10Y EUR sw ap y ield; %
2.50
2.55
14
15
increased 1bp/day, while Bobl and Bund implieds increased 0.4bp/day. Over the past few weeks, we have recommended outright short gamma positions on 3Mx10Y. We had argued that implieds were likely to stay low and delivered volatility to tread below implieds. However, the 10+bp move on Wednesday highlighted the risks of selling gamma at the current low levels of implied volatility (3Mx10Y is currently priced at 5.0bp/day). We estimate that on Wednesday, when 10Y swap yield increased 10+bp, a short gamma position in 3Mx10Y would have lost around 9 days of gamma carry.7 Exhibit 15 shows the estimated number of days of carry lost to various yield moves if we initiate short gamma positions at current levels. Going forward, we do not discount the possibility of further jumps in yield. This mainly reflects the emerging and asymmetric risk of convexity-hedging flows (mortgage related paying) in the US mortgage markets if yields continue to risk. This duration-extension-led increase in rates could potentially feed through to the EUR markets and could thus be detrimental for short volatility positions. To be sure, we continue to favour short gamma positions as delivered volatility in yields is likely to stay below implieds over a long term (say 3M). However, we are wary of the jump risk. Thus, we reduce our conviction on outright short gamma positions (see below). Additionally, implieds now appear cheap
7 We use current implied volatility and 3M delivered volatility on the underlying swap to calculate carry.
Exhibit 17: Instead, initiate short gamma position via low-risk proxy such as selling 3Mx10Y vs. buying 3Mx5Y gamma. Returns from this switch have exhibited a positively convex relationship to outright short gamma positions
Rolling 2W returns* from selling 3Mx10Y straddles vs. buying a gamma equivalent amount of 3Mx5Y straddles regressed against rolling 2W returns from selling 3Mx10Y straddles outright; past 2Y; bp/day
40 20 0 -20 -40 -100
y = 0.002x 2 + 0.340x - 0.882 R 2 = 52%
-50 0 50 2W return from selling 3Mx 10Y gamma; bp of notional
100
* Returns calculated using J.P. Morgan volatility indices, which assume daily delta hedging and zero transaction cost. Options are re-struck at the beginning of each month.
compared to the level of rates (Exhibit 16). Therefore, we recommend exiting short 3Mx10Y gamma positions at a small loss (see Trade Recommendations). Instead, we recommend low-risk short gamma proxies such as selling 3Mx10Y swaption straddles vs. buying a gamma-equivalent amount of 3Mx5Y swaption straddles for several reasons. First, returns from this gamma-neutral switch have exhibited a convex relationship to that of an outright short gamma position (Exhibit 17). Second, the implied volatility spread is currently trading close to its multi-year highs (Exhibit
21
Implied volatility spread (3Mx10Y 3Mx5Y) versus 3M delivered volatility spread*; past 10Y; bp/day
Exhibit 18: Additionally, this switch offers positive gamma carry
2 1 0 -1 -2 -3 2002 2004 2006 2008 2010 2012 Current imp spread: 0.8bp/day
Rolling 3M returns* from selling 3Mx10Y straddles vs. buying a gamma equivalent amount of 3Mx5Y straddles regressed against 3M prior implied volatility spread (3Mx10Y 3Mx5Y); past 3Y; bp/day
Exhibit 19: and has historically been profitable when initiated at current level of implied volatility spread (0.8bp/day). These tail switches have, however, lost money if initiated at < 0.3bp/day
150 100 50 0 -50 -100 -0.5
y = 55.72x + 9.05 R 2 = 54%
* Delivered volatility spread is defined as 3M delivered volatility on 3Mx10Y swaps 3M delivered volatility on 3Mx5Y swaps. The highlighted areas indicate prior episodes of either low volatility and/or high excess liquidity during which 10Y implied was at par or below 5Y volatility.
0.0
0.5 1.0 1.5 3M prior imp v ol spread; bp/day
2.0
* See Exhibit 17 for definition of returns.
18). Historically, during periods of high excess liquidity, low central bank activity and low volatility, 10Y volatility trades at par or below 5Y (see highlighted section in Exhibit 18). While we do not expect that level of normalisation to occur over the trade horizon, we do believe that 10Y volatility is likely to decline relative to 5Y volatility as the volatility surface normalises. Third, this switch offers positive gamma carry (the 3M delivered volatility spread is 0.4bp/day below the implied volatility spread). Additionally, the delivered volatility spread has, in general, remained below the current level of implied volatility spread, a trend we expect to continue over the next few weeks. The one exception to this was during year-end 2008 when technical flows were dominant. Finally, this switch has generally been profitable when initiated at current levels (Exhibit 19). Thus, we recommend selling 3Mx10Y gamma vs. buying 3Mx5Y. On a relative basis, we like selling Schatz volatility vs. buying maturity-matched swaption volatility. The recent increase in Schatz implied volatility compared to maturity-matched swaption volatility provides an attractive entry point.8 This implied volatility spread of 0.6bp/day is close to the highs of the past 3 months and is about 1.7bp/day above the 1M delivered volatility spread (Exhibit 20). With excess liquidity at extremely high levels and the ECB temporarily on hold,
8 Implieds on Schatz options increased 1bp/day whereas implieds on maturity matched swaptions increased only 0.5bp/day.
Exhibit 20: At the front end, we recommend selling Schatz volatility vs. maturity-matched swaption volatility as this switch offers positive gamma carry
Schatz/Swaption implied volatility spread* versus 1M delivered volatility spread**; past 3M; bp/day
2 1 0 -1 -2 -3 16-Dec 03-Jan 21-Jan 08-Feb 26-Feb 16-Mar 1M deliv ered v ol spread Imp v ol spread
* Schatz implied volatility minus maturity matched swaption implied volatility. ** 1M delivered volatility of Schatz futures 1M delivered volatility of maturity matched swaps. Note: Futures are rolled 10D before option expiry.
Schatz yields are likely to continue to under-deliver their swaption counterparts as they remain in a tight range. Furthermore, we do not expect the implied volatility spread to increase significantly higher even if Schatz yields continue to grind higher. Indeed, as Exhibit 21 illustrates, the implied volatility spread (defined as Schatz volatility maturity matched swaption volatility) exhibits a convex relationship to Schatz yield (with implieds spread declining rapidly when yields decline but
22
are capped when yields increase). Thus, we recommend selling Schatz volatility vs. buying maturity-matched swaption volatility (see Trade Recommendations).9
Trade Recommendations
Curve: Implement reds/blues weighted EONIA curve steepener. Buy Jun12 mid-curve put spread funded by selling call spread. Initiate 5s/30s bear flatteners. Close 1s/3s bull flatteners and Jun12/Jun13 Euribor bear flatteners. Exit receiving 5Y in 1s/5s/12s level-neutral fly. Hold greens/10s weighted steepeners. Hold 2s/5s/10s bull belly richeners and 3s/7s/15s OTM bear-bellycheapeners Receive 500mm 1Yx1Y EONIA swap (start date 20 Mar 2013) vs. paying 168.5mm 3Yx1Y EONIA swap (start date 20 Mar 2015) to enter into a weighted reds/blues EONIA curve steepeners at -11bp (defined as 0.33* 3Yx1Y EONIA - 1Yx1Y EONIA); Buy the 99.00/98.75 Jun12 mid-curve put spread funded by selling the 99.25/99.50 Jun12 mid-curve call spread at 3 cents with Jun13 Euribor at 99.075; Buy 100mm 3Mx5Y 1.82% payers (notification date 16 Jun 2012) vs. selling 23mm 3Mx30Y 2.82% payers (notification date 16 Jun 2012) at close to flat net premium to enter into a 5s/30s conditional bear flatteners at 100bp vs. spot level of 99.4bp and 3M forward level of 93.4bp; Exit at a loss longs in 100mn 1.33% 3Mx3Y receivers vs. short 297.7mn 1.25% 3Mx1Y receivers to exit a conditional bull flattener at 8.0bp vs. spot level of 21.6bp and forward level of 24.5bp (Global Fixed Income Markets Weekly, 6 January 2012); P/L since inception: -34bp of notional; Exit at a loss longs in 1000 98.875 Jun12 Euribor puts vs. shorts in 1000 98.75 Jun12 Euribor mid-curve puts to remain into a Jun12/Jun13 Euribor bear-flattener at 12.5bp vs. forward levels of 23bp (Global Fixed Income Markets Weekly, 15 December 2011); P/L since inception: -3cents; Close at a loss receiving 75mm 3Mx5Y vs. paying 245.0mm 3Mx1Y and 22.6mm 3Mx12Y to exit a level neutral fly (defined as 75% * Yield 5Y - 50% * Yield 1Y - 50% * Yield 12Y) at -50.5bp vs. an entry level of -55.5bp (Global Fixed Income Markets Weekly, 9 March 2012); P/L since inception: -5bp of yield;
9 We like to remind our readers that we currently have an outright short volatility in Schatz in our portfolio. We have expressed this view via selling 109.90/110.50 (or 13/44bp of yield) Jun12 Schatz unhedged strangles. We recommend holding on to that trade.
Front Schatz* implied volatility maturity matched swaption volatility regressed against 2Y German b/m yield; past 6M; bp/day
Exhibit 21: Also, we do not expect the implied volatility spread (Schatz swaption) to continue rising even if yields increase as super-high excess liquidity will potentially keep yields rangebound
2.5 2.0 1.5 1.0 0.5 0.0 -0.5 0.10
y = -3.7x 2 + 5.1x - 0.3 R 2 = 46%
16-Mar-12
0.20
0.30
0.40
0.50
0.60
0.70
2Y German b/m y ield; %

* Futures are rolled 10D before option expiry.
Stay short 100% risk (50mn) in 2.345% 3Mx10Y swaps vs. long 66% risk in 27Mx1Y (311mn) 1.495% swaps to remain in a weighted steepener at 134.5bp vs. entry level of 135.8bp (weighted spread defined as 3Mx10Y 0.66*27Mx1Y) as a carryefficient proxy to 2s/10s curve steepener (Global Fixed Income Markets Weekly, 24 February 2012); P/L since inception: -1.3bp of yield; Stay long 100mm 1Mx7Y 2.02% payers vs. selling 113.3mm 1Mx3Y 1.26% payers and 25.8mm 1Mx15Y 2.68% payers to remain into a conditional bear belly cheapeners at 5bp vs. spot level of 2.8bp and 1M forward level of 3.4bp (Global Fixed Income Markets Weekly, 9 March 2012); P/L since inception: -2.8 bp of notional; Hold longs in 100mn 1.67% 3Mx5Y receivers (notification date 27 April 2012) vs. shorts in 1.135% 122.6mn 3Mx2Y receivers and 2.39% 3Mx10Y 26.4mn receivers to remain in a conditional bullbelly richener in the 2s/5s/10s 50:50 weighted fly at -9.25bp vs. forward level of -8.8bp and spot level of -10.3bp (Global Fixed Income Markets Weekly, 27 January 2012); P/L since inception: -1.0bp of notional. Swap spreads: Hold Jun12 Schatz ASW narrowers outright and hedged with Jun12 FRA/OIS wideners Continue to receive 100mn Schatz CTD expirymatched swaps and sell 910 110.20 Jun12 Schatz futures to remain in Jun12 Schatz swap-spread narrower at 75.1bp vs. an entry level of 76.3bp
23
(Global Fixed Income Markets Weekly, 24 February 2012). P/L since inception: +1.2bp of yield; Continue to receive 100mn Schatz CTD expirymatched swaps, sell 911 Jun12 Schatz futures, sell 704 Jun12 Euribor futures and receive 698mn Jun12 IMM EONIA swaps to remain in Jun12 Schatz swapspread narrower hedged for FRA/OIS widener at 38.9bp vs. an entry level of 40bp (Global Fixed Income Markets Weekly, 2 March 2012); P/L since inception: +1.1bp of yield. Volatility: Sell 3Mx10Y vs. buying 3Mx5Y EUR swaption straddles. Sell Jun12 Schatz gamma vs. maturity matched swaption gamma. Take small profit in short 3Mx10Y EUR swaption straddles. Stay short 109.90/110.50 Jun12 Schatz unhedged strangles. Stay long GBP 2Yx1Y vol vs. GBP 1Yx1Y vol Sell 100mn 2.49% 3Mx10Y EUR swaption straddles (notification date 16 June 2012, maturity date 20 June 2022) vs. buying 157mn 1.79% 3Mx5Y EUR swaption straddles (notification date 16 June 2012, maturity date 20 June 2017) at an implied volatility spread of 0.75bp/day. This trade requires active delta hedging; Sell 1145 110 Jun12 Schatz straddles vs. buying 100mn 1.15% maturity matched swaptions (notification date 25 May 2012, maturity date 14 Mar 2014) at an implied vol spread of 0.55bp/day. This trade is structured to be gamma neutral at inception and requires active delta hedging; Exit at a loss short 100mn 2.34% 3Mx10Y EUR swaption straddles at 5bp/day vs. an entry level of 5.1bp/day. This trade required infrequent delta hedging (once every two weeks) (Global Fixed Income Markets Weekly, 24 February 2012); P/L since inception: -12bp of notional; Continue to sell 1000 109.90/110.50 Jun12 Schatz unhedged strangle for 14.5cents vs. entry level of 17cents (Global Fixed Income Markets Weekly, 24 February 2012); P/L since inception: +2.5cents; Stay long 100mn 1.40% GBP 2Yx1Y straddles (notification date 20 January 2014, maturity date 20 January 2015) vs. short 112mn 1.21% GBP 1Yx1Y straddles (notification date 20 January 2013, maturity date 21 January 2014) at an implied spread of 1.1bp/day (defined as 2Yx1Y 0.8*1Yx1Y) vs. an entry level of 1.55bp/day (Global Fixed Income Markets Weekly, 20 January 2012); P/L since inception: -5bp of notional.
Closed Trades in 2012

Trade Duration Long 6Mx6M EONIA Long 2Y6Mx6M EONIA Long Dec12 EONIA Curve Greens/10s weighted steepeners Receive 5Y in 1s/5s/12s level-neutral fly Conditional curve and flies 1s/5s bull flatteners Mar12 Schatz/Bund bear steepener 1s/3s bull flatteners Jun12/Jun13 Euribor bear flatteners Swap Spreads Mar12 Schatz ASW wideners Mar12 Bund bull wideners Options (outright) Short Mar12 Schatz straddles Buy 3Mx5Y EUR gamma Short Mar12 Schatz straddles Sell 3Mx10Y gamma Options (relative) Sell Mar12 Schatz vs. mat matched swaption 20 Jan 12 Sell 3Mx10Y EUR vs. 3Mx5Y Buy Mar12 Bund vs. mat matched swaption Buy Jun12 Bund vs. mat matched swaption 03 Feb 12 20 Jan 12 27 Jan 12 10 Feb 12 10 Feb 12 8.0 -4.0 18.0 8.0 15 Dec 11 06 Jan 12 04 Nov 11 20 Jan 12 24 Feb 12 20 Jan 12 10 Feb 12 16 Mar 12 10.0 -58.0 7.0 -12.0 15 Dec 11 20 Jan 12 20 Feb 12 24 Feb 12 -11.0 0.0 09 Dec 11 06 Jan 12 20 Jan 12 06 Jan 12 15 Dec 11 24 Feb 12 16 Mar 12 16 Mar 12 8.5 0.0 -11.5 -3.0 03 Feb 12 10 Feb 12 09 Mar 12 16 Mar 12 0.0 -5.0 09 Dec 11 06 Jan 12 03 Feb 12 24 Feb 12 20 Jan 12 02 Mar 12 10.0 5.0 1.0 Entry Exit P&L
10 Feb 12 02 Mar 12
Trade P&L is shown in bp for all trades except option trades, which are shown in bp of notional. Conditional trades are normalised by the PVBP of the underlying * Option Expiry; ** Annualised bp
* P/L for open trades calculated using Thursdays closes.
24
European Rates Strategy Global Fixed Income Markets Weekly March 16, 2012 Francis DiamondAC (44-20) 7325-3541 francis.diamond@jpmorgan.com J.P. Morgan Securities Ltd.
United Kingdom
10Y gilt yields rose sharply over the past week, driven by technicals and US yields 10Y gilts have broken out of the range that has been in place since December and we think yields can move higher still driven, by negative technicals and a continued risk-on dynamic We go short 10Y duration but with a tight stop loss Take profit on 5s/10s steepener We expect the 10s/30s curve to become directional as 10Y yields rise further enter 10s/30s gilt curve flattener and we note that entering 10s/30s bear flatteners via 3M payers looks attractive Stay long the belly of 10s/30s/50s gilt fly, as we expect ultra-long gilt issuance in the coming months Gilt RV: The belly of the 3T19/4T20/4s22 fly is rich, take profit on selling the belly of the 3T21/5s25/4T30 fly, take profit on selling 4s60 vs. 4Q55 on a cash-for-cash basis Swap RV: We recommend paying the belly of the level-adjusted 3s/7s/15 swap fly We expect 167bn of gilt issuance in FY12/13, but given the uncertainty around several components of the remit, issuance could be in the 150-190bn range The idea of 100Y gilts was mooted by the government - we think investor demand would be limited Enter tactical 5Y swap spread narrowers given 1) our bearish view, 2) attractive valuations; 3) our view of increased short nominal gilt issuance for FY 12/13
Exhibit 1: The increase in 10Y gilt yields over the past week was the largest in the past three years
Weekly change in 10Y par gilt yield; bp
40 30 20 10 0 -10 -20 -30 -40 Mar 09 Sep 09
29bp
Mar 10
Sep 10
Mar 11
Sep 11
Mar 12
Exhibit 2: 10Y gilts have broken out of the trading range that has been in place since early December 2011
Gilt 4s22 yield; %
2.8 2.6 2.4 2.2 2.0 Sep 11 Nov 11 Jan 12 Mar 12
Break-out! We turn bearish, enter 10s/30s flatteners

The past week has seen a sharp up-move in government bond yields globally, with 10Y par gilt yields posting their largest weekly rise of the past three years (Exhibit 1).
In our view the move feels very technical in nature as both 10Y US Treasuries and 10Y gilts have broken out of their yield ranges that has been in place since December (Exhibit 2). We think that the drivers for the move are more US specific, as the macro backdrop in the UK has not changed over the past week yet the beta between gilts and USTs has increased sharply (Exhibit 3). The move by Fitch to put the UK on negative outlook is not based on new information but did result in some underperformance of gilts vs. bunds after the announcement. The speed of the rise in gilt yields has surprised us and we had thought that gilts would struggle to break-out of the well-established trading range until the fundamentals began to improve. Now that this range-break has
25
occurred we think 10Y yields can move higher as: 1) the move appears to be predominantly futures driven and anecdotally we think cash gilt duration positions are light; 2) technicals are supportive with our technical analysts targeting the 2.64 -2.70 level in 4s22, and 3) we expect the risk-on dynamic to continue. However, we recognize that unless the market begins to price base rate tightening that the rise in 10Y gilt yields and steepening in the 2s/10s curve is limited. In addition, the recent sell-off in yields looks similar to previous bull-market corrections (Exhibit 4) and we are conscious that the sell-off could fade in strength without support from improving economic fundamentals. We go short 10Y duration but look to trade this with a tight stop loss (current 4s22 yield @ 2.45%, target 2.60%, stop loss 2.37%) We take profit on our tactical 5s/10s steepener. The curve is 2bp away from its steepest level for the past few months and this part of the curve is the segment least directional with 10Y yields. Given our bearish duration view we recommend entering 10s/30s gilt curve flattener. Over the past few months as the BoE has been conducting QE purchases, the 10s/30s curve has generally been non-directional with 10Y yields, although there have been with sporadic instances of directionality. However, as 10Y par yields rise above the 2.50% level we expect the 10s/30s curve to become much more directional (Exhibit 5), especially as QE purchases look unlikely to be extended in May. In addition, the flattening in 10s/30s seen so far has lagged that seen on average in the previous bull-market corrections (Exhibit 4). A similar dynamic is also observed in swap space where the directionality of 10s/30s swaps increases substantially with 10Y swap yields above 2.70% (currently 2.64%). Given our curve view, we think 10s/30s bear flatteners are attractive, which can be entered for zero cost via 3M payers at 70bp, the same level as priced by the forwards. 10Y and 30Y implied vols trade at the same level and the rate carry and slide is only -1.5bp per month. We stay long the belly of the 10s/30s/50s gilt fly, as a way to express a bearish view on 10Y yields and given our expectation of ultra-long supply (40-50Y gilts) in the coming months.
Exhibit 3: and the beta between gilts and US Treasuries has increased sharply over this past week
2.0 1.5 1.0 0.5 0.0 -0.5 15 Dec 30 Dec 14 Jan 29 Jan 13 Feb 28 Feb
Rolling 5 day beta between10Y UK par yields and 10Y UST benchmark yield
14 Mar
Exhibit 4: The current sell-off looks similar to previous bull-market corrections

Changes in the level of gilt yields and the curve in current vs. previous bullmarket sell-offs*; bp unless stated Change
Period 16 Mar 11 - 12 Apr 11 18 Aug 11 - 1 Sep 11 5 Oct 11 - 28 Oct 11 Av erage 9 Mar 12 - 16 Mar 12
2Y 19 3 1 8 3
10Y 23 24 29 25 31
2s/5s 1 21 15 12 20
2s/10s 5s/10s 10s/30s 4 20 29 18 28 3 -1 14 5 7 -9 -13 -15 -12 -3
* defined as periods of more than 20bp increase in 10Y gilt yields in the period from Feb11 Mar 12
Exhibit 5: We expect the 10s/30s gilt curve to start trading directionally if 10Y yields continue to rise
10s/30s par gilt curve regressed against 10Y par yields, last 12M; bp
140 120 100 80 60 40 2.0
current y = -0.42x + 2.17 R 2 = 82%
y = -0.01x + 1.04 R 2 = 0% 2.5 3.0 10Y par y ield; % 3.5 4.0
Gilt and swap RV

In the 8-10Y sector of the curve we note that the belly of the 3T19/4T20/4s22 fly is close to its richest level since last August in yield space, although is not as rich in ASW
26
space (Exhibit 6).This fly has shown limited directionality with the curve and level of yields. In the 10-13Y sector, gilt 5s/25s has underperformed over the past week and we take profit on our recommendation to sell the belly of the 3T21/5s25/4T30 fly. Further out, gilt 4s60 has corrected from its very rich levels and we take profit on our recommendation to be long 4Q55 vs. 4s60 on a cash-for-cash basis. In swap space, the 3s/7s/15s fly has shown strong directionality with the level of yields over the past year and the belly of the fly currently looks rich vs. 7Y swap rates. We recommend paying the belly of the leveladjusted 3s/7s/15 swap fly (risk weights 66%: -100%:66%), which is close to its richest level over the past 12 months (Exhibit 7).
Exhibit 6: The belly of the 3T19/4T20/4s22 fly is rich

50:50 fly in yield and ASW space; bp
-5
y ield
6 ASW 4 2 0
-10
-15 current lev el in y ield = -16bp -20 Mar 11 Jun 11 Sep 11 Dec 11
-2 -4 -6 Mar 12
Exhibit 7: The level-adjusted 3s/7s/15s swap fly looks rich

Level-adjusted 3s/7s/15s swap fly*; bp
-70
av erage = -78bp
More on the FY 12/13 issuance remit, 100Y gilts not likely in our view
The gilt issuance remit for FY12/13 will be announced following the Chancellors budget speech on Wednesday. We think that this remit could contain some surprises, given that there are several uncertain factors that could drive the headline gilt sales number. In Exhibit 8, we reiterate our baseline forecast of 167bn of gross gilt sales in FY12/13 but we illustrate that the potential range for gilt issuance is quite large, at around 150-190bn. As we have discussed previously (GFIMs, 9 Mar) we think the issuance remit could be affected by uncertainty over the size of the overshoot on the financing for the current fiscal year and the treatment of the assets of the Royal Mail Pension Fund in the national accounts. One additional source of uncertainty is the funding for the credit easing scheme which is expected to be launched the day before the budget. We had initially expected this scheme to allow participating banks to issue debt underwritten with a government guarantee, but there is a growing possibility that this scheme could be pre-funded directly via gilt issuance, with participating banks paying a fee to the government to access the funds. This scheme is expected to be up to 20bn in size, and if it were to be funded via gilts, we think this would result in an increase in the supply short maturity gilts, as the scheme is expected to be operational for only a few years.
-75
-80
-85 Mar 11 Jun 11 Sep 11 Dec 11 Mar 12
* Calculated using risk weights 66%:100%:66%. The 3s/7s/15s fly has a 97% r-squ with the level of 7Y yields over past 12M
Exhibit 8: We see both upside and downside risks to our FY12/13 gilt issuance forecast
Gross gilt issuance under a low issuance, baseline and high issuance scenario; bn unless stated
Low
Baseline
High
scenario scenario scenario CGNCR* Redemptions Reserv e Financing Short Term financing Adj.** Roy al Mail PF adjustment*** SME guarantee^ NS&I T-bill issuance Gross Gilt sales 128 53 6 -7 -25 0 2 2 151 128 53 10 -7 -13 0 2 2 167 128 53 10 -7 0 10 2 2 190
* CGNCR = Central Government Net Cash Requirement ** Financing adjustment from expected better fiscal outturn in FY11/12 ***Impact from absorption of the Royal Mail Pension Fund into the National Accounts ^ Potential gilt issuance from SME guarantee program
27
Our forecast for the maturity split for gilt issuance remains the same as we presented last week i.e. a 3% increase in short nominal issuance (given the low level of spot and forward years and recent strong demand), a 1% increase in linker issuance and reductions in medium and long nominal issuance by 2% and 1% respectively. The recent announcement that the Treasury is considering issuing 100Y gilts should be followed by the launch of a consultation process by the DMO, but we think the likelihood of a 100Y gilt actually being issued is low. Given the flatness of the 30s/50s nominal yield curve a 100Y gilt would likely have a yield slightly below the current 50Y gilt yield (by simply linear interpolation) and only offer around 5.5 years more duration than the existing 2060 bond (Exhibit 9). Whilst this would represent attractive funding for the government, we think investor interest for a nominal bond with these characteristics would be limited and we think the potential size and liquidity of such a bond could be low, given the lack of intermediary bonds between 50Y and 100Y maturity. However, we think this announcement does highlight the governments desire to focus on funding costs and to that extent we think increasing long linker issuance is likely (50Y real yields are around 18bp currently). We also think this announcement increases the possibility of ultra-long gilt issuance in the 50-60Y area of the curve. We continue to expect a tap of the 2060 line or maybe a new 2062 bond in the first few months of the coming fiscal year.
Exhibit 9: A hypothetical 100Y nominal gilt would not offer enough of a yield pick-up or duration increase to appeal to investors in our view
Estimated yield*, modified duration and PVBP for a hypothetical 3.5% 100Y gilt compared with existing 30Y and 50Y gilts Maturity Yield, % Mod. Dur., y ears PVBP
07-Dec-2042 22-Jan-2060 15/03/2112*
3.43 3.42 3.38
17.7 22.7 28.5
21.5 25.9 29.4
* derived from linear interpolation of 30Y and 50Y gilt yields
Exhibit 10: 5Y swap spreads remain too wide based on our high frequency model
Residual from regressing 5Y par gilt maturity matched swap spread vs. 5Y par yields and rolling back FRA/OIS spread*, last 12M; bp
15 10 5 0 -5 -10 -15 Mar 11
current = 4.2bp
Jun 11
Sep 11
Dec 11
Mar 12
* 5Y swap spread = -0.12 * 5Y par + 0.21 * rolling 2nd FRA/OIS + 0.54. R-squ: 73%
Exhibit 11: Gilt 4s16 has outperformed as 3-7Y gilt swap spreads have tightened over the last week
Change in swap spreads, 9 16 Mar; bp
Enter tactical 5Y swap spread narrower

Swap spreads have narrowed across the curve as gilt yields have risen over the last week, leaving both 5Y and 10Y swap spreads at close to their tightest levels for the past few months. The directionality of swap spreads with the level of yields has increased markedly and we think swap spreads can continue to narrow if yields rise further. Despite the tight levels, we recommend entering tactical 5Y swap spreads narrowers as: 1) we expect the upcoming gilt remit for FY12/13 to show a modest increase in short nominal issuance (see GFIMs Mar 9), which we do not think is generally expected by investors, and 2) 5Y swap spreads remain too wide based on our high frequency model (Exhibit 10).
3 2 1 0 -1 -2 -3 -4 -5 -6
4H19
4T15
1T17
8T17
At a micro level we note that gilt 4s/16s has outperformed in the 3-8Y sector of the curve as swap spreads have tightened over the past week (Exhibit 11). This bond trades rich on our par curve model as it is
28
3T19
8s15
2s16
4s16
5s18
larger than the 2017 lines, but we would not rule out a further reopening of this bond in the next fiscal year. We recommend positioning for our narrowing view in gilt 4s16.
2012 closed trades P/L

bp unless stated
TRADE DURATION Short 10Yx 5Y forw ard CURVE 5s/30s gilt flattener 10s/30s gilt flattener 5s/12s sw ap curv e steepener 5s/10s gilt steepener RELATIVE VALUE Lev el- and curv e-adj. long 5s18/4s22/5s25 Sell 4s16 v s. 1T17 on ASW Long lv l. And curv e adj 3s/12s/25s sw ap fly Long belly lv l. Adj. 2s/15s/30s sw ap fly 30Y sw ap spread w ideners Long belly 4H19/4T20/3T20 Long belly 5s18/4s22/4Q27 Short belly 3T21/5s25/4T30 fly Short 4s60 v s. 4Q55 cash-for-cash INFLATION Receiv e 2Y RPI Long ILG16 30s/50s RY curv e flattener Short belly ILG16/ILG17/ILG22 RY fly Long 30Y UK BE v s. 30Y France BE Short ILG50 v s. ILG47 cash-for-cash 15-Dec-11 06-Jan-12 10-Feb-12 10-Feb-12 10-Feb-12 10-Feb-12 21-Feb-12 24-Feb-12 24-Feb-12 17.0 2.0 13.0 10.0 110p 24-Feb-12 -105p 15-Dec-11 16-Sep-11 27-Jan-12 20-Jan-12 03-Feb-12 03-Feb-12 03-Feb-12 10-Feb-12 24-Feb-12 06-Jan-12 20-Jan-12 10-Feb-12 24-Feb-12 02-Mar-12 09-Mar-12 09-Mar-12 09-Mar-12 09-Mar-12 2.0 3.0 4.0 7.0 5.0 -1.0 3.5 4.0 24p 15-Dec-11 20-Jan-12 27-Jan-12 24-Feb-12 06-Jan-12 10-Feb-12 10-Feb-12 16-Mar-12 16.0 -10.0 7.0 3.0 27-Jan-12 10-Feb-12 138c ENTRY EXIT P/L
Go short 10Y gilts Sell 75mn of gilt 4s22 @ 2.45%. Target 2.60%, stop loss @ 2.37. 3M carry and slide 9bp. Enter 10s/30s flatteners Sell 50mn of gilt 4s22 vs. buying 23.5mn of gilt 4H42 @ 104bp. Target 95bp, stop loss @ 110bp. 3M carry and slide is -4bp. Sell the belly of the 3s/7s/15s level-neutral swap fly (66%:100%:66% risk weights) Sell 50mn of 7Y swaps vs. receiving 72.3mn of 3Y and 17.8mn of 15Y @ -82bp. Target -75bp, stop loss @ -85bp. 5Y swap spread narrowers Sell 50mn of gilt 4s16 vs. receiving maturity matched swaps @ 59.5bp. Target 50bp, stop loss @ 63bp. Take profit on 5s/10s gilt curve steepener Close long 50mn of gilt 1T17 vs. selling 29.3mn of gilt 3T21 @ 114bp. P/L since inception is 3bp. (recommended 24 Feb). Take profit on short in belly of 3T21/5s25/4T30 fly (50:50) Close short 30mn of gilt 5s25 vs. buying 21mn of gilt 3T21 and 12mn of gilt 4T30 @ -1.5bp. P/L since inception is 4bp (recommended 10 Feb). Take profit on short in 4s60 vs. 4Q55 cash-for-cash Close short 20mn of gilt 4s60 vs. buying 20mn of gilt 4Q55 @ a relative price ratio of 0.9612. P/L since inception is 24p (recommended 24 Feb). Close short belly of the 4s16/1T17/5s18 fly (50:50) Unwind short 50mn of gilt 1T17 vs. buying 25mn of gilt 4s16s and 19mn of gilt 5s18 @ -4.0p. P/L since inception is 0bp (recommended 20 Jan). Sell the belly of the 5s18/4H19/3T20 fly (50:50) Sell 30mn notional of gilt 4.5% Mar19 vs. buying 17mn notional 5s18 and buying 13mn notional of gilt 3.75% Sep20 @ -7.5bp. Target -3.5bp, stop loss @ -9bp (recommended 9 Mar). Keep reds/greens swap curve steepener Pay 50mn of 2Yx1Y GBP swaps vs. receiving 50.4mn of 1Yx1Y GBP swaps @ 32bp. Target 45bp,
04-Nov -11 24-Feb-12
stop loss @ 15bp.3M carry and slide is -3bp. P/L since inception is 6bp (recommended on 2 Mar). Stay long belly of 10s/30s/50s gilt fly cash-andduration neutral fly Buy 40mn of gilt 4Q40 vs. selling 16mn of gilt 3T21 and selling 25mn of gilt 4s60 @ 46bp. Target 30bp, stop loss @ 50bp.P/L since inception is 0bp. Stay long the belly of the 4Q32/4T38/4H42 fly (50:50) Buy 30mn notional of gilt 4T38 vs. selling 19mn notional of gilt 4Q32 and 14mn notional of gilt 4H42 @ weighted spread of 5.0bp. Target 2bp, stop loss @ 7bp. P/L since inception is 0bp (recommended 3 Feb). Keep paying 12Mx6M GBP swaps Pay 50mn of 12Mx6M swap @ 1.25. Target 1.30%, stop loss @ 1.05%. 3M carry and slide is -2bp. P/L since inception is 8p (recommended 20 Jan). Keep paying belly of 2s/5s/10s GBP swap fly via 3M payers (buy payers on 5Y vs. selling payers on 2Y and 10Y) Pay 100mn of 5Y swap vs. receiving 50mn of 2Y swaps and 50mn of 10Y swaps via 3M payer options.
29
Zero cost entry level -19bp, 3M forward -19bp, spot level -22bp. Stay short the belly of the 2Q14/2T15/4T15 fly (50:50) Sell 30mn of gilt 2T15 vs. buying 21mn of gilt 2Q14 and 12mn of gilt 4T15 @ weighted spread of 2bp. Target 11bp, stop loss @ -0.5bp. P/L since inception is 0bp (recommended 6 Jan). Stay long ILG16 BE Buy 10mn cash of ILG16 vs. selling 29.5mn cash of gilt 4s16 @ a breakeven spread of 278bp. Target 280bp level, stop loss @ 255bp. P/L since inception is 22bp (recommended on 24 Feb). Stay long belly of the ILG22/32/40 real yield cashand-duration neutral fly Buy 15mn of ILG22 vs. selling6mn of ILG22 and 9mn of ILG40 @ spread of 21bp. Target 12bp, stop loss @ 25bp. P/L since inception is 0bp (recommended on 24 Feb).
30
US Fixed Income Strategy Global Fixed Income Markets Weekly March 16, 2012 Srini RamaswamyAC (1-212) 834-4573 Kimberly L. Harano (1-212) 834-4956 J.P. Morgan Securities LLC.
US Cross Sector
Despite including a stringent macroeconomic stress scenario, the Feds Comprehensive Capital Analysis and Review (CCAR) confirmed that large US banks in aggregate are well-capitalized and allowed several banks to raise dividends and announce stock buyback programs These positive results, along with supportive economic data, fueled a substantial sell-off in government bonds and a rally in risky assets This weeks FOMC meeting contained no surprises, but the small tweaks to the statement suggested both that QE3 is less likely at upcoming meetings and that the Fed is likely to err on the side of being slow to embrace improving data Rising energy prices, pending bank downgrades and the potential for a weaker earnings season are risks, but we believe the positive news from the stress tests and a generally supportive macroeconomic backdrop will keep the risk-on momentum going. Stay overweight risky assets We think the sell-off in Treasuries will continue, driven by technicals, but we look for only a modest rise in yields and maintain our 2.50% target for 10-year yields by mid-year
Exhibit 1: Back to rally mode
Current level,* change since 3/9/12, quarter-to-date change, and change over 4Q11 for various market variables
Current Chg from 3/09 QTD chg 4Q11 chg Global Equities (level) S&P 500 E-STOXX FTSE 100 Nikkei 225 Sovereign par rates (%) 2Y US Treasury 10Y US Treasury 2Y Germany 10Y Germany 2Y JGB 10Y JGB 5Y Sovereign CDS (bp) Spain Portugal Italy Ireland Funding spreads (bp) 2Y EUR par swap - par gov't spd 2Y USD par swap - par gov't spd EUR FRA-OIS spd USD FRA-OIS spd 1Y EUR-USD xccy basis Currencies EUR/USD USD/CHF USD/JPY JPM Trade-weighted USD Spreads (bp) 30Y CC MBS L-OAS 10Y AAA CMBS spd to swaps JULI portfolio spd to Tsy JPM US HY index spd to worst EMBIGLOBAL spd to Tsy MAGGIE (Euro HG spd to govies) US Financials spd to Tsy Euro Financials spd to govies 10Y AAA muni/Tsy ratio (level) 30Y AAA muni/Tsy ratio (level) Commodities Gold futures ($/t oz) 1659.50 -39.20 118.60 -74.60 Oil futures ($/bbl) 107.06 -0.34 8.23 19.63 * 3/15/12 level for Europe and US corporate credit spreads, and the J.P. Morgan tradeweighted USD index; 3/16/12 level for all others. 1.317 0.916 83.55 81.44 30.7 215.0 189.8 616.8 321.4 153.9 229.6 221.6 96% 101% 0.005 -0.003 1.76 0.34 -8.2 -5.0 -6.5 -15.7 -21.0 -9.1 -11.7 -12.2 -1.9% -2.8% 0.025 -0.027 5.84 -0.81 -15.3 -60.0 -47.0 -107.3 -104.9 -74.0 -101.1 -130.6 1.5% -20.8% -0.051 0.037 0.95 0.23 -0.6 -90.0 -17.6 -83.9 -38.6 16.6 -3.4 25.1 -15.6% 1.6% 88.3 22.6 35.4 31.4 -50.3 -9.0 -0.9 -3.1 -1.4 3.9 -32.7 -24.0 -35.7 -24.3 49.6 21.8 18.6 7.7 12.3 -27.3 394 1376 353 618 -2 80 -16 0 12 197 -134 -135 -1 -36 13 12 0.390 2.361 0.293 2.137 0.114 1.138 0.049 0.262 0.200 0.220 0.001 0.149 0.126 0.419 0.191 0.244 -0.014 0.232 -0.032 -0.080 -0.406 -0.046 -0.017 -0.089 1404.2 2608.3 5965.6 10129.8 33.3 92.3 78.1 200.1 146.6 291.8 393.3 1674.5 126.2 136.9 443.8 -244.9
Markets spring forward as winter fades

Markets experienced a significant risk-on rally in a week that brought positive economic data, favorable bank stress test results, and an unsurprising FOMC statement. Equities outperformed, government bond yields rose, and credit spreads narrowed sharply (Exhibit 1). A key catalyst for this weeks rally was the relatively strong outcome of the Feds stress tests for banks, known as the Comprehensive Capital Analysis and Review (CCAR). As we have noted recently, the stress test involved considerably onerous economic and market scenarios (see Special Topic; see also Cross Sector Overview, US Fixed Income Markets Weekly, 3/2/12). Despite the stringent nature of the stress scenario, the results were surprisingly positive, with most of the nineteen banks meeting minimum capital requirements even in such an adverse scenario. Four of the nineteen bank holding companies did not pass the test (Ally, Citi, SunTrust, and MetLife), while Fifth Third received limited approval to
carry out its capital plans. On the whole, the results confirm that large US banks are well-capitalized. Despite projected losses of $534bn over nine quarters under the hypothetical stress scenario, the nineteen bank holding companies in the test were projected to maintain an aggregate tier 1 common ratio of 6.3% in 4Q13 (versus 10.1% in 3Q11). These results, coupled with the Feds
31
approval for dividend increases and stock buybacks for several banks subject to the tests (Exhibit 2), set a very positive tone early in the week. In addition, economic data were generally supportive of the risky asset rally. First, initial jobless claims fell to 351K, while the four-week average of claims was unchanged at 356K, marginally above the cycle low of 355K (Exhibit 3). Initial claims have now flattened out around a level that is favorable for the recovery (see US: Initial claims get back down to the cycle low, Daniel Silver, 3/15/12). In addition, continuing claims fell to a new low for the cycle. Second, February retail sales rose 1.1%, but more importantly, January and December sales were revised up and now suggest that real consumer spending is tracking a decent 1.5-2.0% annualized growth rate in 1Q12 (see Turn-of-the-year spending pothole now looks shallower, Michael Feroli, 3/13/12). Third, manufacturing IP increased 0.3% in February and the growth in January was revised up from 0.7% to 1.1%. On the other hand, sentiment indicators were less upbeat. Both the Empire State and Philadelphia Fed surveys increased in the latest month, signaling some improvement in general business conditions, but the details were mixed to slightly weaker. Moreover, the University of Michigan confidence measure ticked down from 75.3 to 74.3 in the preliminary March reading, likely due to rising energy prices. Finally, inflation data remained tame, with core CPI rising 0.1% in February. One factor that was not necessarily supportivebut not a surprise eitherwas the FOMC statement. The Fed did not take any balance sheet actions, and a few modest changes in the statement language suggested diminished prospects of QE3 at upcoming meetings. The Fed seemed marginally less concerned about the growth outlook, noting that that the unemployment rate has declined notably recently, and commenting that strains in global financial markets have eased. On inflation, the Fed noted that the recent rise in energy prices will push up inflation temporarily but stated that it expects inflation to subsequently run at or below mandateconsistent levels. All in all, there were enough changes in the statement to show that the Committee is watching and reacting to the data, but the changes were minor enough to leave the impression that the Fed would prefer to err on the side of being too slow rather than too quick in embracing improving data (see A quiet Fed day, at least for monetary policy, Michael Feroli, 3/13/12). Looking ahead, our strategy in US markets remains the same. We continue to see a positive backdrop for risky
32
Exhibit 2: The Feds approval for dividend increases and stock buybacks for several banks helped set a positive tone in markets
Capital actions announced for select banks in the 2012 CCAR
4Q11 Dividend ($/share) BAC BBT C FITB JPM PNC RF STI USB WFC BK STT 0.01 0.16 0.01 0.08 0.25 0.35 0.01 0.05 0.13 0.12 0.13 0.18
Qtrly Dividend
2011
2012 Fed
Approved ($/share) 0.01 0.20 0.01 0.08 0.30 TBA 0.01 0.05 0.20 0.22 0.13 0.24
Buyback Approved Growth ($mn) Buyback ($mn) 0% 25% 0% 0% 20% NA 0% 0% 56% 83% 0% 33% 0 0 0 0 8,862 0 0 0 336 2,416 879 NA 0 0 0 Limited to event 15,000 Modest, not disclosed 0 0 3101 Up YoY, but not disclosed 1160 1800
Note: See Special Topic for more details. TBA = To Be Announced. Source: J.P. Morgan estimates, company data, Bloomberg.
Exhibit 3: Both initial and continuing claims are at or near lows for the recovery
Four-week average of initial claims (sa) versus four-week average of continuing claims (sa); 000s 000s
700 650 600 550 500 450 400 Continuing claims
7000 6000 5000 4000 3000 Initial claims
350 2000 Mar 08 Oct 08 Apr 09 Nov 09 May 10 Dec 10 Jul 11 Jan 12
assets overall. To be sure, risks remain. One key risk remains elevated energy prices. Brent oil prices have averaged $124/bbl over the past month, 14% above their average levels in 4Q11, and continue to pose a risk to economic growth. In addition, supply remains a headwind in several sectors, and bank ratings downgrades are still expected to occur in coming weeks, potentially dampening risk sentiment.
One additional risk for spread products is a sustained sharp sell-off in Treasuries, which would likely lead to negative returns and potentially trigger outflows from spread products. However, we do not think this is a major concern currently, for two reasons. First, although we remain bearish on duration, we look for only a modest rise in yieldswe continue to target 2.50% for 10-year yields at mid-year. In order for 10-year yields to retrace to 3%, either sovereign stress in Europe needs to fall further, U.S. growth forecasts need to be revised significantly higher, or market expectations on the timing of Fed tightening needs to move forward (see Treasuries). Second, in sectors such as high grade, we view the backup in rates as a net positive, since we believe that investors who have been waiting for higher yields to invest will outweigh those who may look to reduce their exposure to the asset class due to the recent negative return. Similarly, in high yield we believe that a rise in 10-year yields to 2.50% could easily be absorbed by spreads. Thus, for now, we think the positive news from the bank stress testson top of diminished near-term risks around Europewill keep the momentum going in risky assets, and we remain broadly overweight. In high grade, we recognize the risks around Moodys pending downgrade of US banks and the potential for a weaker earnings season. However, we think the rise in yields, the rally in equities, strong bank stress test results and lower bond supply are all positive for spreads, so we remain overweight high grade (see Corporates). Similarly, we remain positive on high yield. Heavy supplyalready a quarterly recordis positive for two reasons: it reflects strong demand, and given the focus on refinancing bond and loan facilities, it helps support lower medium-term default expectations (see High Yield). We also remain overweight emerging market sovereigns and corporates. Although markets are close to our targets for sovereign and corporate spreads, the factors that have kept us bullish are largely unchanged. The pace of EM corporate and sovereign issuance has slowed relative to the beginning of the year while inflows remain robust, and tail risks have declined (see Emerging Markets). In contrast, in CMBS, we note that legacy CMBS has been lagging the broader market, with A4s now largely de-correlated from equities. With spreads now through our mid-year target, we think further tightening potential
may be limited. Our top pick in the space remains new issue subordinates, particularly single-As (see CMBS). In ABS, we continue to highlight strong demand, with the market easily absorbing nearly $9bn of new issues this week. For investors searching for yield, we recommend timeshare ABS given the attractive pick-up and seller-servicer support (see ABS). .
33
US Fixed Income Strategy Global Fixed Income Markets Weekly March 16, 2012 Terry BeltonAC (1-212) 834-4650 Meera Chandan (1-212) 834-4924 Kimberly L. Harano (1-212) 834-4956 J.P. Morgan Securities LLC.
US Treasuries
Momentum is likely to cause yields to trend higher for several weeks; we remain biased for higher intermediate rates still targeting 10-year yields to reach 2.5% by mid-year However, the sell-off in the front end appears overdone; look for front-end Treasury rates to retrace this weeks move targeting 2-year yields to move back below 30 bp next month Bill issuance is poised to turn negative in April; buy 2-year Treasury notes versus OIS Sell 2.625% Jun-14s versus a combination of 1.5% Dec-13s and 2.125% Dec-15s; Jun 14s are rich and their large foreign ownership makes them vulnerable to increased foreign selling Stay bullish on TIPS breakevens, but unwind tactical 10s/30s TIPS breakeven curve steepeners
Exhibit 1: On a vol-adjusted basis, the sell-off this week was most severe in the 3- 5-year sector of the curve
Change in Treasury yields since March 6 divided by 6-month standard deviation of 8-day yield changes
3.2 3.0 2.8 2.6 2.4 2.2 2.0 2y 3y 5y 7y 10y 30y
Exhibit 2: Breaking the range: 10-year yields have usually trended higher for several weeks after moving above their 200 day moving average
10-year Treasury yields in the business days around instances where 10-year yields first moved above their 200-day moving average*; %
Market views
Treasury yields gapped higher this week with 2-year yields increasing 4 bp, 5-year yields increasing 22 bp, 10-year yields increasing 26 bp, and 30-year yields increasing 22 bp. The move, which followed a sustained period of improved funding conditions in Europe, stronger US labor market data, and a rally in risky assets, accelerated this week as rates finally broke out of the very narrow trading range they have held since November. With the sell-off, 10-year notes are now yielding 2.30%, their highest since October and 43 bp above their levels at the start of the year. While the sell-off was led by 10-year notes, the move in the 3- and 5-year sector of the curve was even larger when looked at on a volatility-adjusted basis. Threeyear Treasuries have sold off 18 bp since March 6, representing a 3 standard deviation move (Exhibit 1), and effectively wiping out 9 months of carry for investors long this sector of the curve. The outsized move reflects both bad positions (as 3- and 5-year notes were popular places to earn carry) as well as the heightened vulnerability of the 2015-2017 sector of the curve to changes in Fed expectations if the labor market continues to strengthen.
4.2 4.1 4.0 3.9 3.8 3.7 3.6 3.5 3.4 -40 -30 -20 -10 0 10 20 30 Business days around first move above 200d average 40 Average 14-Mar-2012(Y1)
2.6 2.5 2.4 2.3 2.2 2.1 2.0 1.9 1.8
* Data includes all instances since 2002 where 10-year yields first moved above their 200day moving average after trading below it for at least 3 months; dates include 7/15/03, 11/29/04, 1/25/07, 5/29/08, 5/7/09, 12/7/10 and 3/14/12
Despite the magnitude of the sell-off, we remain biased for higher intermediate rates still targeting 10year yields to reach 2.5% by mid-year. While fundamentals were the main catalyst for yields to break out of their narrow trading range, technicals are now supportive of additional follow-through. Because markets that are rangebound for a prolonged period usually produce significant exposure in yield curve carry trades, sell-offs that push yields outside a long-held trading range tend to create momentum, with yields overshooting value as investors unwind these trades. This is evident in Exhibit 2 which highlights the average
34
Exhibit 3: Even with this weeks sell-off, December 2014 OIS appear too low given the asymmetric risk from downside unemployment surprises
December 2014 OIS rate versus unemployment rate; %
The transactions bias in monthly TIC data Treasury collects data on cross-border flows between US and foreign residents under the TIC (Treasury International Capital) reporting system. This system provides insight into international buying of US securities and has various data releases, including preliminary data on transactions in long-term securities (released monthly) and final survey-based holdings of long-term US securities (formerly released annually, but will be released monthly going forward). While this data provides substantial insight into foreign buying of US securities, it suffers from certain biases that could result in inaccuracies. For example, the preliminary monthly data have a transactions bias which results in distortions when trying to attribute purchases to certain countries. For example, if an Italian resident purchases U.S. Treasuries using a financial intermediary in Switzerland, the sale of Treasuries would be recorded vis-vis Switzerland, not Italy. This results in an overestimate in the net purchases made by countries that are large international financial centers (such as UK) and an underestimate of net purchases by foreign buyers who transact in US Treasuries outside the US. These country-level inaccuracies are corrected to a large extent by the final survey-based holdings data. The preliminary data for January was released this week by Treasury, and shows that China purchased $7.5bn coupon Treasuries during the month. However, we note that this is most likely an underestimation of its actual purchases during the month, given the transactions bias discussed above. Indeed, we find that simply totaling the monthly preliminary net purchases made by China each year has grossly underestimated the change in its final holdings of coupon Treasuries over the same period. For the year ending June 2011, the preliminary data showed that China purchased $53bn coupon Treasuries, while the final data showed that China purchased $194bn coupon Treasuries over the same period. Because China likely uses a UK intermediary for some of its Treasury purchases, we find that their actual net purchases can be better captured from the preliminary TIC data by adding some portion of the buying attributed to the UK. Exhibit A highlights this by fitting a model of final purchases released in the annual data to the preliminary monthly data. The model suggests that, based on the latest preliminary data, Chinas actual purchases of coupon Treasuries in January were likely closer to $29bn. Exhibit A: A model for estimating final purchases of coupon Treasuries by China
Variable Coeff. Intercept -36.2 Prelim. net purchases by China 2.3 Prelim. net purchases by UK 0.4 Estimated final purchases by China in January R2=92%; Model fitted since 2002
Source: J.P. Morgan, Treasury
1.4 1.3 1.2 1.1 1.0 0.9 0.8 0.7 0.6 0.5 Nov 11
OIS fair value
8.9 8.8 8.7 8.6 8.5 8.4
OIS rate Unemployment rate
8.3 8.2
Jan 12
Mar 12
behavior of 10-year yields after they have moved above their 200-day moving average (which occurred on Wednesday this week). These data suggest that, in such instances, yields continue to trend higher for several weeks by an average of an additional 10-20 bp. This is broadly consistent with the near-term targets of our technical analysts, moreover, who expect momentum to push 10-year yields towards 2.40% (Global FI Technical Strategist, 3/14/12). Beyond technical pressures, we continue to view forward OIS rates as too low given the uncertainty around the Feds unemployment rate forecast. As discussed last month, our model that links forward OIS rates to the unemployment rate suggests fair value for December 2014 OIS is still 20 bp above current levels (Exhibit 3). Thus, even after this weeks sharp sell-off, forward OIS valuations appear rich and provide some fundamental support for the sell-off to continue given the current level of the unemployment rate. Further improvements in the labor market, moreover, should push these forward rates higher still; we estimate the fair value of December 2014 OIS will increase roughly 50 bp for a 0.5% point decline in the expected unemployment rate for 4Q13 (see U.S. Fixed Income Markets Weekly, 2/24/12). Finally, a deteriorating outlook for foreign sponsorship of Treasuries supports higher rates over the medium term. The foreign exchange reserves of the largest foreign holders of Treasuries have been largely unchanged over the last six months with no net buying of Treasuries since September (Exhibit 4). To be sure, TIC data released this week suggests better buying during January
Tstat January -1.7 5.7 7.5 2.6 32.9 28.9
35
Exhibit 5: Recent comments from Chinese officials on FX reserve diversification

Date Mar-12 Mar-12 Mar-12 Feb-12 Jan-12 Nov-12 Name/ description PBOC official statement Yi Gang, vice-governor of the PBOC and head of the State Administration of Foreign Exchange Li Daokui, Member, Monetary Policy Committee, PBOC Lou Jiwei, Chairman of CIC Xia Bin, PBOC adviser and monetary policy committee member Cheng Siwei, former vice chairman of the Standing Committee of the 9th and 10th National People's Congress Li Daokui, Member, Monetary Policy Committee, PBOC Comment It will make continued efforts in 2012 to manage the country's reserve assets with "new ideas" and in a more "effective" manner. China will continue to diversify its investments in foreign bonds, while keeping risk control a top priority. Concerns over safety, liquidity and potential revenues are three major factors affecting the government's thinking. Under such principles, we will continue our investment in Europe. China will continue to strengthen its foreign exchange reserves diversification, increase investment in euro-denominated assets, and reduce investment in U.S. Treasury bonds "Infrastructure is under-invested in European countries and the US Infrastructure represents a suitable choice for sovereign wealth funds to invest directly or through fund managers, with the aim of seeking stable and sound financial returns." Called on China to increase its gold reserves as a long-term strategy to diversify its foreign exchange reserves and promote yuan's internationalization Foreign-exchange reserves, now $3.2 trillion, should instead total 20 percent of GDP, or about $1.2 trillion "The incremental parts of our of our foreign reserve holdings should be invested in physical assets...We would like to buy stakes in Boeing, Intel, and Apple, and maybe we should invest in these types of companies in a proactive way...Once the US Treasury market stabilizes we can liquidate more of our holdings of Treasuries" China is purchasing European bonds in a bid to diversify its foreign exchange reserves and reduce global dependence on the U.S. dollar. This will lessen the world's dependence on the U.S. dollar as the sole global reserve currency and begin a shift toward a more multipolar reserve system. "China should urgently assess risks from being the main foreign investor in U.S. debt and diversify its foreign-currency reserves more quickly. China should buy more non-financial assets with its reserves to diversify risks and should seek to globalize the yuan. " China should use some of its foreign exchange reserves to purchase energy and metal minerals that are of strategic importance. The nation should also optimize the structure of its foreign exchange reserves by diversifying away from U.S. dollar Treasuries.
Sep-11
Sep-11
Xinhua News Agency, Official press agency
Aug-11
Xia Bin, PBOC adviser in a publication Xu Nuojin, Vice governor of the PBOC's Guangzhou branch
Jun-11
Source: China Daily, Bloomberg
including net purchases from China that were reported at $7.5 bn and could have been as large as $30 bn (see grey box). This buying is small, however, compared to the $118 bn of selling in 4Q11. Looking ahead, we continue to look for weak demand for Treasuries from China and view the selling in 4Q11 as a structural shift rather than a temporary flow. Comments from senior PBOC officials support this and suggest that Chinas reserve managers have begun acting on their numerous statements on the need to diversify out of US Treasuries into physical assets and other currencies (Exhibit 5). While these factors are supportive of higher rates, we would highlight that the near-term magnitude of any selloff from current levels should be relatively modest absent a change in Fed expectations. Our short-term fair value model of 10-year yields suggests yields have now reached fair value (Exhibit 6). Valuations remain low compared to early last year both because consensus growth forecasts have fallen, and because flight-toquality risks from Europe remain somewhat elevated with semi-peripheral spreads still twice their levels compared to one-year ago. In order for 10-year yields to retrace to 3%, either sovereign stress in Europe needs to fall further, U.S. growth forecasts need to be revised
36
Exhibit 4: FX reserves of the largest holders of Treasuries have been unchanged since September
Treasuries held in custody at the Fed excluding repo versus foreign exchange reserves of the largest Treasury holders*; $bn
6000 5900 5800 5700 5600 5500 5400 5300 5200 Mar 11 Sep 11 Mar 12 FX reserves Treasury custody holdings at the Fed
2680 2660 2640 2620 2600 2580 2560 2540
* Includes FX reserves of South Korea, Brazil, Japan, China, Russia and
Taiwan.
significantly higher, or market expectations on the timing of Fed tightening needs to move forward. For now, however, we maintain our mid-year target on 10-year yields at 2.5% (Exhibit 7), and will wait for further
Exhibit 6: 10-year Treasury yields are back to fair value

Actual versus fair value* of 10-year Treasury yields; %
Exhibit 7: J.P. Morgan rate forecast

%
Actual Rates Effective funds rate 3-mo LIBOR 3-month T-bill (bey) 2-yr Treasury 5-yr Treasury 10-yr Treasury 30-yr Treasury 1m ahead 2Q12 3Q12 4Q12 16 Mar 12 16 Apr 12 30 Jun 12 30 Sep 12 31 Dec 12 0.13 0.47 0.09 0.36 1.11 2.30 3.41 0.10 0.40 0.04 0.29 1.15 2.35 3.45 0.10 0.45 0.02 0.30 1.25 2.50 3.60 0.10 0.50 0.02 0.30 1.25 2.50 3.60 0.10 0.50 0.02 0.30 1.25 2.50 3.60
3.6 3.4 3.2 3.0 2.8 2.6 2.4 2.2 2.0 1.8 1.6 Jun 11 Sep 11
Actual Fair value
Dec 11
Mar 12
Exhibit 8: The recent increase in front-end rates has been partly driven by outflows from government money market funds
*10-year Treasury yield fair value modeled as 1.97 + 0.357 * 5yx5y inflation swap rate (%) + 0.454 * 3mx3m OIS rate (%) + 0.178 * 1-year ahead J.P. Morgan GDP growth forecast (%) 0.288 * J.P. Morgan positions index 0.003704 * semi-peripheral Europe 5-year CDS spreads (bp)
Assets under management under government and prime money market funds; $bn
960 940 920 900 880 860 840 820 800 Sep 11
Source: iMoneyNet
Government funds Prime funds
1510 1500 1490 1480 1470 1460 1450 1440 1430 1420
improvement in the labor market before revising that target higher. While we remain biased for higher intermediate rates, the sell-off in the front end appears overdone to us, with 2year notes reaching June 2011 levels earlier this week. Front-end Treasury rates have weathered a one-two-three punch in recent weeks with outflows from government money funds weakening demand for front-end Treasuries (Exhibit 8), a seasonal increase in bill supply causing GC repo rates to spike, and technically driven de-risking this week as rates broke out of their trading range and investors unwound carry trades. Going forward, we look for front-end Treasury rates to retrace this weeks move targeting 2-year yields to move back below 30 bp next month. A key driver of this move is front-end supply, as government money fund flows have stabilized and bill supply is poised to turn sharply negative as Treasury tax receipts increase in April. To position for declining front-end supply, we recommend buying 2-year Treasury notes versus OIS (see Trade recommendations). The 2-year Treasury/OIS spread is near the upper end of its trading range and has been well correlated with bill supply (Exhibit 9). Quarter end cyclicals are also modestly supportive as GC repo has tended to narrow into quarter end.
Nov 11
Jan 12
Mar 12
Exhibit 9: Look for 2-year Treasuries to richen versus 2-year OIS given our outlook for negative bill supply
2-year Treasury spread to OIS (bp) versus monthly net issuance of T-bills* ($bn) bp $bn
18 16 14 12 10 8 6 4 2 0 Nov 10 May 11 Nov 11 May 12
* Grey box is used to highlight J.P. Morgan projections.
2y Tsy/ OIS spread; bp Tbills net issuance; $bn
100 80 60 40 20 0 -20 -40 -60
37
Exhibit 10: Off-the-run 5s and 7s with high foreign ownership have cheapened
Top 15 Treasury issues with the highest foreign purchase at auction
Orig. Rem. term Term (yrs) (yrs) 10 3 5 10 5 10 3 3 5 10 7 10 7 10 5 8.9 0.8 2.7 8.4 2.3 8.7 0.7 1.0 2.6 9.4 4.3 9.2 4.7 7.4 2.5 Amt. bought by foreigners at auction ($bn) 26 21 21 21 21 20 17 17 17 16 16 16 15 15 15 Yld error (bp) -1.1 -0.6 1.4 0.5 -0.7 -0.5 -1.2 0.0 1.2 -3.4 1.8 -2.0 0.4 3.3 1.3 3m chg in yld error (bp) 0.7 0.4 1.2 1.3 -0.3 0.9 0.7 -0.4 1.4 -0.7 2.1 -0.6 0.3 2.3 0.7
Exhibit 11: Foreign ownership of issues maturing in late 2014 and 2016 is particularly high
Foreign purchases at auction grouped by maturity date; $bn
Cpn
Mat
3m zscore
80 60 40 20 0
1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16 1Q17 3Q17 1Q18 3Q18 1Q19 3Q19
3.625 1.125 2.125 2.625 2.625 2.625 1.375 1.375 2.375 2.125 3.25 3.125 2.75 3.625 2.375
2/15/21 12/15/12 11/30/14 8/15/20 6/30/14 11/15/20 11/15/12 3/15/13 10/31/14 8/15/21 6/30/16 5/15/21 11/30/16 8/15/19 8/31/14
0.8 1.1 1.6 1.2 -0.6 0.9 0.4 0.0 1.6 -0.7 0.8 -0.2 2.0 1.3 1.8
Maturity
Source: Treasury
Exhibit 12: The FY 2012 budget deficit is running nearly 10% below the same period in FY 2011
Percentage change in receipts, outlays and budget deficit thus far in FY 2012 relative to FY 2011; %
Issues with 3-month yield error z-score of greater than 1.5 are bolded. Source: J.P. Morgan, Treasury
5% 2.8%
On the yield curve, we recommend underweighting 2.625% Jun-14s versus a combination of 1.5% Dec13s and 2.125% Dec-15s on a curve and level neutral basis. The 2.625% Jun-14 is rich on the curve and is likely to cheapen if foreign investors continue to reduce their Treasury holdings. While CUSIP-level data on foreign ownership of notes and bonds is not available, Treasury does release data on the percentage of issue size foreign investors take down in each auction. Exhibit 10 shows a list of the 15 issues with the largest foreign purchases at auctions. The exhibit shows that three out of the four off-the-run 5-year notes with high foreign ownership on this list have cheapened recently, and currently have yield error z-scores of 1.5 and greater. A notable exception is 2.625% Jun-14s, which have not cheapened despite foreign ownership of $21bn. Looking ahead, we think it is likely that foreign selling could extend to the 2.625% Jun-14s, and recommend selling this issue versus other issues that are not held in size by foreign investors. Foreign buying of 1.5% Dec13s and 2.125% Dec-15s was only $4.3bn and $4.8bn at auctions, respectively, and currently appear modestly cheap versus the Jun-14s on a curve- and level-neutral basis. Thus, we recommend selling 2.625% Jun-14s versus a 86:22 risk weighted barbell of 1.5% Dec-13s and 2.125% Dec-15s (see Trade Recommendations).
38
0% -2.4% -5%
-10% Receipts
Source: Treasury
Outlays
-9.4% Deficit
Finally, we note that issues maturing in late-2014 and 2016 could stay vulnerable in the near term, if foreign selling persists. As shown in Exhibit 11, foreign ownership of issues maturing in that part of the curve is especially large.
US Budget Outlook
Treasury released details of its February budget this week, highlighting that the budget deficit was $231.7bn during the month. Thus far in FY2012, the budget deficit has totaled $581bn, or 9.4% below the same period in FY 2011, helped by both higher revenues and lower outlays (Exhibit 12). In addition, the CBO also released updated
budget projections for FY 2012-2022 incorporating recent changes in to the legislation. Their FY 2012 budget forecast (released January) was revised up by $93bn to $1.2tn. The recent data from both sources is broadly consistent with our own FY 2012 budget deficit forecast of $1.2tn, or 7.5% lower than that in the prior year.
Exhibit 13: Consumers inflation expectations have increased recently
Consumers 1-year ahead and 5-10year head median price expectations as reported in the University of Michigan sentiment survey; % %
5.0 4.5 4.0 3.5 3.0 2.5 2.0 Mar 10 5-10 year ahead Oct 10 Apr 11 Nov 11 1 year ahead
3.2 3.1 3.0 2.9 2.8 2.7 2.6
TIPS
The risk-on rally and sharp sell-off in nominal Treasuries helped push breakevens wider this week. The key events for the TIPS market were the Fed purchase operation on Wednesday and Fridays CPI report. In the purchase operation, the Fed purchased only $1.1bn TIPS, the smallest purchase since Operation Twist began. Once again, purchases were concentrated at the long end, with the Fed buying $1bn in the 28-30-year sector, including $0.6bn Feb-42s. The CPI report for February was slightly disappointing, showing that headline CPI rose 0.44% in February, below expectations of a 0.57% gain. However, the report still implies that carry will be attractive in April, with longs in 5-year and 10-year breakevens carrying positively by 6.4bp and 2.2bp, respectively. All in all, the modest decline in oil prices, the weaker-than-expected CPI report, and the Fed purchase operation caused the breakeven curve to steepen this week: 5-, 10-, 20- and 30-year breakevens widened by 4bp, 12bp, 16bp, and 17bp, respectively. Looking ahead, we remain bullish on TIPS breakevens. If the risk-on rally continues as we expect, breakevens will likely continue to grind wider. Second, todays University of Michigan consumer sentiment report showed that consumers inflation expectations have been rising in recent months, especially their near-term expectations (Exhibit 13). To the extent that consumer expectations reflect broader inflation expectations, this increase is likely supportive of wider breakevens. Third, over the very near term, we think the results of the Feds purchase operation argue for wider breakevens. One potential reason why the Fed bought an unusually small amount of TIPS is because investors offered them an unusually small amountonly $2.9bn, a record low. We think the low amount of TIPS offered to the Fed reflects strong investor demand for TIPS. Indeed, as Exhibit 14 shows, over the past eight months (post-QE2), breakevens have tended to widen after Fed purchase operations with small offered amounts. This relationship suggests that 10-year breakevens could widen about 12bp
Exhibit 14: Breakevens have tended to widen after Fed purchase operations where the amount offered to the Fed was low
1-week change in Jan-21 TIPS breakevens after a Fed purchase operation regressed against the amount of TIPS offered in the operation; 8/11-2/12; bp
15 10 5 0 -5 -10 -15 3.0 3.5 4.0
y = -8.27x + 35.90 R = 0.45
4.5
5.0
5.5
Amount of TIPS offeredin Fed purchase operation; $bn
after the operation, versus the 3.5bp they have widened so far. Thus, we continue to look for wider breakevens. On the curve, we recommend unwinding our tactical 10s/30s breakeven curve steepener now that the nearterm steepening effects from the Fed purchase operation and nominal 30-year bond auction are likely behind us (see Trade recommendations). In addition, this curve no longer looks mispriced relative to the nominal 10s/30s curve and oil prices. Separately, we also recommend unwinding our Jan-14/Apr-14 TIPS yield curve steepener now that this curve looks close to fairly priced relative to the broader curve.
39
Looking ahead to next week, the key event for the TIPS market will be Thursdays 10-year TIPS reopening. Compared to history, valuations are mixed: 10-year real yields are slightly higher than they were before the January auction, while breakevens are substantially higher than their January levels (Exhibit 15). It is interesting to note, however, that over the past two years the first reopening of the year for 10-year TIPS has attracted the highest bid-to-cover ratio and the most negative tail of the year. If this pattern holds, we are likely to see a strong auction and subsequent widening in breakevens.
Exhibit 15: Ten-year real yields are slightly higher than they were in January, while breakevens are considerably wider than their January levels
Auction statistics for 10-year TIPS; current cycle statistics as of 3/16/12
Size Auction date 01/11/10 04/05/10 (re) 07/08/10 09/02/10 (re) 11/04/10 (re) 01/20/11 03/24/11 (re) 05/19/11 (re) 07/21/11 09/22/11 (re) 11/17/11 (re) 01/19/12 Average 03/22/12 (re) 13 ($bn) 10 8 12 10 10 13 11 11 13 11 11 15 BE before Yield before 244.2 226.5 173.2 158.4 217.0 235.8 238.9 236.2 232.4 188.8 196.0 205.6 212.8 241.0 1.352 1.681 1.242 0.997 0.452 0.931 0.958 0.770 0.553 -0.018 0.037 -0.205 0.729 -0.114 Bid/ 2.65 3.43 2.88 2.80 2.91 2.37 2.97 2.66 2.62 2.61 2.64 2.91 2.79 Primary 56% 55% 44% 51% 40% 59% 68% 56% 45% 34% 42% 50% 50% Direct 3% 8% 4% 3% 2% 3% 7% 3% 14% 36% 12% 13% 9% Indirect 41% 37% 52% 47% 58% 38% 25% 41% 42% 30% 46% 36% 41% Tail (bp) -0.8 -4.1 -3.0 0.0 4.5 6.0 -4.5 1.0 -3.1 1.8 1.4 -3.0 -0.3 auction (bp) auction (% ) cover dealer % bidder % bidder %
Sell 2.625% Jun-14s versus 1.5% Dec-13s and 2.125% Dec-15s The 2.625% June-14s have relatively high foreign ownership, and could come under pressure like other off-the-run 5s in this sector with high foreign ownership. Not only do Dec-13s and Dec-15s have relatively low foreign ownership, they also appear modestly cheap relative to Jun-14s. This trade is weighted to level and curve neutral. Buy 86% risk, or $136.7mn notional of T 1.5% Dec13s (yield: 0.352%; bpv: $180/mn). Sell 100% risk, or $122.3mn notional of T 2.625% Jun-14s (yield: 0.434%; bpv: $234/mn). Buy 22% risk, or $16.5mn notional of T 2.125% Dec15s (yield: 0.788%; bpv: $383/mn). Weighted spread is -4.3bp. One-month weighted carry is 0.3bp and roll is 0.2bp. Buy 2-year Treasuries versus OIS The 2-year Treasury/OIS spread is at the upper end of its trading range and is likely to narrow as bill supply turns negative in April. Quarter-end cyclicals are also modestly supportive as GC repo has tended to narrow into quarter end. Buy 100% risk, or $101.1mn notional of T 0.25% Nov-13s (bpv: $169/mn) versus 100% risk, or $100mn notional matched maturity OIS at a spread of 11bp. One-month weighted carry is 0.5bp and roll is 0.2bp. Stop out of weighted 4s/25s steepeners hedged with reds/10s flatteners This carry trade has become extremely directional with the level of rates, reflecting the negative convexity in the trade. We stop out of this trade at a loss. Unwind overweight on 96% risk, or $156.8mn notional of T 2.125% Feb-16s (yield: 0.847%).
40
Unwind underweight on 78% risk, or $25mn notional of T 4.75% Feb-37s (yield: 3.26%). Unwind overweight on 100% risk, or $76.4mn notional of T 2% Nov-21s (yield: 2.258%). Unwind underweight on 100% risk, or 2,732 EDM3 contracts (price: 99.33). (US Fixed Income Markets Weekly, 1/27/12). P/L since inception: -25.7bp of yield. Unwind tactical 10s/30s breakeven curve steepener We recommend unwinding our tactical 10s/30s breakeven curve steepener now that the near-term steepening effects from the Fed purchase operation and nominal 30-year bond auction are likely behind us. Furthermore, this curve no longer looks mispriced relative to the nominal curve and oil prices. Unwind short 100% risk, or $25mn notional of TII 0.125% Jan-22s (yield: -0.117%). Unwind long 100% risk, or $9.7mn notional of TII 0.75% Feb-42s (yield: 0.868%). Unwind long 50% risk, or $14.2mn notional of T 2% Feb-22s (yield: 2.298%). Unwind short 50% risk, or $6.7mn notional of T 3.125% Feb-42s (yield: 3.408%). (US Fixed Income Markets Weekly, 3/9/12). P/L since inception: +4.7bp of yield. Unwind underweight in Apr-14 TIPS versus Jan-14 TIPS After the recent steepening, this curve now looks close to fairly priced relative to the broader curve, so we recommend unwinding this trade.
Unwind long 100% risk, or $25mn notional of TII 2% Jan-14s (yield: -1.937%); Unwind short 100% risk, or $25.4mn notional of TII 1.25% Apr-14s (yield: -1.834%); (US Fixed Income Markets Weekly, 2/24/12). P/L since inception: +5.4bp of yield. Maintain 2s/6s steepeners hedged with 9th/11th Eurodollar flatteners Stay overweight 100% risk, or $475.6mn notional of T 0.25% Feb-14s (yield: 0.361%). Stay underweight 33% risk, or $50mn notional of T 2.875% Mar-18s (yield: 1.408%). Stay underweight 100% risk, or 3,725 EDM4 contracts (price: 99.88). Stay overweight 85% risk, or 3,166 EDZ4 contracts (price: 98.565). (US Fixed Income Markets Weekly, 3/9/12). P/L since inception: +2.7bp of yield. Maintain 5s/10s and 5s/30s flatteners Stay underweight 100% risk, or $148.6mn notional of T 0.875% Jan-17s (yield: 1.103%). Stay overweight 63% risk, or $50mn notional of T 2% Feb-22s (yield: 2.296%). (US Fixed Income Markets Weekly, 3/9/12). P/L since inception: +4.9bp of yield. Stay underweight 100% risk, or $281.3mn notional of T 0.875% Jan-17s (yield: 1.103 %). Stay overweight 71% risk, or $50mn notional of T 3.125% Feb-42s (yield: 3.41%). (US Fixed Income Markets Weekly, 3/9/12). P/L since inception: +5.3bp of yield. Stay overweight 4s and 8s versus 6s Stay overweight 69% risk, or $151.7mn notional of T 3.25% May-16s (yield: 0.936%). Stay underweight 100% risk, or $168.7mn notional of T 2.25% Nov-17s (yield: 1.339%). Stay overweight 40% risk, or $50mn notional of T 3.375% Nov-19s (yield: 1.831%). (US Fixed Income Markets Weekly, 3/2/12). P/L since inception: -0.6bp of yield. Stay in 2s/7s steepeners hedged with reds/ greens flatteners Stay overweight 100% risk, or $170.1mn notional of T 0.25% Feb-14s (yield: 0.361%). Stay underweight 98% risk, or $50mn notional of T 1.375% Feb-19s (yield: 1.682%). Stay underweight 98% risk, or 1,327 EDM3 contracts (price: 99.33).
Closed trades in 2012

P/L reported in bp of yield unless otherwise indicated TRADE ENTRY
Nominal Treasuries 10-year duration shorts Curve Underweight 4s versus 3s and 7s Buy 2.375% Jun-18s versus 1.875% Oct-17s 7s/30s flatteners Buy Nov-21 Cs versus Ps 4s/6s steepeners vs. reds/greens flatteners 7s/30s flatteners 3s/7s flatteners 4s/25s steepeners hedged with reds/10s flatteners 01/20/12 02/10/12 -11.1 EXIT P/L
12/09/11 10/14/11 01/06/12 09/23/11 01/06/12 02/10/12 02/12/12 01/27/01
01/06/12 01/06/12 01/27/12 01/06/12 01/27/12 02/24/12 02/24/12 03/16/12
0.9 -2.8 -14.2 -0.2 3.0 3.5 8.5 -25.7
Misc. Sell 2s versus OIS 12/09/11 01/06/12 Buy 5s versus OIS 01/06/12 02/04/12 Sell 2-year Treasuries vs. JGBs swapped into USD 08/12/11 02/10/12 Buy the March CTD Bond basis 12/09/11 02/24/12 TIPS Sell 5-year TIPS on a breakeven basis 10s/30s breakeven curve steepener Underweight Apr-14 TIPS versus Jan-14 TIPS
0.8 5.0 44.0 1/32nds
12/16/11 01/20/12 03/09/12 03/16/12 02/24/12 03/16/12
-12.3 4.7 5.4
Stay overweight 100% risk, or 1,354 EDZ4 contracts (price: 98.565). (US Fixed Income Markets Weekly, 2/24/12). P/L since inception: 0.3bp of yield. Maintain exposure to belly cheapening trades Stay overweight 94% risk, or $307.1mn notional of T 0.25% Feb-15s (yield: 0.555%). Stay underweight 100% risk, or $157.4mn notional of T 2.75% Feb-18s (yield: 1.389%). Stay overweight 42% risk, or $25mn notional of T 6.625% Feb-27s (yield: 2.842%). (US Fixed Income Markets Weekly, 2/24/12). P/L since inception: +1.1bp of yield. Stay overweight 75% risk, or $191.7mn notional of T 0.25% Jan-15s (yield: 0.535%). Stay underweight 100% risk, or $112.8mn notional of T 1.25% Jan-19s (yield: 1.664%). Stay overweight 54% risk, or $25mn notional of T 6.625% Feb-27s (yield: 2.842%). (US Fixed Income Markets Weekly, 2/3/12). P/L since inception: -2.9bp of yield.
41
Stay underweight May-38s versus May-37s Stay overweight 100% risk, or $48.9mn notional of T 5% May-37s (yield: 3.258%). Stay underweight 100% risk, or $50mn notional of T 4.5% May-38s (yield: 3.290%). (US Fixed Income Markets Weekly, 2/10/12). P/L since inception: +0.3bp of yield. Stay underweight on-the-run 10s versus triple olds Stay underweight 100% risk, or $50.6mn notional of 2% Feb-22s (yield: 2.296%). Stay overweight 100% risk, or $50mn notional of T 3.125% May-21s (yield: 2.139%). (US Fixed Income Markets Weekly, 2/3/12). P/L since inception: -0.9bp of yield.
Stay in weighted 2s/3s steepeners Stay overweight 100% risk, or $219.8mn notional of T 0.125% Dec-13s (yield: 0.350%). Stay underweight 70% risk, or $100mn notional of T 0.25% Jan-15s (yield: 0.535%). (US Fixed Income Markets Weekly, 1/27/12). P/L since inception: +1.8bp of yield. Stay overweight 6.5% Nov-26s versus a weighted barbell of Aug-23s/Feb-31s Stay underweight 62% risk, or $39mn notional of T 6.25% Aug-23s (yield: 2.430%). Stay overweight 100% risk, or $50mn notional of T 6.5% Nov-26s (yield: 2.825%). Stay underweight 38% risk, or $16.5mn notional of T 5.375% Feb-31s (yield: 3.051%). (US Fixed Income Markets Weekly, 1/20/12). P/L since inception: -3.3bp of yield.
42
US Fixed Income Strategy Global Fixed Income Markets Weekly March 16, 2012 Srini RamaswamyAC (1-212) 834-4573 Praveen Korapaty (1-212) 834-3092 Alberto Iglesias (1-212) 834-5116 J.P. Morgan Securities LLC. .
US Interest Rate Derivatives

Turn neutral on intermediate maturity swap spreads; issuance-related narrowing pressures remain, but growing asymmetric risk of paying flows from servicers and REITs is a tactical offset Stay positioned for wider long-end spreads We continue to recommend trades designed to profit from yield curve renormalizationinitiate 3s/7s steepeners hedged with weighted 2s/Blues flatteners The rise in yields has pushed 5-year yields well above recent averages, making for attractive entry points into option-based limited-risk bullish trades buy 3Mx5Y receiver swaptions struck at spot levels versus selling an equal amount of receivers at a lower strike to position for the possibility that yields return to recent average levels Initiate EDM4/EDU5 flatteners hedged with EDH5/EDM6 steepeners to earn attractive carry on a well hedged basis Short volatility positions in the 3Mx10Y sector experienced much greater sensitivity to yields than has been typical, due to the fact that skews were realized to a greater extent than has been the norm recently This is typical of periods when yields are poised to breakthrough the recent range to the upside stay short gamma in the 10-year sector, but upsize the short duration hedge
Exhibit 1: Yes Virginia, there is still negative convexity to hedge

Estimated dollar duration of the aggregate mortgage servicing rights universe, regressed against mortgage current coupon yields; $bn of 10-year equivalents
-60 -80 -100 -120 -140 -160 -180 -200 -220 -240 2.6 2.8 3.0 3.2 3.4 3.6 3.8 4.0 4.2 4.4
MBS 30-year current coupon yield; %
Y = 89.8218 X1 - 454.9358 R = 93.01% standard error = 12.0065 period = Mar 15,11 - Mar 15,12
Exhibit 2: and mortgage related paying flows could increase if yields break out of their range, producing positive spread directionality in a continued selloff
Rolling 1-month beta between daily changes in 7-year swap spreads and 7-year Treasury yields, averaged around dates when rates first broke out of their 6-month range on the upside
15
10
-5
Swaps
Swap spreads mostly narrowed in the past week, despite a considerable rise in yield levels. Maturity matched swap spreads in the belly of the curve are narrower by 23bp in the 3- to 5-year sector and 2bp in the 10-year sector, but wider by 0.3bp in the long end of the curve. The modest compression in swap spreads belies the more violent nature of the move in yields; Treasury yields are about 30bp higher in the 7- to 10-year sector, and 10-year yields are now near their six-month highs. In the intermediate sector, we now recommend taking profits on spread narrowing positions. Our narrowing
-20
-10 0 10 # business days around range-break date*
20
* Dates used are 5/31/2007, 5/22/2009, 3/25/2010, 12/14/2010 and 2/4/2011. These dates represent the first date in each contiguous period where 10-year Treasury yields rose above the 6month maximum as of the previous day.
bias in intermediate sector swap spreads has been mainly motivated by the intra-year seasonal pattern of rising corporate supply (and the associated swapping activity) in the March-to-May period. This factor remains a valid one; the pace of issuance remains well above average, as we highlighted last week, and this weeks spread narrowingin the face of sharply higher yieldsis partly a reflection of issuance-related pressures on swap spreads. Notwithstanding the likely continuance of such narrowing pressure, we now recommend turning neutral
43
on intermediate swap spreads, because of growing (and asymmetric) risk of paying from mortgage hedgers and REITS, if rates continue to drift higher. To be sure, with the Fed owning one quarter of the Agency MBS market, with GSE portfolios shrinking, and with prepayments structurally slower due to refi capacity constraints and negative home equity, the hedging flows from mortgage portfolios and servicers in this weeks sell-off have likely been relatively modest. Nonetheless, there is still negative convexity to hedge. We estimate that the aggregate duration of the mortgage servicing universe lengthens by about $1bn 10-year equivalents per each 1bp rise in current coupon mortgage yields (Exhibit 1). Assuming that half of this negative convexity is dynamically managed, paying flows from servicers could pick up going forward if yields continue to rise and break through the upper end of the relatively tight range they have held since August 2011. Some evidence for this is seen in Exhibit 2. Over the past 5 years, 10-year Treasury yields have broken out of their 6-month trading range on five occasions; on average, the subsequent beta between intermediate swap spreads and Treasury yields has tended to pick up, hinting at rising mortgage-related paying flows. This risk is likely asymmetric from current yield levels, and is one tactical reason to be cautious regarding spread narrowing trades. A second risk to spread narrowing positions has to do with potential hedging flows from mortgage REITs. As our mortgage strategists have noted often in recent years, REITs have emerged as important marginal buyers of Agency MBS, with relatively sizeable holdings in aggregate (although they remain small in comparison to the two GSEssee Exhibit 3). To be sure, the business model for REITs centers on levered carry and allows for greater ability to run duration risk in comparison to the GSEs; thus, they are not necessarily dynamic hedgers. Nonetheless, it is reasonable to assume that such investors might look to de-risk their portfolios in periods where rates appear likely to break out of a regime, leading to sizeable hedging flows on an episodic basis. To assess the likely hedging flows from REITs, we created a composite market value index of the top 5 REITs from Exhibit 3. We then regressed rolling 3month changes in the index (in order to cancel out dividend accretion effects) against rolling 3-month changes in market variables, to estimate the current risk exposure of REITs in the aggregate. The results are shown in Exhibits 4 and 5.
44
Exhibit 3: REITs have become a key marginal buyer of MBS in recent months and years
Amounts of Agency MBS held by the top mortgage REITs, q/q change and annual change as of 2011 year-end Agency Holdings ($MM) REIT 2011Q4 Q/Q Change Y/Y Change Annaly Capital Management, Inc. 106,069 (1,517) 25,420 American Capital Agency Corp. 54,784 12,512 41,273 Hatteras Financial Corp. 17,792 34 8,155 Capstead Mortgage Corporation 12,252 25 3,751 Invesco Mortgage Capital Inc. 10,524 363 6,318 CYS Investments, Inc. 9,372 (26) 3,062 Anworth Mortgage Asset Corporation 8,762 18 1,027 MFA Financial, Inc. 7,444 (75) 1,463 Two Harbors Investment Corp. 6,056 (627) 4,840 ARMOUR Residential REIT, Inc. 5,394 (582) 4,232 Dynex Capital, Inc. 1,965 (107) 773
Top 10 Total Top 5 Total 240,414 201,420 10,019 11,417 100,315 84,917
Exhibit 4: A composite index of the top 5 REITs stock prices has tracked the MBS index price in recent months
The J.P.Morgan MBS index price, versus a weighted average of the top 5 REITs stock prices*
20.5 20.0 19.5 19.0 18.5 18.0 17.5 Sep 11 MBS index price Weighted average REIT index price
108.5
108.0
107.5
107.0
Oct 11
Nov 11
Jan 12
Feb 12
106.5 Mar 12
* We used prices of the top 5 REITs in the previous table, with weights of 0.625, 0.193, 0.05, 0.058 and 0.074. Weights based on shares outstanding.
Such an analysis is no doubt imperfect, as numerous other factors could affect traded REIT prices. In addition, coefficients are not stable over longer periods, but this is unsurprising given that REIT holdings of Agency MBS have risen sharply mainly over the past year or so. Nonetheless, three observations are worth making. First, REITs on aggregate seem to hedge a significant portion of duration risk, evidenced by the relatively small coefficient with respect to rates. Second, REITS on aggregate benefit from yield curve steepening. While surprising at first glance, it may reflect the fact that MBS index durations have remained in the 2- to 3-year range in recent months, meaning that if REITs hedged duration using 5-year and 10-year instruments (liquid points in the
Treasury futures / swap markets), they would implicitly be in yield curve steepening positions. Third, REITs are (unsurprisingly) short convexity, and exposed to a widening in the MBS basis. The first two observations suggest that REITs are relatively well hedged currently; however, it also suggests that REITs may be operating under tighter net duration risk limits than generally assumed, meaning that they could become active in hedging any material increase in MBS durations. But perhaps most important, given their considerable mortgage spread exposure, in conjunction with currently tight OAS levels and diminished prospects for QE3-related MBS purchases, REITs could become more active in hedging some part of their spread exposure. This will likely mean paying in swap spreads, given the correlation between mortgage OAS levels and swap spreads. In sum, although issuance remains elevated and threatens to bias intermediate swap spreads narrower, the emerging and asymmetric risk of mortgagerelated paying if yields continue to rise is a powerful tactical offset. Therefore, we now turn tactically neutral on swap spreads, and recommend unwinding spread narrowers in the 10-year sector (see Trade recommendations).
Exhibit 5: REITs on aggregate appear to hedge duration risk, but remain exposed to a widening in MBS spreads
Estimated aggregate exposure* of the top 5 REITs to rates, the curve, convexity and MBS spreads; Aggregate REIT exposure to: Coefficient T-stat 5Y swap yield, $mn/bp -3.2 -1.0 2s/10s curve (adjusted for yield), $mn/bp 54.0 12.4 Long options return* -33.1 -2.4 MBS OAS, $mn/bp -27.6 -2.8 R-squared 88% Data range Past six months
* All coefficients estimated using regression of rolling 3M weighted REIT index price change versus rolling 3M change in 5Y swap rates, adjusted 2s/10s swap curve, long convexity returns and MBS index OAs. Adjusted curve calculated as 2s/10s curve minus 0.58*5Y swap yield. Interpretation of the convexity return coefficient is as follows: REITs stand to lose $33.1mn in a 3-month period where a $1bn notional long 3Mx10Y straddle position produces $1mn in daily-delta-hedged P/L.
Exhibit 6: Stay positioned for a renormalization of the yield curve

115 110 105 100 95 90 85 80
3Mx7Y minus 3Mx3Y plus (0.646*3Mx2Y) minus (0.334*3Yx1Y) swap yield spread; bp
Weighted spread Prior mean Recent mean
Swap yield curve

On the swap yield curve, we continue to recommend efficient ways of positioning for a renormalization. As we highlighted last week, the Feds communications of its funds rate projections has caused the yield curve to shift to a new regime since August 2011. However, while this new yield curve is the result of markets taking the Feds projections at face value and treating it as a de facto commitment, risks to the expectation of a flat-until4Q14 funds rate are growing as the labor market continues to strengthen. In our view, trades designed to position for such a renormalization should have several characteristics they should be relatively non-directional and meanreverting, but should have experienced a discrete shift in their mean levels as part of the change in yield curve regime. In addition, given the uncertain timing of any renormalization (although this weeks sharp move upwards in December 2014 forward OIS rates definitely suggests that such a renormalization is already underway), such trades should ideally have flat or positive carry & slide. (For a more detailed discussion of
75 Mar 11 Jun 11 Sep 11 Dec 11 Mar 12
this theme, see Interest Rate Derivatives, US Fixed Income Markets Weekly, 3/9/2012). One such trade that currently appears attractive is a 3s/7s swap curve steepener, hedged with a weighted 2s/Blues flattener. As seen in Exhibit 6, this trade exhibits all the above characteristics, and has essentially flat carry and slide. Therefore, we now recommend initiating 3-month forward 3s/7s swap curve steepeners, hedged with a weighted 3Mx2Y/Blues flattener (see Trade recommendations). At the same time, this weeks sharp rise in yields also creates attractive opportunities to position for a reversal towards lower yields (if that were to occur) via options. For instance, 5-year spot swap rates have risen by over 20bp this week, closing at 1.347% versus a 1-month average (as of a week ago) of 1.13%. To position for the possibility that rates do not continue their upward renormalization, but instead drift back lower to recent averages, we recommend a receiver swaption spread;
45
specifically, we recommend buying 3Mx5Y receiver swaptions struck at the 5-year spot swap yield, and selling an equal-notional amount of receiver swaptions struck at 1.13%i.e., the recent average level (see Trade recommendations). The maximum profit in this position, which would occur under a return to recent yield levels, is 21.7bp of yield. Maximum loss on the position is 7bp of yield. We also recommend adding exposure to well-hedged carry trades. In particular, we recommend a 10th / 15th ED flattener hedged with a 13th / 18th ED steepener (1:1 weighted). The weighted spread corresponding to this trade is attractive from an entry-level perspective (near its YTD highs), offers about 6bp of slide over 3 months, and is well hedged (it moved by barely 1bp during this weeks sell-off). Risk on this trade (measured as the 2year standard deviation of rolling 3-month change in the weighted spread) is 8.8bp. Therefore, we now recommend initiating EDM4/EDU5 flatteners hedged with EDH5/EDM6 steepeners (see Trade recommendations).
Exhibit 7: Synthetic strategies that combine cash investments with Treasury futures positions outperformed the bond index returns in 1Q12
Quarterly returns* on the J.P.Morgan US Government Bond Index, quarterly returns on a synthetic replication strategy** and excess returns on the synthetic strategy; bp of total return
Index 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 -49 208 417 -109 -117 268 403 121
Synthetic asset -36 207 394 -109 -117 264 374 62
Excess return 13 -1 -23 -1 0 -4 -28 -60 19
93
113
* Quarters defined to begin on first delivery day. For instance, 2Q11 refers to the period from 3/1/2011 5/31/2011. ** Replication strategy constructed using a cash investment in 3M Agency discount notes, and mimicking index risk with TU, FV, TY and US Treasury futures. Futures positions rebalanced monthly.
Bond Index replication

With March Treasury note and bond futures close to expiry, and with most investors having rolled into June, we review the performance of synthetic assets created with Treasury futures during 1Q12. As shown in Exhibit 7, synthetic Treasury assets created by combining cash investments in 3-month Agency discos and long positions in 2-, 5-, 10-year note futures and bond futures (weighted to match the partial-bpvs of the J.P.Morgan US Government Bond Index) have outperformed the index for the first time in the past eight quarters. The total return of the synthetic asset in 1Q12 was 113bp or about 19bp more than the returns in the index. As was the case last quarter, the performance of the synthetic asset has closely followed the movements of the 15s/30s Treasury curve during 1Q12, outperforming as the curve steepened (Exhibit 8). The outperformance has thus been in line with that expected from a replication of the long-end bucket of the bond index using bpv-weighted bond futures contracts. The former extends out to 30-year maturities while the latter has a CTD in the 15-year sector, leaving exposure to the 15s/30s curve as an implicit consequence. Looking ahead, as we did in December, we continue to recommend replacing positions in the bond futures contract with a bpv-equivalent position in the ultra-long
46
Exhibit 8: The outperformance of the synthetic strategy is a consequence of the steepening of the 15s/30s Treasury curve
Cumulative excess return on synthetic strategy* over the J.P.Morgan US Government Bond Index versus the 15s/30s Treasury par curve; bp of total return bp
30 25 20 15 10 5 0 -5 Dec 11
Cumulative excess return 15s/30s Treasury par curve
0.52 0.50 0.48 0.46 0.44 0.42 0.40 0.38
Jan 12
Feb 12
Mar 12
* See previous exhibit.
bond contract as a way to mitigate this long-end Treasury curve exposure in synthetic assets. The ultra-long bond contracts CTD is in the 25-year sector, and is likely to be a better proxy for the long-end maturity bucket of the bond index. Thus, synthetic asset strategies that use the ultra-long bond contract instead of the bond futures contract should produce a more stable replication of the index. This would have been true in 1Q12 as well, as seen in Exhibit 9.
Exhibit 9: an exposure that can be mitigated by using the ultralong bond futures contract in place of the bond contract in synthetic asset strategies
Cumulative excess return on two synthetic strategies* over the J.P.Morgan US Government Bond Index; bp of total return
Exhibit 10: Short volatility positions underperformed this past week

P/L* from short straddles in various options instruments since 3/9/12 and current levels of volatility; bp of notional**
Return Return Theta Adj** Gamma PL Vega PL Current Implied Vol
Current Realized Vol
30 Ultra 20 Bond
10
6M2Y -7 -75 -1.3 -5.4 2.7 2.7 6M5Y -30 -78 -6.7 -23.8 4.8 4.6 6M10Y -41 -41 -9.3 -31.6 6.1 5.1 6M30Y -74 -32 -15.1 -58.7 6.2 5.2 Front FV -24 -63 0.2 -23.9 4.7 4.5 Front TY -33 -38 5.0 -37.8 6.0 5.4 Front US -56 -30 -33.2 -22.7 6.7 5.6 * Returns calculated using the J.P. Morgan Volatility Index, which assumes daily delta rebalancing and zero transaction costs. Options are re-struck at the start of each month. ** Adjusted to a theta-neutral amount of 6Mx10Y swaptions.
Exhibit 11: Swaption volatility actually underperformed the skew this week
Dec 11 Jan 12 Jan 12 Feb 12
-10 Dec 11
* Baseline strategy creates a synthetic asset by combining 3M Agency discos with partial bpvweighted positions in TU/FV/TY and US bond futures. The second strategy replaces positions in the classic bond futures contract with bpv-equivalent positions in the ultra-long bond futures contract..
Actual change in swaption implied volatility levels since 3/9/2012 for options expiring between 1 month and 5 years, on 1- to 30-year underlying swap rates, versus expected change*; abp
20 15 10 3m10y 5 3m2y 0 2y tails -5 0 1y tails 5 10 15 Expected change in swaption implied volatility*; abp 20 y = 0.7457x - 1.6438 R = 0.704
Options
Implied volatility rose sharply into the middle of the week, but retraced later in the week. The rise in implieds came as yields rose to recent highs and threatened a further breakout from their recent range. Rising implied volatility, coupled with elevated delivered volatility, proved quite damaging to short volatility positions, particularly ones delta-hedged using normal deltas as seen in Exhibit 10. What is more notable is that even with these sharp increases week-on-week, implied volatility largely rose by less than what might have been expected, given exante skews; as seen in Exhibit 11, implied volatility across the vol surface generally rose by about 75% of the amount priced into skews as of a week ago. Although this must be deemed an underperformance of implied volatility, our short 3Mx10Y volatility positions lost money this week, even net of the short-duration hedge that we had recommended to address the intrinsic directional exposure of realized volatility (but not the directionality of implied volatility as priced into the skew). The reason is two-fold; first, our delta-hedging assumes the use of normal deltas, meaning that any increases in normal implied volatility (unless otherwise hedged out) results in vega P/L. Second, we had viewed skews as rich, and unlikely to be realizedan analysis analogous
* Derived from the swaption skew as of 3/9/12, evaluated as twice the difference between the implied volatility at a strike equal to the ATMF rate plus the yield change over the week, and the implied volatility at a strike equal to the ATMF rate.
to the exercise in Exhibit 11, but for the 3-month period ending as of a week ago, would show close to a zero beta (slightly negative, in fact), supporting our a priori decision to not explicitly hedge the skew. Thus, our short-duration hedge, which was empirically estimated over the past 18 months when skews were generally flatter than now, proved largely inadequate this week. So why were skews realized to a greater extent this week? We believe it is to a great extent because yields are now much closer to breaking out of the recent range. Rangebound markets tend to produce increased exposure to carry trades, including short volatility positions, as investors seek to take advantage of stable markets to earn excess returns. This appears true of the current
47
Exhibit 12: Given the recent range-bound nature of rates the market appears to have been generally short gamma
Rolling 1-month partial beta of the returns for the top 20 mutual funds versus returns from short 6Mx5Y swaption straddles*;
Exhibit 13: Implied volatility has tended to exhibit increased sensitivity to yields in episodes where yields have broken out of ranges to the upside
Weekly change in 3Mx10Y implied volatility minus the change priced into ex-ante skews (bp/day), averaged over (i) the past 5 years, as well as (ii) conditionally averaged in episodes where yields have broken out of a range to the upside*. The average change in 10-year swap yields (%) in those episodes is also presented for reference
0.4 0.3 0.2 0.1
0.6 0.5 0.4 0.3 0.2 0.1 0.0 -0.1 -0.2 -0.3 -0.4 Jun 11 Sep 11 Dec 11 Mar 12
0.0 -0.1 Overall average Conditional average Conditional chg in rates

* Defined as any day when the yield level exceeds the six month maximum as of the prior day.
* Partial beta calculated from rolling 1-month regressions of return of daily returns versus daily delta hedged return from selling 3Mx10Y straddles, daily change in red ED and 10-year yields, and daily change in MBS and credit spreads.
environmentas seen in Exhibit 12, the major US bond funds, for instance, have likely maintained a short gamma bias for all of the first quarter. However, this growth in short volatility exposure can also mean that when yields break through ranges, investors might seek to cover short vol exposure, producing greater sensitivity of implied volatility to yield levels (assuming yields break out of the range towards the upside). This is illustrated in Exhibit 13, where we show the average difference between the weekly change in 3Mx10Y implied volatility and the change expected based on yield changes and the ex-ante skew. This average has been essentially close to zero over the past five years. However, conditioned upon upside rangebreaks (which we define as any day when the 3Mx10Y swap yield exceeded its 6-month maximum as of the previous day), the excess weekly increase in implied volatility was positive, averaging nearly 0.4bp/day. For reference, the corresponding average conditional change in rates was about 26bp, as also seen in Exhibit 13. Where does this leave us? Going forward, we recommend maintaining short gamma positions, but with an upsized rate hedge. We have often noted that the reactive nature of implieds to a sharp rise in delivered volatility, coupled with the fact that sharp increases in realized volatility tend not to persist unless supported by fundamentals, means that short gamma positions tend to outperform following a spike in implied volatility. This is likely to be the case in the current context; our Treasury
48
strategists are bearish but expect 10-year yields to stabilize near 2.5%, and our model projects that maintaining short gamma positions going forward should prove considerably profitable. However, our model framework also requires the directionality of short straddle returns to be properly hedged. In this regard, with yields poised to break further out of recent ranges, we would expect implied volatility levels to exhibit greater sensitivity to yield levels at least tactically, making skews more likely to be realized. Hedging the directionality of implied volatility for the fixed-strike option that we are short requires an additional swap notional of $10mn; thus, we recommend maintaining a short gamma bias, but recommend upsizing the short duration hedge from $10.7mn to $20mn notional of a pay-fixed 10-year swap position (see Trade recommendations).
Initiate 3Y / 7Y steepeners hedged with weighted 2Y / Blues flatteners We continue to recommend trades that provide an attractive way to position for a possible renormalization of the yield curve to a pre-August 2011 regimea likely outcome if future employment reports continue the strong trend. This weighted spread exhibits little directionality with front-end
rates, flat carry, and is likely to continue to trend higher as the yield curve eventually normalizes. Initiate 3Mx3Y/3Mx7Y swap curve steepeners hedged with weighted 3Mx2Y/3Yx1Y curve flatteners (0.646/0.334 weights) at a weighted yield spread (defined as 3Mx7Y minus 3Mx3Y + 0.646*3Mx2Y minus 0.334*3Yx1Y) of 87.4bp. Carry and slide on this trade is approximately flat over 3 months. Buy 3Mx5Y receiver spreads Considering the possibility that rates do not continue their upward renormalization, but instead drift back to recent averages, we recommend positioning for a reversal towards lower yields via options; buy 3Mx5Y receiver swaptions struck at the current 5Y spot swap yield, and sell an equal-notional amount of receiver swaptions struck at the 1-month average of 1.13%. Buy $100mn notional of a 1.347%/1.13% 3Mx5Y receiver swaption spread (1:1 weighted, notification 06/18/2012, maturity 06/20/2017; buy the 5Y spot 1.347% strike and sell the 1.13% strike, ATMF at 1.464%) @ a premium of 34bp of notional. Initiate EDM4 / EDU5 flatteners hedged with EDH5 / EDM6 steepeners We recommend adding exposure to well-hedged carry trades such as the 10th / 15th ED flattener hedged with 13th / 18th ED steepener (1:1 weighted). This trade is also attractive from an entry level perspective. Buy 1000 EDU5 futures versus selling 1000 EDM4 futures and also buy 1000 EDH5 futures versus selling EDM6 futures @ a yield spread of 2bp, defined as EDM4 yield minus EDU5 yield + EDM6 yield minus EDH5 yield. Three month carry on this trade is 6.5bp. Stay short delta-hedged 3Mx10Y swaption straddles, but upsize duration short We continue to recommend selling 3Mx10Y vol hedged for rates. However, given the greater likelihood of skews being realized as yields rise, we recommend upsizing the short-duration swap hedge. Stay short $100mn notional of 3Mx10Y swaption straddles (notification date 6/11/2012, maturity date 6/13/2022, ATMF and strike 2.189%) versus paying fixed in $20mn notional (upsizing our previous recommendation of $10.7mn notional) of a 3Mx10Y forward starting swap (swap start date 6/13/2012, swap end date 6/13/2022) (US Fixed Income Markets Weekly, 03/02/12). P/L since inception: loss of 5.8abp.
Stop receiving in 10-year swap spreads hedged with 20% risk in September FRA-OIS wideners Having changed our view on intermediate swap spreads to neutral due to growing risk of paying from mortgage hedgers and REITs in a selloff, we recommend unwinding this trade. Stop receiving in $100mn notional of 2% Feb 22 maturity matched swap spreads (cover shorts in $100mn notional of 2% Feb 22s, and stop receiving fixed in $96.2mn notional of a 2/15/2022 swap), and stop paying 20% of the risk (or $18035/bp) in September 2012 3M FRA-OIS spreads @ a profit of 2.5bp of yield (US Fixed Income Markets Weekly, 2/24/12). Stop receiving fixed in the belly of a 3-month forward weighted 5s/10s/30s swap butterfly This weighted yield spread has converged to the 6month average value at inception of the trade. Therefore, we recommend unwinding it. Stop receiving fixed in $100mn notional of a 3Mx10Y forward starting swap (swap start date 04/24/2012, swap end date 04/25/2022), stop paying fixed in $133mn notional of a 3Mx5Y forward starting swap (swap start date 04/24/2012, swap end date 04/24/2017) and stop paying fixed in $21.9mn notional of a 3Mx30Y forward starting swap (swap start date 04/24/2012, swap end date 04/24/2042) @ a profit of 2.7bp of yield (US Fixed Income Markets Weekly, 1/20/12). Stop paying in 3.25% June 16 spreads versus receiving in 3.25% July 16 maturity matched swap spreads This trade was designed to take advantage of the dislocation in the swap spread curve term structure for old 7-year in the Apr-June 2016 maturity sector, which has considerably corrected. Thus, we recommend unwinding this trade. Unwind longs in $100mn notional of 3-1/4% June 16 and stop paying fixed in $105.3 notional of a 06/30/2016 swap; cover shorts in $98mn notional of 31/4% of July 16 and stop receiving fixed in $103.5mn notional of a 7/31/2016 swap @ a profit of 0.9bp of yield (US Fixed Income Markets Weekly, 03/02/12). Maintain Reds / 10Y steepeners hedged with weighted 2Y / Blues flatteners Maintain 1Yx1Y/3Mx10Y swap curve steepeners hedged with weighted 3Mx2Y/3Yx1Y curve flatteners (1.11/0.485 weights) (US Fixed Income Markets
49
Weekly, 03/09/12). P/L since inception: profit of 10.6bp of yield. Maintain conditional belly cheapening positions in a sell-off on the EDU3/7Y/25Y butterfly using ED midcurve puts and payer swaptions Stay long $100mn notional of 6Mx7Y payer swaptions (notification 09/14/12, maturity 09/18/19, strike 1.797%), stay short 1598 0EU2 99.375 puts (midcurve option expiry 09/14/12, EDU3 strike 99.375), and stay short $22.3mn notional of 6Mx25Y receiver swaptions (notification 09/14/12, maturity 09/18/37, strike 2.845%). (US Fixed Income Markets Weekly, 03/02/12). P/L since inception: profit of 2.2bp of yield. Maintain 30-year swap spreads wideners Continue to pay in 4.75% of Feb 2041 spreads (stay long $100mn notional of the 4.75% of Feb 2041, and continue to pay fixed in $110.3mn notional of a 02/15/2041 swap). (US Fixed Income Markets Weekly, 2/24/12). P/L since inception: loss of 0.8bp of yield. Maintain 5-year swap spread wideners in a rally Stay long 1,000 FVM2 123.25 calls (FVM2 @ 12304, strike 123.25, expiry 5/25/2012) and stay short $129mn notional of a 05/25/12x8/31/16 receiver swaption (notification 05/25/12, swap start date 07/05/12, maturity 8/31/16, strike 1.073%, ATMF 1.098%) (US Fixed Income Markets Weekly, 2/24/12). P/L since inception: loss of 0.7bp of yield. Stay long 3Mx1Y payer spreads Stay long $100mn notional of a 0.506%/0.756% 3Mx1Y payer swaption spread (1:1 weighted, notification 5/10/2012, maturity 5/14/2013, ATMF 0.506%; buy the ATMF strike and sell the A+.25 strike) (US Fixed Income Markets Weekly, 2/10/12). P/L since inception: profit of 0.1bp of yield. Maintain belly cheapening position on the 1-year forward 2s/5s/10s swap butterfly Continue to pay fixed in $100mn notional of a 1Yx5Y forward starting swap (swap start date 02/14/2013, swap end date 02/14/2018, yield 1.513%), continue to receive fixed in $138.3mn notional of a 1Yx2Y forward starting swap (swap start date 02/14/2013, swap end date 02/17/2015, yield 0.734%) and continue to receive fixed in $29.6mn notional of a 1Yx10Y forward starting swap (swap start date 02/14/2013, swap end date 02/14/2023, yield 2.354%) (US Fixed
Closed trades in 2012
P/L reported in bp of yield for swap spread, yield curve and miscellaneous trades, and in annualized bp of volatility for option trades, unless otherwise specified
Trade Swap spreads 10-year swp sprd widener Front end swap spread wideners via options Pay Aug 20 vs Feb 20 sprds (hedged) Rec in 10Y swp sprds (hedged) Pay 3.25 Jun16 vs rec 3.25 Jul16 swp sprds Yield curve 5s/10s swp sprd crv steepeners 3m fwd 1s/15s crv flatteners via rec swptns Buy belly of EDZ2/EDZ3/EDZ4 bfly Buy wtd WN calendar sprd PL in 32nds Rec in belly of 3M fwd wtd 5/10/30s swap bfly Options relative value Sell 10s/30s YCSO vs 6Mx2Y swptn strddls Buy 6Mx5Y vs 9Mx5Y swptn strddls Entry 01/06/12 01/06/12 01/20/12 02/24/12 03/02/12 Entry 11/04/11 01/06/12 01/20/12 02/10/12 01/20/12 Entry 10/28/11 01/20/12 Exit 1/20 2/3 2/3 3/16 3/16 Exit 2/3 2/3 3/2 3/2 3/16 Exit 1/27 2/10 P/L (1.8) (4.4) 1.7 2.5 0.9 P/L (3.5) (16.1) (9.9) 1.9 2.7 P/L 18.2 (0.6)
Income Markets Weekly, 2/10/12). P/L since inception: loss of 2.1bp of yield. Maintain conditional 2s/30s steepeners via 3-month expiry options, versus selling 3-month expiry caps on the 2s/30s CMS curve Stay long $50mn notional 3Mx30Y payer swaptions (notification 5/3/2012, swap start date 5/8/2012, swap maturity date 5/8/2042, ATMF and strike 2.883%) versus staying short $500mn notional 3Mx2Y payer swaptions (notification 5/3/2012, swap start date 5/8/2012, swap maturity date 5/8/2014, ATMF and strike 0.5275%); also stay short $998.5mn notional of 3-month expiry 1-look caps on the 2s/30s CMS curve (end date 5/8/2012, ATMF CMS 10s/30s yield spread and strike at 239.7bp) (US Fixed Income Markets Weekly, 2/3/12). P/L since inception: profit of 1.4bp of yield. Maintain 30-year matched maturity swap spread wideners, hedged with 5-year swap spread wideners and the 5s/30s Treasury yield curve Stay long $50mn notional of 3.125% of Nov 2041s and pay fixed in $51.6mn notional of a 11/15/2041 swap; also, stay long $95mn notional of 0.875% of Jan 2017s and continue to pay fixed in $67.4mn notional of a 01/31/2017 swap (US Fixed Income Markets Weekly, 1/27/12). P/L since inception: loss of 3.5bp of yield. Maintain synthetic conditional trade by selling 10s/30s YCSO caps versus 10Y receiver swaptions Sell $500mn notional (i.e., $50K/bp forward DV01) of single-look 6-month caps on the 10s/30s swap curve
50
(end date 6/11/12, strike and ATMF 10s/30s CMS yield spread at 60.1bp) versus buying $21.3mn notional of 6Mx10Y receiver swaptions (notification date 06/11/12, maturity date 06/13/22, ATMF and strike 2.335) (US Fixed Income Markets Weekly, 12/09/11). P/L since inception: loss of 0.4bp of yield. Stay long 6Mx30Y versus 6Mx10Y swaption straddles Stay long $43.7mn notional of 6Mx30Y swaption straddles (notification date 8/24/2012, maturity date 08/29/2042, ATMF and strike 2.849%) and stay short $100mn notional of 6Mx10Y swaption straddles (notification date 8/24/2012, maturity date 8/30/2022, ATMF and strike 2.220%) (US Fixed Income Markets Weekly, 2/24/12). P/L since inception: loss of 5.7abp. Stay short 6M single-look CMS curve straddles on the 2s/10s swap curve Stay short $250mn notional of 6-month curve straddles on the 2s/10s CMS curve (end date 09/06/2012, ATMF CMS 2s/10s yield spread and strike at 1.64%) (US Fixed Income Markets Weekly, 03/02/12). P/L since inception: loss of 3.8abp. Stay long delta-hedged 3Mx2Y swaption straddles layered with a duration long Stay long $100mn notional of 3Mx2Y swaption straddles (notification date 6/11/2012, maturity date 6/13/2014, ATMF and strike 0.620%) and continue to receive fixed in $28.6mn notional of a 3Mx2Y forward starting swap (swap start date 6/13/2012, swap end date 6/13/2014) (US Fixed Income Markets Weekly, 03/09/12). P/L since inception: profit of 0.3abp.
51
Japan Rates Research Global Fixed Income Markets Weekly March 16, 2012 Takafumi Yamawaki (81-3) 6736-1748 Yuya Yamashita, CFA (81-3) 6736-1493 JPMorgan Securities Japan Co., Ltd
Japan
The bank left the policy unchanged, as was widely expected. Most had expected to see usual rangebound moves this week, but the sell-off in US Treasuries following the FOMC statement triggered a sell-off in JGB futures. The futures were sold off by 139 cents in two days The concept of relative values was lost and that of momentum gained grounds. The implied volatilities in the gamma sectors exploded There had existed some backgrounds that could accelerate sell-offs, such as 1) Greece completing the debt exchange, 2) the significant rally in equities and depreciation of the JPY since the beginning of this year, and 3) the long-lasting range-bound JGB market and skewed positioning Going forward, we do not expect a large sell-off or a consistent rise in yields from here, because 1) there are still another 3 months until Operation Twist ends, 2) trend-following speculative investors must cover the shorts at some point in the future, 3) the short-to-intermediate yields will likely remain relatively low and stable as long as the BoJ continues to buy JGBs under the Asset Purchase Program (APP), and 4) equities may have a fall-back We unwind the 5s/8s flattener while maintaining long 7Y via weighted 5s/7s/10s butterfly The rise in gamma volatilities appears to provide a good opportunity for selling short expiry options. We here recommend selling 3Mx10Y payers swaption with the strike of ATMF + 20bp
Exhibit 1: The futures price broke lower than the 200-day moving average, probably switching on selling by trend-following speculative investors
Front JGB futures price and 200-day moving average; yen
144 143 142 141 140 139 138 Apr '11
JGB Futures price 200 day moving average Jun '11 Aug '11 Oct '11 Dec '11 Feb '12
Source: Bloomberg, J.P. Morgan
Exhibit 2: The 5Y yield broke the range higher and closed at 0.37% on 15 March. The move was impressive, considering the fact that the medium-term sector had remained very firm after the BoJs meeting in February 2012
5Y JGB yield since April 2011; %
0.60 0.55 0.50 0.45 0.40 0.35 0.30 0.25 0.20 Apr '11 0.28 0.35
Jun '11
Aug '11
Oct '11
Dec '11
Feb '12
Overview
The week started on a slightly bullish tone despite the strong US payroll numbers last Friday. Some investors might have expected further monetary easing in the BoJs Monetary Policy Meeting on 12 and 13 March. After all, the BoJ did not surprise the market. The bank left the policy unchanged, as was widely expected. Although no change in the policy was the consensus view, some had expected an indication of further easing in the banks statement or at Governor Shirakawas press conference after the meeting. However, it appears that there was no such hint. With no apparently strong
52
market drivers, most had expected to see usual rangebound moves this week. The picture dramatically changed after the sell-off in US Treasuries following the FOMC statement on 13 March. The sell-off in the US equivalent triggered the sell-off in JGBs. The futures were sold off by 46 cents on the next day, which translates to 4.3bp in 7Y yields. The futures price broke lower than the 200-day moving average, which probably switched on selling by trend-following speculative investors (Exhibit 1). Another wave of selling came on the following day and the futures price declined by another 85 cents. The futures price drove the selling came on the following day and the futures price
declined by another 85 cents. The futures price drove the cash market. Although the 5Y yield managed to stay within the recent range of 0.28-0.35% on 14 March, it broke the range higher and closed at 0.37% on 15 March (Exhibit 2). The move was impressive, considering the fact that the medium-term sector had remained very firm after the BoJ announced the expansion of the APP in February. The super-long sectors remained relatively strong on the curve, but the 20Y sector was choppy before and after the 20Y auction. Although the earlier expectation was negative, the auction result turned out to be extremely strong, with the average yield coming 1bp through the offer side of the morning close. Then, the curve massively bear flattened. However, the market once again followed the recent pattern of heavy upside after strong auction results, and the new 20Y JGB were sold off by about 4bp. Meanwhile, the 30Y and 40Y sectors remained strong in the super-long sectors as well as on the entire curve. It seems that real money investors took the sell-offs as a good opportunity to build positions before fiscal year-end (end of March) It appeared that the concept of relative-values was lost and that of momentum gained grounds. The futures sector (7Y-8Y) was sold off by more than 10bps and the shape of the yield curve around 7Y now appears extreme. The super-long sectors remained firm amid the considerable sell-off in the shorter sectors (Exhibit 3). The swap curve was also shifted upwards but the striking difference from the JGB curve is in the super-long sectors. The super-long end swap curve moved higher in a relatively parallel fashion (Exhibit 4), causing a richening in the super-long end ASWs. The implied volatilities exploded, especially in the gamma sectors. The gamma volatilities spiked and the rise was more than what had been implied by the skew. For example, the skew of the 3Mx10Y payers swaption a week ago had predicted an approximately 0.1bp/day rise in implied volatility per every 10bp increase in the ATMF. However, the actual 10bp rise in the ATMF this week resulted in a 0.94bp/day rise in the implieds. The rise in the vega sector volatilities also outperformed the same skew prediction, but the extent was a lot smaller than in the gamma sectors (Exhibit 5). We think these facts indicate that the price actions in the volatility market might have reflected simply the short-term price movements in the underlying interest rates and not
Exhibit 3: The futures sector (7Y-8Y) was sold off by more than 10bps. The super-long sectors remained firm amid the considerable sell-off in the shorter sectors
JGB yield change over this week; bp
12 10 8 6 4 2 0 1 2 3 4 5 6 7 8 910 12 15 20 Maturity 25 30 40
Exhibit 4: The super-long end swap curve moved higher in a relatively parallel fashion, causing a richening in the super-long end ASWs
Swap rate change over this week; bp
9 8 7 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 101112131415161718192021222324252627282930
Exhibit 5: The gamma volatilities spiked and the rise was far more than what had been implied by the skew, while the rise in the vega sector volatilities was relatively limited
3Mx10Y and 2Yx10Y ATMF implied volatilities since 2011; bp/day
5.00 4.50 4.00 3.50 3.00 2.50 2.00 1.50 Jan '11 May '11 Sep '11 Jan '12 2Y x 10Y 3M x 10Y
53
investors long-term or structural views such as Japans fiscal concerns. While the sell-off in US Treasuries after the FOMC statement did trigger the sell-off in JGBs, in hindsight, there did exist some background that could accelerate sell-offs. First, Greece finally completed the debt exchange. The possibility of sudden and disruptive risks had significantly lowered, making it easy for investors to buy risky assets instead of safe assets. Second, rally in debts and equities can take place under global monetary easing, as we suggested last week. Still, the rally in equities and the depreciation of the JPY since the beginning of this year was significant and could have been a good reason for bond investors to reduce positions. Third, the JGB market had been range-bound for so long and investors positions could have been skewed too much towards longs. Going forward, we do not expect a large sell-off or consistent rise in yields from here. There could still be some portfolio adjustment activities of domestic investors, and trend-following speculative investors may make another round of shorts on the futures. However, there are some reasons to expect a rebound of the moves. First, there is still another 3 months until Operation Twist ends. Upside in JGB yields could be limited, at least in the near future, as long as the Fed purchases the longterm US Treasuries and stabilises UST yields. Second, if the futures price auctions this week were driven by trendfollowing speculative investors, as we believe they were, they must cover the shorts at some point in the future. Third, short-to-intermediate yields will likely remain relatively low and stable as long as the BoJ continues to buy JGBs under the APP, and some market participants expect additional easing measures such as a further upsizing of the JGB purchase under the programme or an extension of the maturity of JGBs eligible under the programme. Finally, the rally in equities since the beginning of this year appears very quick and large when compared with the past movements, prompting us to think of the possibility of a fall-back (Exhibit 6). The Democratic Party of Japan (DPJ) is now doing the preliminary review for the bill on the consumption tax hike. The outline of the consumption tax hike itself, where the rate is hiked to 8% in April 2014 and to 10% in October 2015, was already approved within the DPJ in January 2012 as part of the integrated tax and social welfare reform plan. Then, the plan was officially approved by the cabinet in February 2012. Prime Minister Yoshihiko Noda reportedly plans to submit the
54
Exhibit 6: The rally in equities since the beginning of this year appears very quick and large when compared with the past movements, prompting us to think of the possibility of a fall-back
Nikkei 225 since 2009; Yen
12000 11000 10000 9000 8000 7000 6000 Jan '09
Jul '09
Jan '10
Jul '10
Jan '11
Jul '11
Jan '12
bill to the Diet this month and the party is now discussing specifically the bill on consumption tax hike. According to news reports, some members showed opposition to additional clauses that enable further tax hikes (above 10% after 2015), but not to the originally planned tax hike. It would be difficult to do so after the plan was once approved by the party and then officially by the cabinet. In addition, there are reports that the party leadership could amend or delete such additional clauses so that the party puts together the tax plan and submits the bill within this month. We continue to think that the probability for another Ozawa Shock is very low, but we need to keep monitoring progress on this issue ahead of the bills submission to the Diet.
Trade idea updates

The 5s/8s flattener was particularly hit hard by this weeks future led sell-offs. We unwind the position at a loss. The 5s/8s curve flattened by 8.4bps since we initiated the trade but the loss was partly offset by its good rolldown. Most of the loss came from this weeks sell-off. However, the other reason is that we underestimated the effect of the BoJs announcement last month. After the announcement, the short to intermediate yields even lowered and remained to be low. Even if the futures price rebounds, the BoJs support may keep the 5Y yields at a low level and the flattening of the 5s/8s curve may be limited. Meanwhile, we maintain long 7Y via weighted 5s/7s/10s butterfly. The trade underperformed by 3.1bps since initiation. All of the loss is due to the 7Y long but the
loss has been limited due to the reduced weight in the belly. Though there could be still some sell-offs, we expect the trade to finally perform. As we explained above, we expect a rebound in the futures price with short covering some time in the future. In addition, the weighted butterfly spread was pushed up to the extreme level (Exhibit 7) not only by the 5s/7s but also by the flattening of 7s/10s curves (Exhibit 8). The rise in gamma volatilities appears to provide a good opportunity for selling short expiry options. We recommend selling 3Mx10Y payers swaption with the strike of ATMF + 20bp. The premium paid upfront is currently about 37 cents (mid). We recommend the trade for the following reasons. First, as we explained previously, we view that the outperformance in the gamma sectors simply reflected the bearish price moves in the underlying interest rates and not investors longterm or structural views, and therefore, expect a reversal. Second, the payer skew has been widening since September 2011 and is at around the widest level since 2011 (Exhibit 9). Third, the current ATMF 20bp is about 1.35% and the breakeven swap rate after the premium paid upfront is considered is 1.38%. The level was reached only under extreme environments since mid2010 such as the sell-off backed by the Feds QE2 and the profit-taking selling after the Great Tohoku Earthquake (Exhibit 10).
Exhibit 8: not only by the 5s/7s but also by the flattening of 7s/10s curves
JGB 5s/7s and 7s/10s curves since 2011; bps
55 50 45 40 35 30 25 20 15 10 '11/1 '11/3 '11/5 '11/7 '11/9 '11/11 '12/1 '12/3 7s/10s 5s/7s
Exhibit 9: The payer skew has been widening since September 2011 and is at around the widest level since 2011
Difference between ATM payers vol and 20bp OTM payers vol since 2010; bp/day
0.35 0.30 0.25 0.20 0.15 0.10 0.05 0.00 Jan '10
May '10
Sep '10
Jan '11
May '11
Sep '11
Jan '12
Exhibit 7: The weighted butterfly spread was pushed up to the extreme level
JGB weighted 5s/7s/10s butterfly since 2012; bps
-25
Exhibit 10: The breakeven swap rate level of 1.38% was reached only under extreme environments since mid-2010, such as the sell-off backed by the Feds QE2 and the profit-taking selling after the Great Tohoku Earthquake
Spot 10Y swap rate since 2010; bps
1.6 1.5 1.4 1.3 1.2 1.1 1.0 Spot 10Y swap rate Break-even
Weighted 5s/7s/10s butterfly
-30 -35 -40 -45 -50 -55 0.30
0.50
0.70 7Y JGB Yield (%)
0.90
1.10
0.9 Jan '10
Jun '10
Nov '10
Apr '11
Sep '11
Feb '12
Source: J.P. Morgan *the weighted buttefly = -100% x 5Y + 168% x 7Y -100% x 10Y 55
Recommended trades
Maintain neutral stance on duration Maintain JGB steepeners (such as 8s/30s) Maintain paying 10Y swap via 5s/10s/20s butterfly Maintain FX LIBOR basis 1s/5s steepener Maintain weighted 20s/30s swap spread curve flattener Maintain paying 3x2 forward swap with long JGB futures Maintain long 7Y JGB via weighted 5s/7s/10s butterfly Unwind JGB 5s/8s flattener Sell 3M x 10Y payers swaption with the strike of ATMF + 20bp
56
European Rates Strategy Global Fixed Income Markets Weekly March 16, 2012 Sally AuldAC (61-2) 9220-7816 sally.m.auld@jpmorgan.com J.P. Morgan Securities Australia Limited
Australia & New Zealand

Our current view is that the RBA will be on hold for an extended period, but if policy were to change this year, it would be biased towards lower rates. At the moment, the RBAs expectation is centred on trend growth and inflation consistent with the target band, but the recent data pulse suggests that growth disappointment could be the theme (once again) in 2012. Indeed, after a run of broadly better data earlier in the year, the data pulse has turned negative rather quickly of late Our tactical short-duration position has worn some mark-to-market volatility since we last published, but has performed well over the course of the week as UST 10Y yields finally broke their recent trading range. Our US rates strategy team retains a bearish bias and targets US 10Y yields to reach 2.50%. Our technical strategists also have a bearish view, given that the market has moved from a trading range market to a trending market We continue to believe that AUS-US 10Y spread compression trades are one of the better strategic trades for the Australian market. In a broad sense, the theme of growth rotation (away from EM Asia/Australia towards the US) may continue, especially if high-frequency data momentum is any indicator. We think this trade should perform well when implemented in either real or nominal space Our preferred trade, currently, is a forwardstarting steepener in AUD swaps. These positions do not have too much negative roll-up to spot, given the flatness of the forward curve structure. Also, these trades will perform well if the US curve continues to bear-steepen (the near-term risk, as we note above) or if the RBA ultimately delivers more easings. We recommend entering a 2s/9s swap curve steepener, 1Y forward We think NZ outrights and curve spreads are largely fairly priced given the macroeconomic and policy backdrop and, as such, are neutral duration and curve spreads at these levels. The recent sell-off in NZD rates means that carry and slide in received positions is starting to look attractive again (for example, 1Y/1Y swap offers 3-month carry and slide of 14.4bp). We would look to enter received positions in 1Y/1Y swap at 3.6% (current: 3.42%)
Exhibit 1: Economic surprise index for Australia

Index 100
80 60 40 20 0 -20 -40 -60 -80 -100 Jan-10 Sep-10 May -11
20 day m.a.
Jan-12
Source: J.P. Morgan, Bloomberg
Monetary policy update: how long can the RBAs tough love last?
The broader macro backdrop has not changed much, with the data providing mixed signals on the economy, albeit with a weaker bias of late (consumer confidence, dwelling starts, housing finance, GDP). Our current view is that the RBA will be on hold for an extended period, but if policy were to change this year, it would be biased towards lower rates. At the moment, the RBAs expectation is centred on trend growth and inflation consistent with the target band, but the recent data pulse suggests that growth disappointment could be the theme (once again) in 2012. Indeed, after a run of broadly better data earlier in the year, the data pulse has turned rather quickly of late (Exhibit 1). Obtaining a decent read on the domestic economy is difficult at present, especially distinguishing between the effects of structural changes and cyclical forces. In addition, the exact stance of policy is harder to determine post crisis: fiscal policy will be contractionary if the governments budget forecasts are achieved (Exhibit 2), the AUD seems to have decoupled from commodity prices somewhat, but on the other hand, term yields remain close to all-time lows. It is interesting to observe that the Norges Bank cited a strong currency when it delivered a surprise rate cut this week; as our FX Strategy team noted, The message for investors is not to ignore currency adjustments to the extent that these become a problem for policymakers the group of countries that are erecting ever-higher barriers to prevent excessive currency appreciation just got larger today (a Nordic front for the currency wars that extends from Switzerland to Brazil, and could yet take in other countries such as NZ).
57
When thinking about the broader stance of policy, a longterm chart of the real cash rate is telling. The rise in the real cash rate since the cyclical trough in 2009 has been one of the sharpest tightenings since the early-1990s a 350bp rise in two years (Exhibit 3). Further, while the current level of the real cash rate looks low by historical standards, it probably does not look so low if the currency is taken into account. So, considering one measure at least, the tightening cycle of the past couple of years was quite aggressive. Ultimately, the path of monetary policy is likely to be guided largely by the path of the unemployment rate even the RBAs Deputy Governor has said as much: Of course, it is possible for exchange rates to overshoot An important indicator here is the labour market, with the unemployment rate having been in the 5 to 5 per cent range over the past year. If the unemployment rate were to rise persistently, it might suggest that the contractionary effect of the high exchange rate was more than offsetting the expansionary effect of the investment boom and the terms of trade. If this were to turn out to be the case, monetary policy would have the flexibility to respond provided the inflation outlook remained benign. (Our emphasis) This suggests that the best guide to policy will be leading indicators of the labour market in particular, the unemployment rate. In this context, the recent read on ANZ newspaper job ads was telling (Exhibit 4). It will be interesting to see whether the March data on job ads (due on 10 April) will validate the latest data print. If so, then risks to the policy and economic outlook would be heavily biased towards a significantly higher unemployment rate at some point in 2012. We are taking a small profit on our OIS curve steepener and have now reduced conviction in this trade, given risks to the economic and policy outlook.
Exhibit 2: Aggressive fiscal consolidation

One-year change in budget balance as a % of GDP; ppts
3 2 1 0 -1 -2 -3 -4 -5 1971-72 1979-80 1987-88 1995-96 2003-04 2011-12
Exhibit 3: Real cash rate cycles the last tightening cycle was
%
6.00 5.00 4.00 3.00 2.00 1.00 0.00 -1.00 -2.00 Mar-93
2.8-ppts in 12mths 1.6-ppts in 18mths 2.7-ppts in 72mths 3.5-ppts in 24mths
Aug-97
Jan-02
Jun-06
Nov -10
Exhibit 4: ANZ newspaper job ads look soft

oya % ppts
Strategy update: take profits on tactical shorts and OIS curve steepeners, enter forward-starting swap-curve steepeners
Our tactical short-duration position has worn some mark-tomarket volatility since we last published but has performed well over the course of the week as UST 10Y yields finally broke their recent trading range. Our US rates strategy team retain a bearish bias and target US 10Y yields to reach 2.50%. Our technical strategists also have a bearish view, given that the market has moved from a trading range market to a trending market (see M. Krauss, Global FI Technical Strategist, 14 March 2012). Despite this, we have decided to take profits at current
58
50 30 10 -10 -30 -50 -70 Mar-95
ANZ new spaper job ads, lhs, pushed fw d. 6 mths Annual change in the u-rate, rhs, inv erted
-2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5
Uses Feb reading for Q1 data Feb-00 Jan-05 Dec-09
2.0
levels on our short in 3Y bonds, seeing as yields have reached the top of the recent trading range. As we noted above, we have also taken profits on our AUD OIS curve steepener, largely because we are no longer so confident about the broader policy backdrop being strongly in favour of a neutral rates environment. We continue to believe that AUS-US 10Y spread compression trades are one of the better strategic trades for the Australian market. In a broad sense, the theme of growth rotation (away from EM Asia/Australia towards the US) may continue, especially if highfrequency data momentum is any indicator (Exhibit 5). We think this trade should perform well when implemented in either real or nominal space. Indeed, Exhibit 7 illustrates scope for ongoing real-yield compression in 10Y spreads. Further, if we think about relative inflation-term risk premia, the relative central bank stance (and credibility) should once again favour the AUS 10Y nominal bond over and above the US 10Y nominal bond. We hold our 10Y spread narrowing trade (Entry: 203bp, Current: 197bp, Target: 180bp). Our preferred trade, currently, is a forward-starting steepener in AUD swaps. There are a number of reasons for this. First, these positions do not have too much negative roll-up to spot, given the flatness of the forward curve structure. Second, these trades will perform well if the US curve continues to bear-steepen (the near-term risk, as we noted above) or if the RBA ultimately delivers more easings. Exhibit 7 illustrates that the curve tends to be well correlated with moves in the RBA cash rate. In terms of forward-starting curve spreads, we prefer to implement the trade by receiving 1Y/2Y swap against 1Y/9Y swap: Enter a steepener by receiving 1Y/2Y swap against 1Y9Y swap at a spread of +73bp (vs. a spot spread of +69bp), target a move to +95bp, and place a stop at +63bp. The trade offers 3-month carry and slide of 1.4bp.
Exhibit 5: Relative economic surprise indices, AUS vs. US

Index
150 100 50 0 -50 -100 -150 Jan-10 Sep-10 May -11 20 day m.a. US out-performance Jan-12 AUS out-performance
Exhibit 6: AUS-US 10Y real yield spread

ppts ppts
2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 Jun-99
10y AUS-US real y ield spread, lhs Real GDP spread, rhs, pushed fw d 5q
7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0
Aug-02
Oct-05
Dec-08
Feb-12
Exhibit 7: 2s/9s curve, 1Y fwd vs. RBA cash rate

ppts %
1.5 1.0 0.5 0.0 -0.5 -1.0 Mar-00
Offshore holdings of ACGBs reach a new record-high at the end of 2011

The release of the Balance of Payments data for the December quarter of 2011 showed a new high in offshore ownership of ACGBs. Foreign investors now own a record 76.3% of the Australian governments bond market (Exhibit 8). Net inflows into the market from offshore recorded their fourteenth consecutive quarterly increase net inflows were $21.4bn in the fourth quarter of 2011 (Exhibit 9).
2s9s sw ap curv e, 1Y fw d, pushed fw d. 3m, lhs RBA cash rate, lhs, inv erted
3.0 4.0 5.0 6.0 7.0 8.0
Oct-03
May -07
Dec-10
59
Generally speaking, demand from offshore has largely absorbed most of the net supply in ACGBs over the past two years. ACGBs outstanding have increased by $125bn over the past two years, while offshore holdings have increased by $110bn over the same period. Domestic bank holdings of ACGBs have remained largely stable over the past couple of years (at around $20bn). In our view, foreign demand for ACGBs continues to be driven by central bank reserve diversification and, increasingly, interest from private retail and institutional investors. Australia still retains one of the highest term structures of yields of any AAA-rated sovereign issuer; for many investors, this alone appears to be a compelling justification for investment in ACGBs. We continue to expect offshore demand for ACGBs to keep term yields suppressed in Australia (financial repression does not necessarily respect borders). Our analysis suggests that a 1ppt increase in offshore holdings of ACGBs lowers the fair value estimate of 10Y bonds by around 4.5bp, all other things being equal. Structurally higher foreign demand for ACGBs implies that 1) the term structure of rates in Australia will remain lower than has historically been the case, 2) swap spreads will be structurally wider, and 3) the 3s/10s spread will be structurally flatter.
Exhibit 8: Foreigners hold 76% of ACGBs in issue a new high

Proportion of ACGBs held offshore; ppts
0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 Sep-88 Jun-93 Mar-98 Dec-02 Sep-07
Exhibit 9: No sign that interest in ACGBs is waning

$Quarterly net inflows into ACGBs; AUDbn
30000 25000 20000 15000 10000 5000 0 -5000 Dec-88 Feb-93 Apr-97 Jun-01 Aug-05 Oct-09
RBNZ at peace with higher NZD and lower rates: curves will trade directionally, and we like receiving on dips
The RBNZs Monetary Policy Statement was more dovish than most expected, with the RBNZ citing sustained strength in the currency as reducing the need for future increases in the OCR. The RBNZ appears to have finally accepted that the higher NZD is a structural phenomenon, which, all other things being equal, has generated tighter financial conditions. In addition, the coming fiscal adjustment in New Zealand is significant (Exhibit 10). Taken together, we think the currency and fiscal adjustments imply a low for longer environment for New Zealand term rates. Curve spreads should trade directionally and strategically we would favour being better receivers of NZD rates. We think NZ outrights and curve spreads are largely fairly priced, given the macroeconomic and policy backdrop and, as such, are neutral duration and curve spreads at these levels. The recent sell-off in NZD rates means that carry and slide in received positions is starting to look attractive again (for example, 1Y1Y swap offers 3M carry and slide of 14.4bp). We would look to enter received positions in 1Y1Y swap at 3.6% (current: 3.42%).
60
Exhibit 10: Relative fiscal consolidation NZ leading the pack

ppts
Germany Japan France Canada Euro-area Italy Spain UK United States Australia New Zealand 0 2 4 6 8
Change in budget balance 2011 to 2013 (ppts)
Trade Updates
Current Trades
Date 7-Feb Trade AUS-US 10Y spread contraction trade Entry 203.0bp Current 197.7 P/L +5.3bp Stop 213.0bp Target 180.0bp Comment Hold Trade. We like the spread narrowing trade as a strategic position to reflect AUS outperformance. Take Profits. Outrights have reached the bottom of the recent trading range.
8 Feb
Sell YM1 QTC ASW flattener (Jul-22s vs. Nov14s) AUD OIS steepener (3-month vs. 12month) Buy KfW Jan-16s vs. EIB Apr-15s on ASW AUS 2s/9s swap curve steepener, 1Y forward
96.47
96.20*
+23.0bp
96.60
94.10
9-Feb
44.5bp
29.1
+15.4bp
50.5bp
34.0bp
Take Profits. The trade has reached our target level. Take Profits. We now have less conviction that this position adequately reflects risks to the policy and macro backdrop. Hold Trade.
1-Mar
-17.0bp
-12.2bp
+4.8bp
-25.0bp
flat
1-Mar
-13.5bp
-13.6bp
+0.1bp
-7.0bp
-21.0bp
16-Mar
73.0bp
73.0bp
0.0bp
63.0bp
95.0bp
New Trade.
Source: J.P. Morgan; *Price is YMM2, P/L takes into account the futures roll
61
Forecast Table
Current Australia RBA cash rate 10-year yield New Zealand RBNZ OCR 10-year bond 2.50 4.20 2.50 4.40 2.75 4.30 3.00 4.20 3.25 4.40 4.25 4.33 4.25 4.30 4.25 4.25 4.25 4.20 4.25 4.30 Jun-12 Sep-12 Dec-12 Mar-13
Source: J.P. Morgan (forecast values), Bloomberg (current values)
62
European Rates Strategy Global Fixed Income Markets Weekly March 16, 2012 Aditya ChordiaAC (44-20) 7777-9841 aditya.x.chordia@jpmorgan.com J.P. Morgan Securities Ltd.
Interest rate forecasts

Euro area Refi rate Euribor 16-Mar-12 Jun-12 1.00 0.75 3M 0.85 0.65 2Y 0.34 0.30 5Y 1.07 1.10 10Y 2.06 2.25 30Y 2.71 2.95 2s/10s 172 195 10s/30s 66 70 2s/30s 237 265 2Y 84 70 5Y 65 50 10Y 37 30 30Y 1 5 Sep-12 0.75 0.65 0.30 1.00 2.10 2.80 180 70 250 75 55 35 5 Sep-12 0.50 1.00 0.50 1.30 2.55 3.50 205 95 300 80 40 20 -15 Dec-12 0.75 0.70 0.30 1.00 2.05 2.75 175 70 245 80 60 40 10 Dec-12 0.50 1.00 0.50 1.20 2.40 3.40 190 100 290 80 40 20 -15 Mar-13 0.75 0.75 0.30 0.95 2.00 2.70 170 70 240 85 65 45 10 Mar-13 0.50 1.00 0.50 1.20 2.40 3.40 190 100 290 80 40 20 -15 United States 16-Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Fed funds 0 - 0.25 0 - 0.25 0 - 0.25 0 - 0.25 0 - 0.25 Libor 3M 0.47 0.45 0.50 0.50 0.50 2Y 0.37 0.30 0.30 0.30 0.30 5Y 1.13 1.25 1.25 1.25 1.25 10Y 2.32 2.50 2.50 2.50 2.50 Govt curve 30Y 3.43 3.60 3.60 3.60 3.60 2s/10s 195 220 220 220 220 10s/30s 111 110 110 110 110 2s/30s 306 330 330 330 330 2Y 24 22 22 22 22 5Y 22 25 27 27 27 Swap spreads 10Y 6 6 6 7 7 30Y -28 -28 -27 -27 -27 Australia Cash rate Govt curve
Govt curve
Swap spreads
United Kingdom 16-Mar-12 Jun-12 Base rate 0.50 0.50 Libor 3M 1.04 1.05 2Y 0.48 0.50 5Y 1.23 1.30 10Y 2.45 2.55 30Y 3.49 3.50 Govt curve 2s/10s 197 205 10s/30s 104 95 2s/30s 301 300 2Y 81 80 5Y 49 45 Swap spreads 10Y 19 20 30Y -12 -10 Japan O/N call rate 2Y 5Y 10Y 20Y 30Y 2s/10s 10s/30s 2s/30s
10Y
4.25 4.33
4.25 4.30
4.25 4.25
4.25 4.20
4.25 4.30
New Zealand Cash rate Govt curve 10Y
2.50 4.20
2.50 4.40
2.75 4.30
3.00 4.20
3.25 4.40
Govt curve
0.05 0.11 0.37 1.05 1.81 1.97 94 92 186
0.05 0.12 0.40 1.15 1.80 2.00 103 85 188
0.05 0.13 0.35 1.05 1.80 2.00 92 95 187
0.05 0.13 0.35 1.05 1.85 2.05 92 100 192
0.05 0.13 0.40 1.15 1.95 2.15 102 100 202
63
European Rates Strategy Global Fixed Income Markets Weekly March 16, 2012 Aditya ChordiaAC (44-20) 7777-9841 aditya.x.chordia@jpmorgan.com J.P. Morgan Securities Ltd
Recent curve movements

EUR Govt. curve 2Y 5Y 10Y 30Y 2s/5s 2s/10s 10s/30s Swap curve 2Y 5Y 10Y 30Y 2s/5s 2s/10s 10s/30s GBP
16-Mar-12 1W ago 2W ago 1M ago 3M ago 16-Mar-12 1W ago 2W ago 1M ago 3M ago 0.34 0.15 0.16 0.23 0.21 0.48 0.43 0.39 0.40 0.30 1.07 0.77 0.78 0.86 0.80 1.23 1.02 0.96 0.99 0.89 2.06 1.79 1.80 1.86 1.86 2.45 2.07 2.06 2.11 2.05 2.71 2.44 2.42 2.47 2.38 3.49 3.22 3.22 3.31 3.09 74 61 62 63 59 75 59 57 59 59 172 163 164 164 165 197 164 167 171 175 66 65 62 61 52 104 114 116 119 104 16-Mar-12 1W ago 2W ago 1M ago 3M ago 16-Mar-12 1W ago 2W ago 1M ago 3M ago 1.18 1.07 1.04 1.17 1.34 1.30 1.23 1.17 1.29 1.30 1.74 1.52 1.50 1.59 1.78 1.76 1.58 1.52 1.59 1.55 2.46 2.25 2.22 2.30 2.42 2.64 2.39 2.37 2.42 2.33 2.73 2.53 2.49 2.54 2.50 3.37 3.12 3.12 3.17 3.00 56 45 46 41 43 46 34 35 30 25 127 118 118 113 107 133 116 120 114 103 27 28 27 24 8 73 73 75 75 67
Swap spreads 16-Mar-12 1W ago 2W ago 1M ago 3M ago 16-Mar-12 1W ago 2W ago 1M ago 3M ago 2Y 84 91 86 88 112 81 80 77 87 96 5Y 65 74 71 73 92 49 52 53 58 61 10Y 37 43 40 42 55 19 25 24 24 24 30Y 1 8 6 6 11 -12 -11 -11 -15 -9 2s/5s -19 -17 -15 -16 -21 -33 -28 -24 -28 -35 2s/10s -47 -48 -46 -47 -57 -63 -55 -53 -62 -72 10s/30s -36 -35 -33 -36 -44 -31 -36 -35 -39 -33
USD Govt. curve 2Y 5Y 10Y 30Y 2s/5s 2s/10s 10s/30s Swap curve 2Y 5Y 10Y 30Y 2s/5s 2s/10s 10s/30s JPY
16-Mar-12 1W ago 2W ago 1M ago 3M ago 16-Mar-12 1W ago 2W ago 1M ago 3M ago 0.37 0.32 0.28 0.29 0.23 0.11 0.11 0.11 0.11 0.13 1.13 0.90 0.85 0.86 0.81 0.37 0.30 0.30 0.30 0.35 2.32 2.04 1.98 1.99 1.85 1.05 0.99 0.99 0.94 0.98 3.43 3.19 3.11 3.15 2.86 1.97 1.96 1.94 1.92 1.93 76 58 57 57 58 26 19 19 19 22 195 172 171 170 162 94 88 88 84 86 111 115 113 116 101 92 97 95 98 95 16-Mar-12 1W ago 2W ago 1M ago 3M ago 16-Mar-12 1W ago 2W ago 1M ago 3M ago 0.62 0.58 0.53 0.59 0.72 0.35 0.34 0.34 0.34 0.38 1.36 1.16 1.11 1.14 1.23 0.52 0.46 0.47 0.44 0.48 2.39 2.11 2.07 2.07 2.03 1.10 1.01 1.01 0.96 0.98 3.12 2.87 2.82 2.81 2.59 1.96 1.90 1.89 1.82 1.77 74 58 58 55 51 17 12 12 10 10 177 154 154 148 130 74 67 67 62 60 74 76 74 74 57 86 88 88 86 79
Swap spreads 16-Mar-12 1W ago 2W ago 1M ago 3M ago 16-Mar-12 1W ago 2W ago 1M ago 3M ago 2Y 24 25 25 29 48 24 23 23 24 26 5Y 22 24 25 26 40 16 16 15 13 13 10Y 6 7 8 7 16 5 3 3 0 -1 30Y -28 -30 -29 -33 -28 -3 -7 -6 -11 -17 2s/5s -2 0 0 -3 -8 -8 -7 -8 -10 -13 2s/10s -18 -18 -17 -21 -32 -20 -20 -20 -24 -26 10s/30s -34 -37 -37 -41 -44 -8 -10 -9 -11 -16
64
Recent sovereign cash spread movements

Cash spread to Germany; bp
2Y 1Y min 9 33 4 4 3 380 83 644 102 154 5Y 1Y min 30 84 6 21 6 416 102 685 155 181 10Y 1Y min 31 72 24 30 22 494 125 517 170 188 30Y 1Y min 28 75 32 6 153 302 185 173
16-Mar-12 1W ago 2W ago 1M ago 3M ago Austria 43 58 54 57 70 Belgium 95 110 106 130 236 Finland 16 18 20 22 14 France 45 46 40 47 80 Netherlands 20 22 17 18 30 Ireland 412 434 424 387 769 Italy 192 200 198 313 500 Portugal 1560 1484 1476 1413 1423 Spain 189 197 186 242 308 Wtd. peri. spread* 286 285 281 366 517
1Y max 139 469 51 150 70 2164 713 2216 548 737
1Y avg 47 148 17 48 17 824 315 1355 266 390
1Y SD 1Y z-score 30 0.0 87 -0.5 10 0.0 32 -0.1 13 0.2 310 -1.3 156 -0.8 327 0.6 93 -0.8 133 -0.8
1Y max 219 433 93 187 83 1509 675 2079 495 670
1Y avg 88 200 44 77 39 749 350 1212 308 413
1Y SD 1Y z-score 47 0.0 73 -0.9 21 0.0 39 0.2 17 0.2 227 -1.4 148 -0.4 282 1.0 73 -0.3 120 -0.4
1Y max 189 357 80 188 65 1142 575 1406 500 566
1Y avg 85 181 45 85 38 678 334 957 313 390
1Y SD 1Y z-score 38 0.0 61 -0.6 11 0.4 37 0.3 8 0.9 133 -1.4 124 -0.3 180 1.0 69 0.1 101 -0.2
16-Mar-12 1W ago 2W ago 1M ago 3M ago Austria 78 87 86 88 85 Belgium 125 153 160 159 203 Finland France 103 115 116 116 116 Netherlands 15 14 12 12 9 Ireland Italy 287 314 316 355 459 Portugal 792 815 798 725 676 Spain 318 327 318 347 370 Wtd. peri. spread* 311 355 353 381 451
1Y max 158 297 199 16 515 919 448 500
1Y avg 66 159 85 10 323 594 306 340
1Y SD 1Y z-score 30 0.5 47 -0.5 39 0.6 2 2.6 98 -0.3 141 1.4 60 0.3 89 0.0
*Weighted peripheral spread computed against Germany for Ireland, Portugal, Italy and Spain (weighted by the size of their outstanding bond market). 30Y does not contain Ireland and Finland.
65
Recent sovereign CDS spread movements

CDS spread*; bp
15-Mar-12 1W ago 2W ago 1M ago 3M ago US 29 29 29 29 29 UK 23 23 24 29 54 Germany 26 28 27 34 49 Austria 107 109 102 110 146 Belgium 169 181 175 206 300 Finland 32 32 33 35 39 France 117 119 111 123 163 Netherlands 50 51 47 50 71 Ireland 633 633 597 645 955 Italy 320 324 329 385 588 Portugal 1961 1756 1683 1566 1655 Spain 354 350 318 363 417 Wtd. peri. spread** 445 433 422 464 628
2Y 1Y min 21 21 10 20 62 12 29 10 597 71 569 142 148 5Y 1Y min 40 47 36 50 115 24 63 28 510 125 539 197 189
1Y max 50 58 62 174 382 45 180 75 1606 627 2306 473 657
1Y avg 36 37 32 82 193 28 98 37 915 338 1341 318 423
1Y SD 1Y z-score 10 -0.7 12 -1.2 16 -0.3 49 0.5 83 -0.3 9 0.4 48 0.4 20 0.6 185 -1.5 170 -0.1 395 1.6 85 0.4 150 0.1
15-Mar-12 1W ago 2W ago 1M ago 3M ago US 40 40 40 40 40 UK 63 63 66 75 97 Germany 73 77 75 85 101 Austria 162 165 155 167 199 Belgium 220 232 222 240 326 Finland 64 64 65 69 78 France 175 179 166 180 222 Netherlands 97 99 92 98 126 Ireland 615 615 580 570 740 Italy 368 372 355 401 547 Portugal 1341 1200 1151 1071 1125 Spain 405 400 355 383 433 Wtd. peri. spread** 449 442 415 446 563
1Y max 65 104 120 243 408 90 252 146 1199 583 1522 488 595
1Y avg 51 77 75 132 234 57 151 79 716 357 980 349 412
1Y SD 1Y z-score 10 -1.1 15 -0.9 25 -0.1 55 0.5 70 -0.2 19 0.4 56 0.4 34 0.5 110 -0.9 141 0.1 219 1.7 70 0.8 118 0.3
* 25bp running coupon used for Finland, France, Germany, Netherlands and US. 100bp running coupon used for UK, Austria, Belgium, Greece, Ireland, Italy, Portugal and Spain. Spreads for all the countries except US are in $ CDS and for US it is in CDS. **Weighted peripheral spread computed as CDS spread of Ireland, Portugal, Italy and Spain, weighted by the size of their outstanding bond market.
66
Euro area conventional bond* and bank debt** redemptions

bn
Austria Sov. Banks 1 0 0 2 0 2 0 1 10 1 0 0 0 1 0 0 0 0 13 0 2 1 1 2 0 1 2 14 Belgium Sov. Banks 4 0 0 0 0 2 0 1 0 0 1 11 0 0 7 0 0 13 37 1 0 3 1 0 2 7 6 24 Finland Sov. Banks 0 0 0 1 0 0 0 1 0 0 1 6 0 0 0 0 0 0 7 1 0 0 0 0 0 1 0 4 France Sov. Banks 0 4 18 6 0 2 0 5 28 13 0 12 19 0 5 22 0 0 105 0 5 9 1 3 14 3 11 76 Germany Sov. Banks 19 10 16 3 0 2 19 9 27 10 0 21 16 0 17 24 0 18 177 5 11 9 5 3 18 12 11 108 Netherlands Sov. Banks 0 2 0 10 0 4 0 2 15 2 0 0 0 0 0 16 0 0 31 3 2 1 1 1 9 3 5 46 Core Euro-area*** Sov. Banks 24 17 34 22 0 12 19 20 81 25 2 50 35 1 29 61 0 31 368 10 21 23 9 9 42 26 36 272
Mar-12***** Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Total
Mar-12***** Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Total
Greece Sov. Banks 1 0 0 1 1 1 2 1 1 0 1 1 0 9
Ireland Sov. Banks 0 2 0 0 0 0 0 0 0 0 0 0 0 0 0 3 0 2 0 0 0 1 3 0 1 2 1 15
Italy Sov. Banks 0 5 27 1 2 17 12 11 20 13 30 0 21 0 154 2 6 3 2 2 4 6 4 10 3 10 6 63
Portugal Sov. Banks 0 1 0 0 10 1 0 0 0 0 1 0 0 0 13 0 1 2 2 0 0 0 0 0 0 2 0 9
Spain Sov. Banks 0 6 12 0 0 13 0 2 20 0 0 14 0 0 62 15 10 25 8 3 7 5 10 5 11 7 9 120
Peri. Euro-area**** Sov. Banks 0 15 39 1 12 31 12 13 40 13 32 14 21 0 229 21 17 33 12 5 12 12 18 15 16 22 16 215
* Marketable bonds include: conventionals, linkers, floaters zero coupons and international bonds. ** Maturities in all currencies and jurisdictions and include secured, unsecured and securitised issuance, including MTNs but excluding short-term (maturity of less than one year) and self-funded deals (deals where there is only one bookrunner and it is also the issuer). The data also include any government guaranteed issuance by the banks but no direct issuance by government or government sponsored institutions. *** Austria, Belgium, Finland, France, Germany and Netherlands. **** Greece, Ireland, Italy, Portugal, Spain. ***** For the remaining part of the month. Source: J. P. Morgan, Dealogic
67
Event risk/election calendar

Event risk
Month March 2012 April 2012 Day Mon Tue-Thu ?? Wed Thu Wed Fri-Sun Sun May 2012 Thu Sun Sun Thu Mon Tue-Tue Wed Fri June 2012 Wed Thu Sun Sun Mon Tue Thu-Fri 4 5 11 20-22 22 3 6 6 10 14 15-22 16 25 6 7 10 17 18 19 28-29 Date 19 27-29 Country/Region Event Greece Greece Greece Euro area UK Greece IMF/World Bank France Euro area France Germany UK Euro area G8 UK Euro area Euro area UK France Euro area Euro area Euro area Euro area Greek CDS auction Bond holder meeting dates for foreign law bonds in the Greek PSI Greece parliamentary elections ECB rate announcement BoE rate announcement Ex pected settlement of Greek PSI for foreign law bonds IMF/World Bank spring meeting in Washington French Presidential election (round 1) ECB rate announcement French Presidential election (round 2) State elections, Schlesw ig-Holstein BoE rate announcement Eurogroup meeting (17 finance ministers) G8 summit in Chicago BoE Quarterly Inflation Report EU Council Meeting (EU heads of state) ECB rate announcement BoE rate announcement French legislativ e election (round 1) French legislativ e election (round 2) Eurogroup meeting (17 finance ministers) Ecofin meeting (27 finance ministers) EU Council Meeting (EU heads of state)
Election calendar
Period 2012 22 2013 2014 2015 2016 Date Month ?? April Election in Greece France Austria Germany Italy Belgium Netherlands Finland Portugal Spain Ireland
68
European Rates Strategy Global Fixed Income Markets Weekly March 16, 2012 Aditya ChordiaAC (44-20) 7777-9841 Aditya.x.chordia@jpmorgan.com J.P. Morgan Securities Ltd
Euro-area fact sheet / SMP purchases

Euro-area fact sheet
GDP (bn) 2012 Austria Belgium Finland France Germany Greece Ireland Italy Netherlands Portugal Spain GDP-weighted avg US UK 310 382 198 2,028 2,623 212 159 1,617 623 169 1,094 9,415 15,495** 1,566** GDP growth Inflation* Budget balance^ Prim. Balance Gross debt Curr. acc. bal. (oya, %) 2012 0.7 -0.1 0.8 0.4 0.6 -4.4 0.5 -1.3 -0.9 -3.3 -1.0 -0.3 1.5 0.6 (oya, %) 2012 2.4 2.7 3.0 2.2 1.9 -0.5 1.6 2.9 2.0 3.3 1.3 2.1 1.9 2.9 (% of GDP) 2012 -3.1 -4.6 -0.7 -5.3 -1.0 -7.0 -8.6 -2.3 -3.1 -4.5 -5.9 -3.4 -8.5 -7.8 (% of GDP) 2012 -0.3 -1.3 0.5 -2.5 1.3 1.0 -4.3 3.1 -1.2 0.8 -3.5 -0.2 -5.4 -4.6 (% of GDP) 2012 73 99 52 89 81 198 118 121 65 111 74 91 105*** 89 (% of GDP) 2012 2.8 2.1 0.0 -3.3 4.4 -7.9 1.5 -3.0 7.0 -5.0 -3.0 0.0 -3.1 -0.9 GDPpc (EU=100) 2012 124 116 123 104 108 63 119 90 126 54 80 101 Unempl. rate (%) Latest 4.0 7.4 7.5 10.0 5.8 19.9 14.8 9.2 4.9 14.8 23.3 8.0 8.3 8.3
* HICP; National index if not available **Local currency *** IMF Estimate ^ Net lending (+) or net borrowing (-) Source: EC European Economic Interim Forecast Feb-12, EC European Economic Forecast, Autumn 2011, IMF, Eurostat and ILO
Sovereign ratings
S&P Austria Belgium Cy prus Finland France Germany Greece Ireland Italy Netherlands Portugal Slov akia Slov enia Spain AA+ AA BB+ AAA AA+ AAA SD BBB+ BBB+ AAA BB A A+ A NEG NEG NEG NEG NEG NEG NEG NEG NEG NEG NEG Moody's Aaa Aa3 Baa3 Aaa Aaa Aaa C Ba1 A3 Aaa Ba3 A2 A2 A3 NEG NEG NEG NEG NEG NEG NEG NEG NEG NEG* AAA AA BBBAAA AAA AAA BBBB+ AAAA BB+ A+ A A NEG NEG NEG NEG NEG NEG NEG NEG Fitch
SMP purchases
Trade date Settlement date Weekly (bn) 0.0 0.0 0.0 0.0 0.1 224.9 Amount matured (bn) 1.5 0.0 0.0 0.0 0.0 6.8 Amount offered for sterilization (bn) 218.0 219.5 219.5 219.5 219.5 219.0 First Last First Last
29-Feb 22-Feb 15-Feb 08-Feb 01-Feb
06-Mar 28-Feb 21-Feb 14-Feb 07-Feb
05-Mar 27-Feb 20-Feb 13-Feb 06-Feb
09-Mar 02-Mar 24-Feb 17-Feb 10-Feb
Cumulativ e amount till 31 Jan 2012
* represents under watch; grey highlight: below IG; Outlook:NEG - negative outlook, POS positive outlook, DEV - developing outlook and blank represents stable outlook Notes: 1 Rules for a country to be excluded from its index: 1) J.P. Morgan's EMU IG index requires any 1 of 3 credit ratings (S&P's, Moodys, Fitch) to be below IG. 2) Barclays Capital requires 2 of the above 3 credit ratings to be below IG. 3) Citigroup requires both S&P and Moodys rating to be below IG. 2 Markit iBoxx uses an average rating methodology (S&P, Moodys and Fitch) for a country's exclusion. Source: Bloomberg
Note: Every Tuesday ECB sterilizes SMP purchases during the period between the Wednesday two weeks back (first trade date) and the Tuesday of the previous week (last trade date). This is equivalent to SMP purchases which settle on Monday (first settlement date) to Friday of the previous week (last settlement date). The ECB started buying Italian and Spanish bonds on Monday, 8 August 2011. Source: ECB
69
European Rates Strategy Global Fixed Income Markets Weekly March 16, 2012 Pavan WadhwaAC (44-20) 7777-3370 pavan.wadhwa@jpmorgan.com J.P. Morgan Securities Ltd.
Analyst Certification: The research analyst(s) denoted by an AC on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an AC on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst's compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report.
Other Disclosures
J.P. Morgan ("JPM") is the global brand name for J.P. Morgan Securities LLC ("JPMS") and its affiliates worldwide. J.P. Morgan Cazenove is a marketing name for the U.K. investment banking businesses and EMEA cash equities and equity research businesses of JPMorgan Chase & Co. and its subsidiaries. Options related research: If the information contained herein regards options related research, such information is available only to persons who have received the proper option risk disclosure documents. For a copy of the Option Clearing Corporation's Characteristics and Risks of Standardized Options, please contact your J.P. Morgan Representative or visit the OCC's website at http://www.optionsclearing.com/publications/risks/riskstoc.pdf Legal Entities Disclosures U.S.: JPMS is a member of NYSE, FINRA, SIPC and the NFA. JPMorgan Chase Bank, N.A. is a member of FDIC and is authorized and regulated in the UK by the Financial Services Authority. U.K.: J.P. Morgan Securities Ltd. (JPMSL) is a member of the London Stock Exchange and is authorized and regulated by the Financial Services Authority. Registered in England & Wales No. 2711006. Registered Office 125 London Wall, London EC2Y 5AJ. South Africa: J.P. Morgan Equities Limited is a member of the Johannesburg Securities Exchange and is regulated by the FSB. Hong Kong: J.P. Morgan Securities (Asia Pacific) Limited (CE number AAJ321) is regulated by the Hong Kong Monetary Authority and the Securities and Futures Commission in Hong Kong. Korea: J.P. Morgan Securities (Far East) Ltd, Seoul Branch, is regulated by the Korea Financial Supervisory Service. Australia: J.P. Morgan Australia Limited (ABN 52 002 888 011/AFS Licence No: 238188) is regulated by ASIC and J.P. Morgan Securities Australia Limited (ABN 61 003 245 234/AFS Licence No: 238066) is a Market Participant with the ASX and regulated by ASIC. Taiwan: J.P.Morgan Securities (Taiwan) Limited is a participant of the Taiwan Stock Exchange (company-type) and regulated by the Taiwan Securities and Futures Bureau. India: J.P. Morgan India Private Limited, having its registered office at J.P. Morgan Tower, Off. C.S.T. Road, Kalina, Santacruz East, Mumbai - 400098, is a member of the National Stock Exchange of India Limited (SEBI Registration Number - INB 230675231/INF 230675231/INE 230675231) and Bombay Stock Exchange Limited (SEBI Registration Number - INB 010675237/INF 010675237) and is regulated by Securities and Exchange Board of India. Thailand: JPMorgan Securities (Thailand) Limited is a member of the Stock Exchange of Thailand and is regulated by the Ministry of Finance and the Securities and Exchange Commission. Indonesia: PT J.P. Morgan Securities Indonesia is a member of the Indonesia Stock Exchange and is regulated by the BAPEPAM LK. Philippines: J.P. Morgan Securities Philippines Inc. is a member of the Philippine Stock Exchange and is regulated by the Securities and Exchange Commission. Brazil: Banco J.P. Morgan S.A. is regulated by the Comissao de Valores Mobiliarios (CVM) and by the Central Bank of Brazil. Mexico: J.P. Morgan Casa de Bolsa, S.A. de C.V., J.P. Morgan Grupo Financiero is a member of the Mexican Stock Exchange and authorized to act as a broker dealer by the National Banking and Securities Exchange Commission. Singapore: This material is issued and distributed in Singapore by J.P. Morgan Securities Singapore Private Limited (JPMSS) [MICA (P) 032/01/2012 and Co. Reg. No.: 199405335R] which is a member of the Singapore Exchange Securities Trading Limited and is regulated by the Monetary Authority of Singapore (MAS) and/or JPMorgan Chase Bank, N.A., Singapore branch (JPMCB Singapore) which is regulated by the MAS. Malaysia: This material is issued and distributed in Malaysia by JPMorgan Securities (Malaysia) Sdn Bhd (18146-X) which is a Participating Organization of Bursa Malaysia Berhad and a holder of Capital Markets Services License issued by the Securities Commission in Malaysia. Pakistan: J. P. Morgan Pakistan Broking (Pvt.) Ltd is a member of the Karachi Stock Exchange and regulated by the Securities and Exchange Commission of Pakistan. Saudi Arabia: J.P. Morgan Saudi Arabia Ltd. is authorized by the Capital Market Authority of the Kingdom of Saudi Arabia (CMA) to carry out dealing as an agent, arranging, advising and custody, with respect to securities business under licence number 35-07079 and its registered address is at 8th Floor, Al-Faisaliyah Tower, King Fahad Road, P.O. Box 51907, Riyadh 11553, Kingdom of Saudi Arabia. Dubai: JPMorgan Chase Bank, N.A., Dubai Branch is regulated by the Dubai Financial Services Authority (DFSA) and its registered address is Dubai International Financial Centre - Building 3, Level 7, PO Box 506551, Dubai, UAE. Country and Region Specific Disclosures U.K. and European Economic Area (EEA): Unless specified to the contrary, issued and approved for distribution in the U.K. and the EEA by JPMSL. Investment research issued by JPMSL has been prepared in accordance with JPMSL's policies for managing conflicts of interest arising as a result of publication and distribution of investment research. Many European regulators require a firm to establish, implement and maintain such a policy. This report has been issued in the U.K. only to persons of a kind described in Article 19 (5), 38, 47 and 49 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (all such persons being referred to as "relevant persons"). This document must not be acted on or relied on by persons who are not relevant persons. Any investment or investment activity to which this document relates is only available to relevant persons and will be engaged in only with relevant persons. In other EEA countries, the report has been issued to persons regarded as professional investors (or equivalent) in their home jurisdiction. Australia: This material is issued and distributed by JPMSAL in Australia to "wholesale clients" only. JPMSAL does not issue or distribute this material to "retail clients". The recipient of this material must not distribute it to any third party or outside Australia without the prior written consent of JPMSAL. For the purposes of this paragraph the terms "wholesale client" and "retail client" have the meanings given to them in section 761G of the Corporations Act 2001. Germany: This material is distributed in Germany by J.P. Morgan Securities Ltd., Frankfurt Branch and J.P.Morgan Chase Bank, N.A., Frankfurt Branch which are regulated by the Bundesanstalt fr Finanzdienstleistungsaufsicht. Hong Kong: The 1% ownership disclosure as of the previous month end satisfies the requirements under Paragraph 16.5(a) of the Hong Kong Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission. (For research published within the first ten days of the month, the disclosure may be based on the month end data from two months prior.) J.P. Morgan Broking (Hong Kong) Limited is the liquidity provider/market maker for derivative warrants, callable bull bear contracts and stock options listed on the Stock Exchange of Hong Kong Limited. An updated list can be found on HKEx website: http://www.hkex.com.hk. Japan: There is a risk that a loss may occur due to a change in the price of the shares in the case of share trading, and that a loss may occur due to the exchange rate in the case of foreign share trading. In the case of share trading, JPMorgan Securities Japan Co., Ltd., will be receiving a brokerage fee and consumption tax (shouhizei) calculated by multiplying the executed price by the commission rate which was individually agreed
70
European Rates Strategy Global Fixed Income Markets Weekly March 16, 2012 Pavan WadhwaAC (44-20) 7777-3370 pavan.wadhwa@jpmorgan.com J.P. Morgan Securities Ltd.
between JPMorgan Securities Japan Co., Ltd., and the customer in advance. Financial Instruments Firms: JPMorgan Securities Japan Co., Ltd., Kanto Local Finance Bureau (kinsho) No. 82 Participating Association / Japan Securities Dealers Association, The Financial Futures Association of Japan, Type II Financial Instruments Firms Association and Japan Securities Investment Advisers Association. Korea: This report may have been edited or contributed to from time to time by affiliates of J.P. Morgan Securities (Far East) Ltd, Seoul Branch. Singapore: JPMSS and/or its affiliates may have a holding in any of the securities discussed in this report; for securities where the holding is 1% or greater, the specific holding is disclosed in the Important Disclosures section above. India: For private circulation only, not for sale. Pakistan: For private circulation only, not for sale. New Zealand: This material is issued and distributed by JPMSAL in New Zealand only to persons whose principal business is the investment of money or who, in the course of and for the purposes of their business, habitually invest money. JPMSAL does not issue or distribute this material to members of "the public" as determined in accordance with section 3 of the Securities Act 1978. The recipient of this material must not distribute it to any third party or outside New Zealand without the prior written consent of JPMSAL. Canada: The information contained herein is not, and under no circumstances is to be construed as, a prospectus, an advertisement, a public offering, an offer to sell securities described herein, or solicitation of an offer to buy securities described herein, in Canada or any province or territory thereof. Any offer or sale of the securities described herein in Canada will be made only under an exemption from the requirements to file a prospectus with the relevant Canadian securities regulators and only by a dealer properly registered under applicable securities laws or, alternatively, pursuant to an exemption from the dealer registration requirement in the relevant province or territory of Canada in which such offer or sale is made. The information contained herein is under no circumstances to be construed as investment advice in any province or territory of Canada and is not tailored to the needs of the recipient. To the extent that the information contained herein references securities of an issuer incorporated, formed or created under the laws of Canada or a province or territory of Canada, any trades in such securities must be conducted through a dealer registered in Canada. No securities commission or similar regulatory authority in Canada has reviewed or in any way passed judgment upon these materials, the information contained herein or the merits of the securities described herein, and any representation to the contrary is an offence. Dubai: This report has been issued to persons regarded as professional clients as defined under the DFSA rules. General: Additional information is available upon request. Information has been obtained from sources believed to be reliable but JPMorgan Chase & Co. or its affiliates and/or subsidiaries (collectively J.P. Morgan) do not warrant its completeness or accuracy except with respect to any disclosures relative to JPMS and/or its affiliates and the analyst's involvement with the issuer that is the subject of the research. All pricing is as of the close of market for the securities discussed, unless otherwise stated. Opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients. The recipient of this report must make its own independent decisions regarding any securities or financial instruments mentioned herein. JPMS distributes in the U.S. research published by non-U.S. affiliates and accepts responsibility for its contents. Periodic updates may be provided on companies/industries based on company specific developments or announcements, market conditions or any other publicly available information. Clients should contact analysts and execute transactions through a J.P. Morgan subsidiary or affiliate in their home jurisdiction unless governing law permits otherwise. "Other Disclosures" last revised January 6, 2012.
Copyright 2012 JPMorgan Chase & Co. All rights reserved. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of J.P. Morgan. #$J&098$#*P
Unless otherwise expressly noted, all data and information for charts, tables and exhibits contained in this publication have been sourced via J.P. Morgan information sources.
71
Global Market Movers

19 March
Euro area 1000 BoP Jan Italy 1100 Industrial new orders Jan Japan 1430 Department store sales -0.6%oya Auction 2-month bill United States 1000 NAHB survey Mar 29 0835 NY Fed President Dudley speaks about economy and participates in roundtable 1340 on Long Island
20 March
Germany 0800 PPI Feb Netherlands 0930 CBS cons. conf. Mar Spain Trade balance Jan United Kingdom 0930 CPI Feb 3.2 %oya 1100 CBI industrial trends Mar United States 0830 Housing starts Feb 685,000 Permits 685,000 1245 Chairman Bernanke speaks in Washington, D.C. 1730 Minneapolis Fed President Kocherlakota speaks in St. Louis
21 March
Germany Auction Schatz Mar14 & IL Apr23 Japan 1330 All sector activity index Jan -1.0%m/m, sa Auction 3-month bill United Kingdom 0930 UK Spring Budget MPC minutes Mar A 9-0 vote for unchanged policy is expected. 0930 Public sector finances Feb 7.8 bn, nsa United States 1000 Existing home sales Feb 4.65 mn
22 March
Belgium 1500 BNB bus. Conf. Mar Euro area 1000 PMI flash Mar Mfg 49.2 Index, sa Services 49.0 Index, sa Composite 49.5 Index, sa 1100 Industrial new orders Jan 1600 EC cons. conf. prelim Mar -19.9%bal, sa France 0900 PMI flash Mar Mfg 50.2 Index, sa Services 50.2 Index, sa Composite 50.5 Index, sa Germany 0930 PMI flash Mar Mfg 50.5 Index, sa Services 53.0 Index, sa Composite 53.2 Index, sa Japan 0830 Reuters Tankan Mar 0850 Trade balance Feb -185 billion yen, nsa 1110 BoJ board member Morimotos address in Hyogo prefecture Netherlands 0930 GDP final 4Q United Kingdom 0930 Retail sales Feb Auction IL 2042 United States 0830 Initial claims w/e prior Sat 355,000 1000 FHFA HPI Jan 0.3% (-1.1%oya) 1000 Leading indicators Feb Auction 10-year TIPS (r) $13 bn Announce 2-year note $35 bn Announce 5-year note $35 bn Announce 7-year note $29 bn 1000 Fed Governor Tarullo testifies on regulation and Volcker Rule 1600 Chicago Fed President Evans speaks on monetary policy in Washington, D.C.
23 March
France 0845 INSEE bus. conf. Mar Spain 0900 PPI Feb Japan 0850 Flow of funds 4Q Auction 3-month bill United Kingdom 0930 BBA mortgage lending Feb United States 1000 New home sales Feb 320,000 1430 Atlanta Fed President Lockhart speaks in Washington, D.C.
26 March
Germany 1100 IFO business survey Italy 1000 ISAE cons. conf. Mar Netherlands 1030 CBS bus. conf. Mar United States 1000 Pending home sales Feb 1030 Dallas Fed survey Mar 0700 Philadelphia Fed President Plosser speaks on monetary policy in Paris 0800 Chairman Bernanke speaks to business economists
27 March
Germany 0900 Gfk cons. conf. Mar Japan 0850 Corporate service prices Feb 1400 Shoko Chukin small firm survey Mar United Kingdom 1030 Business investment final 4Q 1100 CBI survey of distributive trades Mar United States 0900 S&P/Case-Shiller HPI Jan 1000 Consumer confidence Mar 1000 Richmond Fed survey Mar Auction 2-year note $35 bn 1245 Chairman Bernanke speaks in Washington, D.C. 2000 St. Louis Fed President Bullard speaks in Beijing
28 March
Euro area 1000 M3 Feb France 0730 GDP final 4Q Germany 1000 CPI 6 states and prelim Mar Italy 1000 ISAE bus. conf. Mar Japan 1110 BoJ board member Miyaos address in Chiba prefecture United Kingdom 0930 GDP final 4Q 0930 BoP 4Q United States 0830 Durable goods Feb Auction 5-year note $35 bn
29 March
Euro area 1100 EC bus. conf. Mar 1100 EC cons. conf. Mar Germany 0955 Employment Feb 0955 Unemployment Mar Spain 0900 HICP flash Mar Belgium 1115 CPI Mar Italy Auction BTPs Japan 0850 Total retail sales Mar Auction 2-month bill United Kingdom 0930 M4 & M4 lending final Feb 0930 Net lending to individuals Feb 0930 Index of services Jan BoE credit conditions survey 1Q United States 0830 Initial claims w/e prior Sat 0830 Real GDP 4Q final 1100 KC Fed survey Mar Auction 7-year note $29 bn 1245 Chairman Bernanke speaks in Washington, D.C.
30 March
France 0845 PPI Feb 0845 Consumption of mfg goods Feb Germany 0800 Retail sales Feb Italy 1000 PPI Feb 1100 CPI prelim Mar 1200 Contractual wages Feb Japan 0815 PMI manufacturing Mar 0830 All household spending Feb 0830 Unemployment rate Feb 0830 Job offers to applicants ratio Feb 0830 Nationwide core CPI Feb 0850 IP preliminary Feb 1400 Housing starts Feb 1400 Construction orders Feb United Kingdom 0001 GfK cons. conf. Feb United States 0830 Personal income Feb 0945 Chicago PMI Mar 0955 Consumer sentiment Mar final
Selective list as of 16 March. Forecasts are m/m, nsa, unless stated & times are local. Telephone your J.P. Morgan representative for an update/more details. Highlighted data are scheduled for release on or after the date shown. Times shown are local.
72

JPM Global Fixed Income 2012-03-17 810381

Hochgeladen von

Dokumentinformationen

Originalbeschreibung:

Originaltitel

Copyright

Verfügbare Formate

Dieses Dokument teilen

Dokument teilen oder einbetten

Freigabeoptionen

Stufen Sie dieses Dokument als nützlich ein?

Sind diese Inhalte unangemessen?

Copyright:

Verfügbare Formate

JPM Global Fixed Income 2012-03-17 810381

Hochgeladen von

Copyright:

Verfügbare Formate

European Rates Strategy

J.P. Morgan Securities Ltd. March 16, 2012

Global Fixed Income Markets Weekly

J.P. Morgan Securities Ltd.

See page 70 for analyst certification and important disclosures.

Stay positioned for risk-on

The outlook for holdouts in Greek foreign-law bonds

100 80 60 40 20 0 0 50 100 150 200 months to mat

y = -8.9Ln(x ) + 67.3 R 2 = 44.6%

1) The best foreign-law bonds for (quiet) holdouts

Intercept LN(months to maturity ) Face v alue (bn) Voting threshold (%)***

10.1 -9.2 -2.1 81.7

0.5 -5.3 -1.2 2.9

2) The (mostly empty) threat of acceleration

Exhibit 7: Birds eye view of our major trade recommendations by currency

Neutral Long ILG16 b/e

Bearish Bullish bias

Appendix 1: Financial covenants in new Greek bonds

Appendix 2: Financial covenants in Portuguese foreign-law bonds

Source: Media articles

2.80 52 50 Global PMI 2.40

48 Jan-10 May -10 Sep-10 Jan-11 May -11 Sep-11 Jan-12

120 110 100 90 80 70 60 Jan-12

Jul11 Aug11 Sep11 Oct11 Nov 11 Dec11 Jan12 Feb12 Mar12

21-Mar Germany 29-Mar Italy

Trades closed in 2012

Change since 9 March 2012; bp

0.35 Apr12 Jun12 Aug12 Oct12 Dec12 Feb13

140 130 120 110 100 90 80 1.20

y = 67.9x - 1.4 R 2 = 92%

1.60 1.80 Blues EONIA; %

y = 77.5x - 52.1 R 2 = 95%

0.75 0.80 0.85 6th Euribor futures y ield; %

Euribor curv e 2nd/6th 3rd/7th 4th/8th

Implied directionality 59% 61% 61%

Deliv ered directionality 49% 42% 36%

Implied Deliv ered 10% 19% 25%

110 100 90 Sep 11 Oct 11 Nov 11 Jan 12 Feb 12

y = 1.0x + 28.4 R 2 = 86% 09-Mar-12 16-Mar-12

2Y benchmark b/m sw ap spread 110 90 70 50

700 600 500 400 300 200 100

30 10 20 30 40 50 60 70 80 90 Back FRA/OIS basis; bp

30 10 Mar 07 Mar 08 Mar 09

Ex cess liquidity Mar 10 Mar 11

bearish conditional structures such as 3s/7s/15s conditional belly cheapeners.

-1 Mar 07 Mar 08 Mar 09 Mar 10 Mar 11 Mar 12

2.5 2.0 1.5 1.0 0.5 0.0 -0.5 1050

y = 0.00001x 2 - 0.12x + 68.93 R 2 = 89% 16-Mar-12

1250 S&P500 index ; points

* See Exhibit 11 for definition of swapped issuance.

y = 8.7*(3Mx 10Y Vol) - 34.7*(10Y Yld) + 63.2 R 2 = 87%

0.6 0.4 0.2 0.0 -0.2 1Y 2Y

Note: Implieds on 1Y tails are based on the 3s curve.

7.5 7.0 6.5 6.0 5.5 5.0 4.5 4.0 2.25

y = 5.78x - 8.35 R 2 = 51%

25 20 15 10 5 0 6 7 8 9 10 11 12 13 1D mov e in 10Y sw ap y ield; bp 1 3 5 9 7 15 12 18

2.35 2.40 2.45 3Mx 10Y EUR sw ap y ield; %

40 20 0 -20 -40 -100

y = 0.002x 2 + 0.340x - 0.882 R 2 = 52%

-50 0 50 2W return from selling 3Mx 10Y gamma; bp of notional

Exhibit 18: Additionally, this switch offers positive gamma carry

150 100 50 0 -50 -100 -0.5

y = 8.7(3Mx 10Y Vol) - 34.7(10Y Yld) + 63.2 R 2 = 87%