Barclays Global Rates Weekly 20100709

INTEREST RATES RESEARCH Global Rates Strategy | 9 July 2010
GLOBAL RATES WEEKLY

The road to normalisation? Global Views on a Page 2
Global Traders’ Guide 44

Risk appetite has stabilised and EGB peripheries have performed. The front end of Europe
Global Economics Calendar 44
remains under pressure as Euro money market conditions continue to normalise. While
confidence remains fragile, we have taken the first steps towards near-term stabilisation. Global Supply Calendar 48
Global Bond Yield Forecasts 49

United States
Treasuries: Demand spreading across the curve 3
United States
The Treasury is scheduled to auction 3y, 10y and 30y bonds next week. Auction
Ajay Rajadhyaksha
allotment data indicate a strong pickup in demand from domestic investors across the
+1 212 412 7669
curve and terming out from foreign investors.
ajay.rajadhyaksha@barcap.com
Swaps: Time to dust off bearish spread wideners? 6
Michael Pond
Money Markets: Money funds – Stiffer competition ahead 9 +1 212 412 5051
TIPS: The concession is done, long live the concession 12 michael.pond@barcap.com
Volatility: Vol decline likely to persist 14 Rajiv Setia

+1 212 412 5507
Europe rajiv.setia@barcap.com
Euro: Near-term outlook and EUR rates trade ideas 17 Europe
This week we look at the short and long ends of the EUR curve and review some of our Laurent Fransolet
+44 (0)20 7773 8385
preferred trade ideas. Despite recent moves, we still like being long the belly on EUR
laurent.fransolet@barcap.com
2s/10s/30s from here.
Alan James
UK Inflation linked: RIP RPI? No, but hi to CPI 22 +44 (0)20 777 32238
The UK government has announced its intention to encourage private pension schemes alan.james@barcap.com
to switch indexation from RPI to CPI. We do not see this as the death knell of the RPI
market, but it is likely to hasten the birth of the CPI market. Japan
Chotaro Morita
+81 3 4530 1717
UK Rates: The irresistible force 25
chotaro.morita@barcap.com
Covered Bonds: Relative value thoughts on the Nordic covered bond market 28
Scandinavia: Riksbank commences rate-hiking cycle 32
Euro Inflation-Linked: OAT€i22 cheap ahead of supply 34
Sovereign Spreads: EGB relative value 35
Volatility: Protection against higher money-market rates with a €1y cap condor 38
Japan
Correction in progress in the rich futures sector 40
Bond markets have entered a temporary correction phase that looks set to continue for
some time. Last week, we recommended shorting futures (7y) in a 5s7s10s butterfly,
assuming futures would weaken during the market downturn, as is the typical pattern.
Surprisingly, however, the sector strengthened over the past week and is now rich.
Nevertheless, we expect flattening over the medium term and continue to recommend
a short 7y position.
PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 49
Barclays Capital | Global Rates Weekly
VIEWS ON A PAGE
US EUROPE JAPAN
Direction Economic data have softened and surprised to the We recommend being slightly short on 5y5y fwd and Risk assets have turned upward, and yields keep
downside of late. Potential remains for headline 10y euro outright, as rates look some 20-60bp too an upward bias. However, dip buying demand
risk out of Europe, in our view. rich and risk aversion is likely to fade. for bargains among bond investors is very
Rates are therefore likely to trade in a range in the strong. The pace of the yield uptrend remains
near term. Remain neutral. very slow
Curve Front-end rates are likely to remain low as the Fed EUR: Keep long the belly on EUR 2s/10s/30s 1y fwd Although there has been a rebound in what we
remains cautious on the economic outlook and the on a strategic basis. Also keep paying the belly on view as excessive over-10y flattening, we do not
level of excess reserves remains high. EUR 5y20y fwd/5y25y fwd/20y30y fwd. expect a genuine steepening trend during the
Given headline risk from Europe, we remain neutral Enter into EUR 2s/10s 1y fwd flattener vs 1y1y fwd vs present correction phase.
on the curve as well. 2y 1y fwd steepener With little flattening leeway through the
UK: Receive 2y3y fwd vs 1y1y fwd. Pay belly intermediate sector, we maintain JGB 5y7y10y
5y25y/5y30y/5y35y fwd Butterfly. short, with more emphasis on 7y10y flattener
Swap Long-end spreads should remain tight, given Keep short Sep Bobl ASW versus EONIA. 10y swap spread widener
spreads Treasury supply at the long end. Also enter into tactical short in Schatz ASW vs Libor As 5y richness comes off, target to establish 5Y
Libor-OIS and 3m-6m basis should widen, on bank Hold also long EUR 10s/30s ASW box. swap spread widener at L-23bp
regulation and headline risk.
Bear spread wideners (sell TYU0 119 puts and buy
swaptions) for possible convexity paying episode.
Other Agency spreads appear wide enough to elicit bank Keep short EDZ1 vs ERZ1.
spread and money manager demand, but we turn neutral GBP: 10yr gilt /bund can perform further
sectors on front-end sectors because we expect them to SEK: Pay June and Sep 10 3M FRA. Hold: SEK-EUR
push wider with swap spreads in the near term. 2s/5s/10s wideners and cross-market shorts in
Take profits on European supras (EIB/KFW) versus greens versus EUR. Hold 5y SGB ASW wideners.
US names, given sovereign contagion risk. Some Keep long Ireland vs Italy in the 3y/5y area.
pockets of value have emerged in GGB space in Keep long Belgium versus Holland in the 7yr area.
names with less exposure to the peripherals.
Inflation Long Jan11s outright versus short Nov RBOB to We look to go long the OAT€i22 at its tap on Thursday JGBs are lacking impetus, with performance
benefit from higher realized CPI. 15 July, given likely support from month-end flows. dominated by buybacks.
Long Jan18-Feb40 breakeven flattener ahead of UK linkers may stay under pressure as a result of
supply concession related to August 30y reopening. proposed pension changes, but IL22 attractive
Also, historical analysis suggests that 10y sector relative value.
tends to richen after new auctions.
Volatility Buy 3m*2y, as it is low historically relative to other Buy an ATM/ATM+25/ATM+50/ATM+75 condor with Take advantage of steep implied volatility curve to
points on the surface and close to all-time low €1y caps for 5 cents as a protection against higher establish target receiving 5y5y (OTM 3m5y payer
realized vol. money-market rates once liquidity surplus in the euro long vs 3m10y payer short with 1:1 notional ratio)
Buy 1x1.5 1y30y 50bp wide payer spreads to position zone is gradually withdrawn. The trade benefits from an
for higher rates. attractive entry level as a result of expensive cap skew.
9 July 2010 2
UNITED STATES: TREASURIES
Demand spreading across the curve

Anshul Pradhan The Treasury is scheduled to auction 3y, 10y and 30y next week. Auction allotment data
212-412-3681 indicate a strong pickup in demand from domestic investors across the curve and
anshul.pradhan@barcap.com terming out from foreign investors. An increase in net stripping activity in the long end
in June also suggests investors are not yet balking at the low level of yields.
Demand spreading across the curve

The Treasury market sold off marginally in the holiday-shortened week, with the 10y ending
at 3.02%, compared with 2.98% as of last Friday’s close. With little economic data to speak
of, the sell-off seems to be driven primarily by a reduction in risk aversion; European
sovereign CDS spreads were generally tighter, LOIS expectations were revised lower along
with lower Libor settings, and the VIX also receded.
The Treasury announced a $1bn The Treasury announced sizes for 3y, 10y and 30y auctions to be held next week (in a
higher-than-expected size for departure from typical cycle, they are scheduled for Monday, Tuesday and Wednesday). It
the upcoming 3y auctions; we reduced 3s by $1bn, to $35bn, and kept 10s and 30s unchanged at the previous reopening
believe it will stabilize auction sizes of $21bn and $13bn, respectively. The reduction in 3y was $1bn less than expected,
sizes by the end of this fiscal year and we believe the Treasury is coming closer to the end of the process of normalizing
auction sizes. As we have highlighted earlier, there is a limit to how much they can be
reduced, due to an acceleration in the amount of coupon debt coming up for maturity over
the next few years. Figure 1 shows that in the fiscal year 2012, ~$1trn of coupon debt will
mature, compared with ~$500bn in the past couple of years, and this number will rise to
$1.4trn by 2014. Hence, even as net borrowing needs decline, there is a limit to possible
cuts in gross coupon issuance. We expect the Treasury to stabilize auction sizes by the end
of this fiscal year.
Demand at auctions: Higher domestic investor participation

Recent auction allotment statistics show domestic participation has picked up across the
curve, and foreign investors seem to be shifting out the curve as well. Figure 2 shows that
domestic investment funds absorbed 22%, 33% and 37% in 3y, 10y and 30y auctions,
Figure 1: A limit to cuts in auction sizes Figure 2: Domestic investor participation picking up
1,600 45% % Auction Alloted to Domestic Investment Funds,

3M Moving Average
1,400 40% 37%
1,200 35%
1,000 30% 33%
800 25%
22%
600 20%
400 15%
200 10%
0
5%
FY- 2007 2008 2009 2010 2011 2012 2013 2014 2015
Oct Nov Dec Jan Feb Mar Apr May Jun
2006
Maturing Coupon Debt,$bn 3s 10s 30s
Source: Barclays Capital Source: Treasury
9 July 2010 3
respectively, in the second quarter, well above that in the first quarter. At the same time,
foreign investors have been terming out. Figure 3 shows that their participation in the front
end has steadily declined since the beginning of the year and picked up slightly at the long
end. Foreign investors have mostly termed out to the 7y/10y sectors. In addition, in the June
bond auction banks, absorbed 9%, though we suspect this was mostly on asset swap as
their participation did not pickup in other sectors.
Demand from domestic investors While foreign investors continue to dominate the front end and domestic investors the long
picking up across the curve end, such a convergence is likely to benefit auctions across the curve. The tails data are
beginning to reflect that, as recent 3y auctions have not come as through as they did in
2009 and bond auctions have not tailed as much either (Figure 4). With the 5s30s/10s30s
curves steepening back to recent highs despite a sharp decline in TIPS breakevens, we
believe there is likely to be decent demand at upcoming long-end auctions. While the
market has rallied quite sharply in the past couple of weeks, a pickup in the stripping activity
in the long end suggests that investors are not yet balking at the low level of yields.
June STRIPS report: A pickup in long end net stripping activity

June STRIPS report highlights The Treasury released the June STRIPS monthly report this week. It showed a pickup in net
that net stripping activity is stripping activity despite a decline in rates, suggesting strong demand for long duration
picking up in the long end securities. Figure 5 shows that the bond STRIPS universe increased $5bn in June, compared
with a monthly run rate of $1.6bn from January to May of this year. More importantly, this
was largely a result of net stripping in the very long end. 25y+ bonds accounted for $6.6bn,
up from a monthly run rate of $2.6bn from January to May.
May 40s stripping activity Interestingly, most of the activity has been in the off–the-run bonds, and not so much in the
low for the stage of aging May 40s. Since the beginning of the year, the outstanding portion held in STRIPS form in the
25y+ sector has increased $20bn, of which Aug 39, Nov 39 and Feb 40s together have
accounted for $18bn (roughly a third each). While May 40s were only recently issued and
have not aged much, even accounting for the stage of aging, stripping activity in that issue
seems low.
In Figure 6, we plot the outstanding amount of STRIPS in issues in the long end against
months passed from issuance of the underlying. For instance, $6.2bn of Feb 40s was held in
stripped form two months from issuance. In comparison, only $0.86bn of May 40s is held in
stripped form. The average outstanding for issues in Figure 4 was roughly $3bn at this
Figure 3: Foreign investors terming out Figure 4: Tails converging across sectors
60% % Auction Alloted to Foreign Investors, 5.0 Tails, bp, 3M Moving Average
3M Moving Average 4.0
50%
3.0
40%
2.0
30%
1.0
20% 0.0
-1.0
10%
-2.0
0% Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun
Oct Nov Dec Jan Feb Mar Apr May Jun
3s 10s 30s 3y 10y 30y
Source: Treasury Source: Barclays Capital
9 July 2010 4
stage. Since activity in bonds just a couple of months shorter has been quite high, this is
not, in our opinion, an indication of a lack of duration demand, but of investors perceiving
May 40s as rich on the curve.
Figure 5: A pickup in net stripping activity in June
8 $bn 6.6
6 5.3
-2
-4
Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10
Net Monthly Increase in Bond STRIPS of which 25yrs +
Source: Treasury
Figure 6: Stripping activity in May 40s slow in the cycle
12 $bn
10
2
Months from issuance
0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
05/15/39 08/15/39 11/15/39 02/15/40 05/15/40

Source: Treasury
9 July 2010 5
UNITED STATES: SWAPS
Time to dust off bearish spread wideners?

Amrut Nashikkar The possibility of convexity paying in a significant sell-off leading to a widening of swap
+1 212 412 1848 spreads cannot be ruled out. While this is not our baseline view, in a conditional form,
amrut.nashikkar@barcap.com current market levels allow for expressing intermediate sector swap spread widening
views at levels nearly 10bp tighter to spot spreads. We outline such a trade.
Piyush Goyal
With 10y rates trading near 3% and 10y swap spreads in mid-single digits, questions about
+1 212 412 6793
whether there could be a swap spread widening similar to the one in May 2009 have begun
piyush.goyal@barcap.com
to arise. Our baseline view on 10y swap spreads is that they will remain in the single digits
over the near term, driven by a combination of high financial issuance and Treasury supply.
However, there remains the possibility of a convexity selling episode such as the one that
occurred in late May and June 2009. With swaption vols trading cheaper to September
Treasury futures option vols, spread wideners conditional on a rate sell-off can be initiated
for zero cost at spread levels that are nearly 10bp tighter to spot. If the recent decline in
spread rate directionality reverses even because of a minor convexity paying episode, such a
conditional spread widener would offer an attractive risk-reward profile. The risk to the
trade would be a rate sell-off that is driven primarily by deficit concerns, which could
tighten, rather than widen, swap spreads. However, other indicators such as sovereign CDS
spreads indicate that these concerns have faded for now.
May 2009: The similarities and the differences

At face value, there are several similarities between market conditions in May 2009 and
now. These include 10y Treasury rates near 3%, 10y swap spreads in the single digits,
primary mortgage rates near all-time lows and the general perception of a weak economy
that will likely keep rates low. When rates did sell off in May 2009, the move was quite
violent, as Figure 1 shows. 10y rates sold off nearly 80bp between mid-May and mid-June
2009, mortgage current coupon rates went from less than 4% to nearly 5%, and 10y swap
spreads widened from 8bp to nearly 43bp at the peak.
Figure 1: 10y rates, 10y spreads and mortgage rates similar Figure 2: The Fed holds more negatively convex fixed rate
to levels in early May 2009 mortgages than the overall fixed rate universe
5.5 10y rate (%) 50 -1.3

Mortgage current coupon (%) -1.4
5.0 10y swap spread (bp, RHS) 40
-1.5
4.5 30 -1.6
-1.7
4.0 20 -1.8
-1.9
3.5 10
-2.0
3.0 0 -2.1
Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10
2.5 -10
Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 MBS Index MBS Index ex-Fed
Source: Bloomberg, Barclays Capital Source: Barclays Capital
9 July 2010 6
Is another convexity paying episode likely if rates back up?

This raises the question about whether a similar episode is likely in case of a back-up in rates.
The answer, in our opinion, is probably not to the same extent. There are several reasons.
First, as our Mortgage Strategy team pointed out in last week’s Securitized Products Weekly,
refinancing activity remains lower than would be expected at these mortgage rates. This is
different from the situation in May 2009, when significant refinancing had taken place in the
first quarter. Primary mortgage rates are still not low enough to induce a refinancing wave,
and tight underwriting standards for agency mortgages make refinancing difficult. As a
result, prepays are expected to be much less sensitive to lower rates, leading to lower
negative convexity (as evidenced by historically high dollar prices on mortgages).
Second, a significant proportion of the mortgage universe is now held by the Fed, which
was not the case in May 2009 because the Fed purchase program was still in its early
stages. Moreover, the Fed holds a disproportionately larger share of the more negatively
convex coupons than the rest of the market (Figure 2). The fact that it does not hedge
duration risk on its mortgage portfolio may be an important factor driving the view that
convexity hedging is now much less significant for swap spreads.
Last but not the least, mortgage hedgers may be set up for a possible sell-off in rates,
considering that rate levels were much higher just three months ago.
Paying may yet occur in a sell-off

That said, the convexity profile of the mortgage universe (ex-Fed) indicates nearly $43bn of
10y equivalents in duration shedding needs in a 50bp sell-off in rates from servicers alone,
and even more so from hedged holders of mortgages such as the GSEs. Our models indicate
that servicer portfolios at these rate levels are skewed more towards paying in a sell-off than
receiving in a rally. Thus, while we do not believe that duration supply because of a
refinancing wave will be a catalyst for a sell-off, if one does occur for fundamental reasons,
there could be paying pressure on swap spreads.
Figure 3: Decline in the beta between swap spreads and Figure 4: Swaption implied vols are lower than Treasury
swap rates futures implied vols
30% 1.3
25% 1.2
20%
1.1
15%
1.0
10%
0.9
5%
0% 0.8
-5% 0.7
Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10
10y swap-spread rate beta (60d realized) 3m*7yr to TY option vol ratio
Source: Barclays Capital Source: Barclays Capital
9 July 2010 7
We hesitate to express an outright widening view on 10y spreads

There are two countervailing forces serving to keep 10y swap spreads in single digits. The
first is swapped financial issuance, which since the end of June has shown indications of
picking up again. The second is concerns about the US fiscal picture, which, in addition to
financial issuance, contributed to the tightness of swap spreads when 10y rates were near
4% in late March and early April. Although swapped financial issuance remains a near-term
tightener for swap spreads, fiscal concerns seem to have receded somewhat, with US
sovereign CDS levels back to where they were before the flare-up of the sovereign crisis in
January. Further, economic data have been on the weaker side, which makes a significant
sell-off in rates less likely. Given these counteracting effects, we hesitate to express an
outright widening view on spreads.
However, bearish spread wideners for out-of-the-money strikes are attractive

We believe that a much more attractive way to express the trade is through bearish spread
wideners – ie, by selling puts on TYU0 and buying a payer swaption on a swap matched
with the CTD, currently the 4.5 May 2017 note.
There is a reason why the trade is attractive: swaptions are less expensive than Treasury
futures options. Contributing to this has been a considerable decline in the directionality of
swap spreads and rates (Figure 3). The reason is that recently, swap spreads have been
widening in rate rallies because they have been driven by a flight to Treasuries and
tightening in rate sell-offs, which have been driven primarily by supply concerns. As a result,
swap rates have become less volatile than Treasury rates.
Figure 4 shows a one year history of the ratio of TY futures option implied vol and
comparable 3m*7y swaption vol. Swaptions typically trade at a premium to Treasury
futures options. But recently, they have cheapened considerably and are trading at a large
discount to Treasury futures options. Some of this can be explained by realized vols, but the
implieds seem to have gone a bit too much in pricing swaptions at lower vol. We expect this
to correct, which offers an additional reason for a bear spread widener that involves selling
the Treasury future put and buying the payer swaption.
The current profile of the delivery basket for TYU0 indicates that a switch is unlikely in a
parallel sell-off of 50bp, which ensures that there will be no duration mismatch between the
swaption and the Treasury futures option legs. Further, selling a TYU0 put at a strike of 119
allows for taking in enough option premium to put on a zero cost bearish spread widener
nearly 10bp tighter than spot spreads (Figure 5).
The risk to the trade remains a slow, supply driven selloff in treasuries and not enough
convexity paying from mortgage hedgers to widen swap spreads. Even in such a scenario,
the fact that a zero cost trade can be initiated at spreads tighter to spot offers some
protection against a repeat of the events of March/April 2010, when spreads tightened as
10y rates sold off.
Figure 5: Details of the trade

Trade Option Fwd Strike Spot Expiry Start
Sell put TYU0P 119.0 2.48% 2.91% 2.38% 8/27/2010 9/30/2010

Buy payer Swaption 2.65% 3.01% 2.58% 8/27/2010 9/30/2010
Spread 17.7 bp 10.1 bp 19.8 bp
Source: Barclays Capital
9 July 2010 8
UNITED STATES: MONEY MARKETS
Money funds: Stiffer competition ahead

Joseph Abate Stiff competition isn’t limited to the soccer pitch – money funds will face pressure from
+1 212 412 6810 banks eager to ramp up their holdings of sticky retail deposits ahead of Basel III.
joseph.abate@barcap.com
Years before Basel III goes into effect and in advance of net stable funding guidelines, US
commercial banks have already begun boosting their retail deposit base.
Money fund rates are 70bp below bank savings rates. To attract additional retail
deposits and pull more funds out of money market accounts, banks may need to widen
this spread further.
Likewise, banks may need to compete more aggressively in the certificate of deposit
market. CDs, however, are an expensive source of funding.
SEC limits on money market funds and their ability to buy higher-yielding term and credit
paper, along with stiff bank competition, will likely put further pressure on the industry to
shrink. In the absence of a significant foray into floating NAV funds, money funds could
contract by more than $500bn, or 20%.
Net stable funding

Long-term debt, equity One of the key requirements for banks to meet the Basel III guidelines is a net stable
capital and retail deposits funding ratio of 1 or higher. This ratio compares all the sources of bank funding to a pre-
are all stable funding sources set schedule of assets and separates those liabilities that are considered “flight prone” –
that is, those that would leave quickly in the event of a financial or funding crisis. Under
Basel III, repo, fed funds, and commercial paper are all considered unstable sources of
bank asset funding. By contrast, long-term debt (with a maturity of longer than 1y),
equity capital and retail deposits are the most stable sources of funding. In examining US
commercial bank balance sheets, we found a gap of approximately $1.7trn between the
available level of net stable funding and what would be required under Basel III. 1
Assuming there is no relief on the stable funding ratio, US institutions might need to raise
Figure 1: Non-large time bank deposits (% bank liabilities) Figure 2: Savings and small time deposits ($ bn)
59 4400 1100
Small time, rhs
57 4200 1050
1000
55 4000
950
53 3800
900
51 3600
850
49 3400
800
47 3200 Savings deposits, lhs 750
45 3000 700
Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10
Source: Federal Reserve Source: Federal Reserve
1
Please see, Liquidity Regulation: (Un)Intended Consequences?, R. Setia, A. Pradhan, and A. Nashikkar, Barclays
Capital, June 18, 2010
9 July 2010 9
$500-750bn in retail deposits. The balance of their stable funding gap could be met
through debt issuance and asset run-offs.
The return of pass-book savings

Deposit funding has Years of disintermediation and access to cheaper sources of wholesale funding have reduced
picked up since 2008… bank reliance on traditional retail deposits. Just before the height of the financial crisis, non-
large time bank deposits accounted for 48% of all commercial bank liabilities (Figure 1). The
flightiness of wholesale funding – particularly repo – at the height of the financial crisis caused
banks to move aggressively to shift their funding mix. A recent BIS paper notes the global shift
to more retail deposit funding, alongside a move away from centralized funding models. 2
Importantly, the authors conclude that the entire shift from wholesale funding reflects market
pressures, rather than the consequences of regulatory efforts.
…entirely in passbook accounts Digging deeper, we find that the increase in deposits at commercial banks is curiously
concentrated. Indeed, all of it has been in passbook-type savings accounts – a savings
vehicle normally associated with Christmas Clubs, toasters, and ornate branch lobbies.
Balances held in certificates of deposit (with balances under $100,000 and geared to retail
depositors) have declined (Figure 2). Since January 2009, passbook savings deposits have
increased nearly $850bn (or almost 25%), while small time deposits have contracted more
than $315bn (or nearly 30%). While some of the increase in passbook savings was driven
by household asset reallocation in the wake of the financial crisis, inflows since January
2010 and since the stabilization in financial markets have also been strong. Both the
increase in passbook balances and the decline in small time accounts have continued this
year, although at a somewhat slower pace. At the same time, balances held in retail money
market accounts have declined (Figure 3). Since the start of the year, retail deposits in both
government-only and prime funds have fallen $175bn, or nearly 13%. Looking at the rate
differential between these accounts, it is not hard to see why.
A question of rate
…as the bank and money Bank Rate Monitor publishes monthly deposit rates for bank money market and certificate
fund spread has widened of deposit accounts. 3 These figures are based on regional surveys and are the most
Figure 3: Retail money fund balances ($ bn) Figure 4: Bank and money market rates (%)
1600 5.0
4.5 MMF
1500 4.0
1400 3.5
3.0
1300 2.5 Bank Rate Monitor
2.0
1200 1.5
1100 1.0
0.5
1000 0.0
Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10
Source: imoney.net Note: The bank rate is the rate paid on money market accounts held at banks
which are similar to money market funds. Source: bankrate.com and imoney.net
2
See Funding Patterns and Liquidity Management of Internationally Active Banks, Committee on the Global Financial
System, Bank for International Settlements, May 2010.
3
See, http://www.bankrate.com/funnel/graph/
9 July 2010 10
frequently referenced deposit rate source in academic studies. However, the results reflect
the lowest offered rate, not the most commonly offered rate; as a result, they tend to have a
downward bias. 4 Nevertheless, beginning in mid-2008, the spread between bank and
money fund rates has widened (Figure 4). Backing out the implied rate on savings deposits
from the Fed’s “M2 own” series also reveals a sharp widening in the bank-to-money fund
rates spread. 5
Money fund competitive disadvantage

Banks may need to raise Retail investors in money funds and bank passbook deposits are similarly concerned with
deposit rates further safety and liquidity, but they are not indifferent to yield. The wider the spread between bank
and money fund rates, the more likely it is retail investors will shift their balances back into
passbook savings accounts. We expect depositors to continue to shun small time deposits
in favor of the greater liquidity in savings accounts. Thus, to raise the estimated $500-
750bn in retail deposits that we estimate banks need to get compliant with the Basel III net
stable funding requirements, bank rates will need to increase.
SEC 2a7 rules put money funds However, estimating the rate sensitivity of retail depositors is tricky. The permanent increase
at a competitive disadvantage in deposit insurance guarantees (to $250,000) makes bank deposits more attractive than
money fund accounts for the extremely risk averse. But even discounting the effect of
deposit insurance, money funds are not competing on a level playing field. The revised 2a7
rules severely crimp their ability to pick up extra yield from investing in term or credit
product. Just to get compliant with their 30% 7-day liquidity requirement forced prime
funds to reduce sharply their holdings of commercial paper and ramp up their low yielding
repo balances. Thus, banks may only need to increase the bank deposit-MMF rate spread by
perhaps 25bp or so in order to attract the extra $500-750bn. To lock in deposits for longer –
say, in 1y small time deposits – would require a bigger rate incentive. Even with 1y CD rates
exceeding 1.15% and over 100bp above money market fund rates, banks continue to lose
these deposits. Assuming no change in money fund rate-setting behavior, the higher yield
offerings at banks could easily pull $500bn out of retail money funds, shrinking aggregate
balances 20%.
However, money funds are not likely to go gently into that good night. Instead, to level the
playing field a bit, we expect them to begin offering floating net asset value funds
(essentially, very short duration bond funds) in addition to their existing array of stable NAV
funds. Without the flexibility of purchasing higher yielding assets, stable net asset funds will
quickly become less attractive options for retail savers – and the only way to prevent
significant outflows is to forsake their stable NAV charter.
Ironically, the same 2a7 fund rules that put the money funds at a competitive rate
disadvantage also make the process of offering floating NAV a bit easier, since the funds are
required to update their back office operations to handle movements in asset prices that
might cause the fund’s net asset value to move above or below $1/share. So far, however,
the development of floating NAV funds has been slow, with just a handful of offerings. But
with banks required to meet net stable funding requirements in short order, money funds
could soon face substantially stiffer competition in the super-safe retail money market.
4
See Bank Imputed Interest Rates: Unbiased Estimates of Offered Rates?, E. Ors and T. Rice, Federal Reserve Bank of
Chicago, November 2006
5
M2-own is the weighted average of the rates received on the interest-bearing assets included in M2 (savings, small
time deposits, and retail money funds).
9 July 2010 11
UNITED STATES: INFLATION-LINKED MARKETS
The concession is done, long live the concession

Michael Pond After a solid auction, we expect the 10y supply concession to be reversed in the coming
+1 212 412 5051 weeks. On the other hand, the market may begin an early set-up for the 30y reopening
michael.pond@barcap.com in August. In line with this view, we recommend putting on 10s30s breakeven flatteners.
Chirag Mirani Solid auction

+1 212 412 6819
Last week, we described our view that the 10y would have to cheapen significantly for a solid
chirag.mirani@barcap.com
auction. Since then, the market cheapened significantly and the auction was solid. We were
most concerned about rich real yields, but as 10y real yields backed up about 18bp from the
announcement, that factor became less of a concern. The auction stopped about 2bp through
the 1pm level on the WI, and indirect bidders took down 51% of the auction, a high since
October 2006. While there was likely broad domestic demand, we expect the auction
allotment data to be released on July 22 to show another sizable take-down by foreign
investors – an indication of continued structural allocations from foreign central banks.
As the market breathes a sigh of relief now that supply has been absorbed, we expect the
concession to be reversed over the next few weeks and 10y breakevens to move back closer
to 2.00%. The new 10y has generally performed well post-auction (Figure 1). However, the
market may begin to build in a concession for the end-of-August 30y reopening well ahead of
time because of increased sensitivity to real yield levels and a lack of historical demand from
foreign investors. To position for these moves, we recommend a 10s30s BE curve flattener.
Figure 1: On average, the newly issued 10y richens as much as 10bp after the auction
10y Avg (AuctionDateYield - GivenDatesYield), 16 New 10y TIPS Auctions

10
8
New Issue Richening
6 Off-the-run
cheapening
4
2
0
-2
-4
-10 -5 0 5 10 15 20 25 30 35 40
Days before/after auction
Note: Using the past 16 TIPS auctions’ data. Source: Barclays Capital
Trade idea: Long TIIJan18-Feb40 BE flattener ahead of 30y TIPS reopening

in August
At the November 2009 refunding announcement, the Treasury announced a switch from a
20y TIPS offering to 30y TIPS (issued on a semi-annual basis, initial offering in February,
followed by a reopening in August). 30y TIPS issuance had been absent in the market since
October 2001. There was considerable uncertainty regarding fair value for this point on the
curve because it was 8y beyond the nearest maturing bond (Apr 32s). In the process, the
bond sector of the TIPS curve cheapened significantly going into the auction (Figure 2). The
9 July 2010 12
30y auction on February 22 tailed by 6-7bp, but the market did retract afterwards. While we
believe there is a large potential domestic demand base at the 30y point, this is still
unproven and may not be significant at real yields below 2%. In our view, the TIIFeb40s
issue will likely cheapen ahead of its reopening auction on August 23, perhaps well before
the auction process.
We believe the best way to take advantage of potential cheapening in the 20-30y sector is
via a relative position versus the 10y sector. Given that the 10y sector had cheapened going
into the auction and the auction went well, we expect the historical post-auction richening
pattern to hold again (Figure 1).
Why a 10s30s breakeven flattener and not a 10s30s real curve steepener?
The reason we favor BE flatteners over real curve steepeners is that the 10s30s nominal
curve is at a fairly steep level. The 10s30s nominal curve is close to the top of its range over
the past year and a half (Figure 3) and may flatten after next week’s auctions. In this
scenario, the real curve is also likely to flatten, albeit at a lower beta. So from a relative value
perspective, we expect 30y TIPS to underperform the 10y sector; we believe this view is
better expressed in breakeven form to eliminate some of the macro curve exposure.
Which 10y point will make for the best 10s30 breakeven flattener trade?
Our forward 1y breakeven report shows that in the 10y sector, Jan17-Jan18 forward 1y BEIs
are trading at 162bp (a fairly low level), implying that Jan18 BEIs are cheap. This is also
confirmed by Jan18s’ 3m z-score of +0.9 versus the real spline curve. Thus, we recommend
that investors put on Jan18-Feb40s BEI flatteners, as this is the best way to position for the
above view. Currently, the Jan18-Feb40 breakeven spread is trading at 60bp; we expect it to
revert to 45bp with a stop-loss at 70bp. The trade has -1bp of carry over a 3m period.
Figure 2: 20y sector cheapened 10-15bp relative to 10y Figure 3: 10s30s nominal yield curve is at its peak over the
going into the new 30y auction in February, but richened past 1.5 years.
thereafter. It is at a favorable entry point now.
65 55 120
60 50
45 100
55
40 80
50 35
30 60
45
25
40 40
20
35 15 20
30 10
0
Nov-09 Jan-10 Mar-10 May-10 Jul-10
Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
Feb40-Jan18 BEI Spread (LHS, bp)
Apr32-Jan18s BEI Spread (RHS, bp) 10s30s Nominal Curve
9 July 2010 13
UNITED STATES: VOLATILITY
Vol decline likely to persist

Piyush Goyal The option market received more supply from callable notes in June than in previous
+1 (212) 412 6793 months. Moreover, the hedging community, including mortgage asset managers and
piyush.goyal@barcap.com insurance companies, remains on the sidelines. This dynamic seems unlikely to change in
the foreseeable future.
Option supply picks up
Callable zero-coupon notes

About $1.35bn initial notional of callable zeroes were issued last month, exceeding the
levels of the preceding two months but in line with the broader declining pattern (Figure 1).
Most of the callable notes mature in 30 years and are callable after the first year.
Accordingly, the option supply is ~ $20mn log vega. This is higher than in the previous two
months but in line with supply during the first quarter of 2010.
We expect issuance to remain tepid: about $2-3bn every quarter. Accordingly, option supply
should be smaller than the market is used to.
Agency callable notes

There was a notable pickup in new issuance of agency callable notes last month. About
$77bn was issued –25% higher than in May. But only $14bn of the issuance was from the
Federal Home Loan bank (FHLB) system. More long-term securities are being issued; thus,
despite the drop in issuance, option supply was roughly $6mn, about the same as in the
past few months.
We expect issuance and related option supply from agency callable notes to remain robust
as there are few alternatives for investors looking for higher yield.
Figure 1: Callable Zero note issuance is on a decline Figure 2: FHLB issuance is also on a decline
7 300 90
6 80
250
70
5
200 60
4 50
150
3 40
100 30
2
50 20
1
10
- 0
0
Q1 06 Q1 07 Q1 08 Q1 09 Q1 10
Jul-08 Nov-08 Mar-09 Jul-09 Nov-09 Mar-10
Issuance ($bn,L) 2-10 curve (bp,R) FHLB Gross Issuance ($bn) Other
Source: Bloomberg Source: Barclays Capital
9 July 2010 14
Total supply
To sum up, the option market received about $26mn in vega supply during June. This is
higher than the past two months. We expect supply to decline over the next few months as
callable zero note issuance decreases.
Smaller demand from hedgers

The declining supply would have been a bigger deal had it been accompanied by rising
demand from hedgers, a scenario we consider unlikely.
Mortgage hedgers
The SEC filings of Fannie Mae and Freddie Mac show that option portfolios at the two
entities declined by about $40bn in notional during the first quarter of 2010 (see “Supply: A
smaller deal”, Market Strategy Americas, June 4, 2010).
The vega exposure embedded in the GSE mortgage portfolio has declined in the past few
quarters, so the lukewarm interest in options is not surprising. Unless rates rise sharply, and
fast, asset managers are unlikely to need much in the way of vega hedges.
In our base case, we do not expect rates to rise by as much as required to bring asset
managers into action. Thus, we expect their demand for options to remain non-existent for
several months.
Insurance companies
We also expect demand from insurance companies to remain small as a result of
insignificant growth in variable annuity sales (Figure 3). Annuities matter because insurance
companies that have sold these policies need to buy long-dated options to hedge the risk
embedded in their policies.
Annuity sales look unlikely to pick up, so hedgers could remain on the sidelines for some
time yet (Figure 4).
Figure 3: Variable annuity sales have reached a plateau… Figure 4: …so hedgers are not buying options
50.0 1600 Floors Outstanding (notional, $bn)

80
1500
45.0 70
1400
60
40.0 1300
50
1200
40
35.0 1100
30
1000 20
30.0
900 10
25.0 800 -
Q1 05 Q1 06 Q1 07 Q1 08 Q1 09 Q1 10 Q4 05 Q4 06 Q4 07 Q4 08 Q4 09
VA Sales S&P Metlife AXA
Source: LIMRA quarterly and annual reports Source: SEC 10-Q filing
9 July 2010 15
Dealer hedging of existing callable zeroes

As discussed in our Primer on Callable Zeroes and Vol (May 21, 2010), dealers hedging the
option supply from callable zeroes become short vol as rates fall, and vice-versa.
Given how low we already are on the level of rates, and dealers’ hedging experience during
May (rates fell, they become short vol and have to buy at expensive levels), the hedging risk
is more towards vol selling. So if rates rise, there may be option selling from the dealer
community. But if rates fall, there may not be much of an impact.
Total demand
Option demand from hedgers, including mortgage asset managers, insurance companies
and the dealer community hedging the callable zeroes, is likely to remain low for the next
several months.
Conclusion
Long-dated options are likely to trade with a bearish bias for the next several months as the
supply from callable notes persists and demand from hedgers remains tepid. We suggest
selling long-dated option structures, such as 5y*5y, 3y*10y, etc.
9 July 2010 16
EURO AREA: RATES STRATEGY
Near-term outlook and EUR rates trade ideas

Cagdas Aksu This week we look at the short and long ends of the EUR curve and review some of our
+44 (0) 20 7773 5788 preferred trade ideas. Despite recent moves, we still like being long the belly on EUR
cagdas.aksu@barcap.com 2s/10s/30s from here. We also enter into EUR 2s/10s 1y fwd flattener vs 1y1y fwd vs 2y1y
fwd steepener and see room for more tactical Schatz ASW tightening in the near term.
Giuseppe Maraffino
This week has generally been good for risky assets. Developed economy stock markets have
+44 (0) 20 3134 9938
bounced about 5%, and euro area government bond spreads, particularly in peripheral
giuseppe.maraffino@barcap.com
space, have re-tightened. The €45bn-less roll in the ECB’s weekly MRO, successful
placement of a new 10y Spanish benchmark, news that the European banking system stress
tests are going to be more detailed than expected, slightly positive tone from the ECB press
conference and relatively reasonable start to the Q2 earning season have all supported the
bounce in risky assets. Apart from these, some other technical factors had already reached
interesting levels to support this week’s moves as well. For instance, the US data surprise
index (developed by our FX colleagues) has already reached very low levels once again
(Figure 1). Moreover, the Bull/Bear ratio from the AAII’s equity sentiment indices has also
fallen recently to about early 2009 levels. We think there is more room for this risky asset
rally to continue in the near term and offer some of trade ideas that we like currently.
Figure 1: US data surprise index vs change in 10y Treasury yields Figure 2: AAII’s Bull/(Bull + Bear) ratio vs S&P
150 1.5 1600 1.0

100 1.0
1400 0.8
50 0.5
0 0.0 1200 0.6
-50 -0.5
1000 0.4
-100 -1.0
800 0.2
-150 -1.5
-200 -2.0 600 0.0
Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-01 Jul-02 Jan-04 Jul-05 Jan-07 Jul-08 Jan-10
USGG10YR Index
S&P Index
1-mth rolling average of activity data Equity Investor sentiment, Bull / (Bull + Bear) ratio (RHS)
surprise z-score (right axis)
We still like the variations of EUR curve flattening risks
Keep long the belly on EUR 2s/10s/30s

Being long the belly on EUR We recommended going long the belly on EUR 2s/10s/30s to position for a strategic
2s/10s/30s barbell still great way flattening of the EUR 2s/10s curve on 16 April (“EUR rates trade ideas”, Global Rates
to be short the front end of the Weekly). Since then, the EUR 2s/10s curve flattened 35bp and the belly on EUR 2s/10s/30s
curve and have curve flattening has richened 30bp. We still like the flattening risk after recent developments concerning
exposure with positive carry liquidity issues at the front end of the EUR curve. The notable drop in the liquidity surplus of
the EUR system following the recent rolls of the LTRO and MRO has already led to a notable
sell-off in EONIA. Overall, we still see the risks biased towards further flattening in 2s/10s in
9 July 2010 17
bear and bull market scenarios on a medium-to-long term basis (we think the curve can
even bull flatten in a double-dip scenario, although this is not our base case). Our model for
EUR 2s/10s with the current and expectations component of the IFO index still points to
flatter levels (Figure 3). Given its correlation with 2s/10s, we still prefer to position via
2s/10s/30s barbell because it is much more advantageous to hold from a carry perspective
(2s/10s/30s has 12bp positive carry over a year, versus 10bp negative carry for 2s/10s).
Overall, we believe being long the belly on EUR 2s/10s/30s barbell is a great way to be short
the front end of the curve and have curve flattening exposure while capturing positive carry
(unlike the latter two trade ideas) and not suffering in further rates rallies.
Figure 3: EUR 2s/10s curve vs our models Figure 4: EUR 2s/10s/30s vs EUR 2s/10s
250 240 270
200 180
170
150 120
100 60 70
50 0
-30
-60
0
-120 -130
-50
Jun 05 Jun 06 Jun 07 Jun 08 Jun 09 Jun 10
Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10
EUR 2s/10s Predicted EUR 2s/10s EUR 2s/10s/30s EUR 2s/10s (RHS)
Also enter EUR 2s/10s 1y fwd flattener vs 1y1y fwd/2y1yfwd steepener

As we have highlighted in our previous publications, the back end of the money market
curve (reds/greens) is correlated with the 2s/10s part of the curve. In the notable curve
flattening since mid-April, reds/greens has actually flattened much more than the 2s/10s
part of the curve, creating a notable dislocation between the two.
For investors uncomfortable with outright flattening risk after the recent curve moves, we
think positioning for the dislocation is a good trade idea. Looking at the regression between
EUR 2s/10s 1y fwd and 1y1y fwd/2y1y fwd, every 1bp move in the latter results in a
roughly 2.8bp move in the former. Thus, for every 50k per bp risk in 2s/10s 1y fwd flattener,
one should have 140k per bp risk on 1y1y fwd/2y1y fwd steepener. Therefore, the whole
structure nets a three leg trade with the following notionals with the aforementioned risks:
Long/Short/Long: 1y1y fwd/2y1y fwd/10y1y fwd: 1445mn/985mn/60mn
We think the dislocation is worth about 40bp on 2s/10s (meaning 2mn profit with the
nominals mentioned above). All the risk and nominal measures here is for illustration
purposes; investors can adjust the risk according to their risk appetite.
9 July 2010 18
Figure 5: Evolution of 1y carry from being long the belly on Figure 6: EUR 2s/10s versus reds/greens
EUR 2s/10s/30s 1y fwd
50 200 60
150 40
30
100
20
10
50
0
-10 0
-50 -20
-30
-100 -40
-50 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10
Jul 05 Jul 06 Jul 07 Jul 08 Jul 09
EUR 2s/10s 1y fwd
1yr carry from being long EUR 2s/10s/30s EUr 1y1y fwd vs 2y 1y fwd (RHS)
Close FRA – EONIA forwards wideners for now, enter Schatz ASW
tactical tightener
Following recent developments in the short end, the 3m spot Libor-EONIA basis has
tightened 8bp on the week in the EONIA spike with the spot basis as low as 20bp on
Thursday. At the same time, tightening in 2011 and 2012 forward basis has been much
more limited than front-month tightening (c.2bp). While we still believe that in the medium
to long term, the market’s own liquidity normalisation is likely to widen the liquidity
premium of the Libor-EONIA basis; in terms of positioning, it might not be the best time to
hold it in the near term. If it takes more time for the Libor to respond to new liquidity
conditions by starting to rise in a more notable way and spot 3m Libor-EONIA sustains early
20bp levels, then we see near-term risk of further temporary tightening in forward Libor-
EONIA basis. Therefore, we close our forward (2011 and 2012 maturity) Libor-EONIA basis
widener and look for better levels to enter this trade again later.
Figure 7: Schatz ASW decomposition into its components Figure 8: Fundamental model
140 50
30
80
10
20
-10
-40 -30
Jan 07 Oct 07 Jul 08 Apr 09 Jan 10 Jan 00 Jan 02 Jan 04 Jan 06 Jan 08 Jan 10
Schatz ASW Schatz FRA - EONIA Schatz EONIA - Ger
Schatz EONIA - Ger Predicted with 3m GC & EUR 1yr ahead German deficit
9 July 2010 19
We have also been highlighting the richness of the EONIA-Germany component of the
Schatz ASW for a long while but always positioned our tactical tightening views in Bobl and
Bund ASW. Apart from other structural factors, we believe one of the reasons that kept the
EONIA-Germany component of Schatz ASW rich was the belief the FRA-EONIA basis had
bottomed out and would widen significantly. While we maintain our Bobl ASW tightener
versus EONIA that we entered on 4 June (“Tactical short in Sep Bobl ASW vs EONIA”, Global
Rates Weekly), we think there is tactical value in selling Schatz ASW versus Libor to position
for temporary near-term Libor-EONIA tightening, as well as a correction in rich EONIA-
Germany tightening on better tone from risky assets. We target mid-50bp levels.
ECB and liquidity update

The market has started Short-term rates continued to increase this week: the results of last Tuesday’s MRO
pricing less accommodative (EUR45bn of the expiring EUR276bn was not rolled) has pushed the liquidity surplus down
liquidity conditions (to about EUR120bn). Furthermore, at the ECB meeting, Trichet did not seem worried about
the latest movements of short rates; in the Q&A session, he stated that banks decided to not
roll part of the expiring liquidity at the 12M and the MRO and that the increase in EONIA
rates is just a “demand-driven phenomena”. This has reinforced expectations that restoring
the exit strategy is in the pipeline. At present, the forward curve sees the EONIA for
December at 0.75% (signalling further reduction in the liquidity surplus/average maturity of
OMOs) and moving above 1% in September 2011 (normalization) – a sharp contrast to
some weeks ago when the market was not expecting EONIA to be 1% before the end of
2011. Indeed, spot 1y OIS rate and Libor rate are at the highest this year: on the forward
curve, the 1y1y OIS is 1.09%, up sharply from the 0.88% at the beginning of May (the u-
turn of the ECB due to the worsening of the Greek crisis). The 1y Libor rate has moved up as
well, in spot and 1y forward, with the former returning above 1% after moving at 0.80-
1.00% since the beginning of the year (Figure 9).
Figure 9: Rising trend Figure 10: Excess reserves (€bn) vs Eonia/refi (bp), 1wk MA
1.25 200 Excess reserves 40

Libor 1y OIS 1y Eonia-Refi (RHS)
150 20
1.00 0
100
-20
0.75 50
-40
0
-60
0.50
-50 -80
0.25 -100 -100

Jan-10 Apr-10 Jul-10 Jan-08 Oct-08 Aug-09 Jun-10
Next week: the start of the new As we stressed in the 2 July Global Rates Weekly, in a context of low liquidity surplus (ie,
maintenance period and the roll c.100bn) and short average duration of the outstanding refinancing operation, the
of the 1M STRO relationship between the liquidity surplus dynamics and EONIA should be stronger as well
as sensitive to the evolution of the excess reserve during the maintenance period. In this
respect, it is important to stress that next week EUR229bn will mature at the weekly MRO
9 July 2010 20
and EUR31bn at the 1M STRO. Based on the recent bank behaviour, it is likely that part of
the STRO will not be rolled and that the roll is concentrated in the MRO. This would further
reduce the liquidity surplus as well as the average duration. Furthermore, the new
maintenance period starts on 14 July: excess reserve should return to positive territory with
the consequent decrease in deposit facility. These two factors should create the potential
for a further increase in the EONIA, likely to move up to 0.50-0.60% (as the movement from
January-June 2009 in Figure 10 suggests). Note that, at present, the July forward EONIA
prices in a fixing at 0.52%, which suggests that some spikes of the EONIA beyond 0.60%
are already priced in.
9 July 2010 21
UNITED KINGDOM: INFLATION-LINKED MARKETS
RIP RPI? No, but hi to CPI

Alan James The UK government has announced its intention to encourage private pension schemes
+44 (0) 20 7773 2238 to switch indexation from RPI to CPI. We do not see this as the death knell of the RPI
alan.james@barcap.com market, but it is likely to hasten the birth of the CPI market.
On Thursday 8 July, Pension Minister Steve Webb made a written statement to the House of
Commons that could have a profound effect on the UK pensions industry. The statement
read as follows:
The Chancellor of the Exchequer announced in the Budget statement on 22 June that, with
some exceptions, consumer prices rather than retail prices will be the basis for uprating
most benefits and public sector pensions.
The Government believe the CPI provides a more appropriate measure of pension recipients’
inflation experiences and is also consistent with the measure of inflation used by the Bank of
England. We believe, therefore, it is right to use the same index in determining increases for
all occupational pensions and payments made by the Pension Protection Fund (PPF) and
Financial Assistance Scheme (FAS).
Consequently we intend to use the CPI as the basis for determining the percentage increase
in the general level of prices for the 12 months ending 30 September 2010 when preparing
the order required under paragraph 2(1) of schedule 3 to the Pension Schemes Act 1993 in
relation to revaluation and indexation of pension rights in defined benefit pension schemes,
and the order made under section 109 of that Act in relation to increases in guaranteed
minimum pensions paid by contracted-out defined benefit schemes in respect of
pensionable service between 1988 and 1997; and amend legislation to enable CPI to be
used for relevant increases in respect of the PPF and FAS.
Using CPI will mean making some small changes to primary legislation to ensure we can apply it
fully in every circumstance. We will bring these before Parliament at the earliest opportunity.
Government can easily change The intent of this statement is clear: to switch, as much as possible, from RPI inflation as the
indexation for schemes that basis for indexation of pensions to CPI inflation. On average, since 1997 (the first year for
reference 1993 legislation which we have a full breakdown of data), RPI inflation has been 0.85% higher than CPI
inflation; since 1988 the difference has been 0.68%, so such a change would tend to reduce
expected future pension liabilities significantly. However, the ability of the government to
adjust accrual of existing private pension liabilities is somewhat limited. The Pension
Schemes Act 1993 set out only the minimum indexation that schemes could henceforth
provide. This minimum was flexibly defined, making it straightforward for the government
to adjust. Each year it is the lower of 5% or the “percentage which appears to [the Secretary
of State] to be the percentage increase in the general level of prices in Great Britain...”
Most large private sector If pension schemes refer to the indexation in the 1993 Act, then their liabilities will adjust
schemes do not refer to the 1993 with respect to CPI once the change is enacted (accruing from the start of 2010 or 2011,
Act, but many smaller ones do depending on whether the change is made by the start of October 2010). However, for
schemes not explicitly referencing the indexation in the Act, existing liabilities should not be
affected unless more exhaustive legislation is brought in. Schemes indexed directly to RPI
inflation should not be affected, nor should those with Limited Price Indexation (LPI).
Although LPI (0,5%) is currently similar to the Act, it is not explicitly flexible or, indeed, the
same, given that the legislation does not define a floor. It is our understanding that most of
9 July 2010 22
the largest UK private sector schemes are linked to RPI or LPI rather than referring to the
linkage in the legislative framework. However, there will be a significant number of schemes
that do reference the legislation and, since the announcement, trustees and finance
directors are likely to be examining the detail of their contracts.
On a PPF basis, pension scheme The current proposal means that some firms will receive a windfall in terms of a much
liabilities will shrink substantially healthier pension funding status than currently, with the scheme members having their
future benefits cut. It is possible that the government will bring more far-reaching legislation
to directly affect more private pension schemes. We expect that the government’s action
will also prompt some of the few remaining open pension schemes to redefine their
accruals for new liabilities on a CPI basis. Until there is greater clarity as to the government’s
strategy, we would expect the announcement to influence the behaviour of many funds
that are not directly affected by the change as currently indicated, with LDI activity in
general curtailed. Almost all firms with defined benefit schemes will also be affected
indirectly by the change in the basis of assessment for the Pension Protection Fund if, in
future, payouts to members transferred to it will also be linked to CPI rather than RPI.
Conceptually, the change in discount rate for PPF assessment should lead to a significantly
better funded pension sector on the s179 basis. The PPF has estimated that every 10bp
change in the inflation assumption affects the aggregate PPF 7800 sample by £9bn.
Realised RPI-CPI basis is not We have very little doubt that, on average, CPI inflation over the long term will be lower than
stable while the CPI curve is not RPI inflation, but the basis in the short term is relatively volatile, so hedging CPI-linked
yet defined liabilities with RPI inflation is far from ideal. Since 1997, the difference between annual RPI
versus CPI inflation has been as high as 2.6% and as low as -3.4%. Most of the big swings in
the differential come from housing, with the sharpest changes stemming from mortgage
interest payments, where this year’s change in methodology should reduce basis volatility.
The stated intention to try to include house prices in CPI if implemented may further reduce
this basis spread and volatility. However, RPI inflation ex-housing over this period has
swung between +1.2% and -0.7% versus CPI. Although CPI inflation swaps have
occasionally traded in the UK, it is likely to take some time before the curve is well enough
defined to provide an effective discount function for measuring the value of CPI-linked
liabilities. Until there is significant CPI supply forthcoming, the basis is likely to be
conservatively priced.
Other liabilities are also likely to We see the government announcement as hastening the start of an active market in CPI-
become CPI based; we expect linked products. We expect that in addition to the potential private pension liabilities already
the DMO to issue CPI bonds by discussed, there will also be significant indexation of funded public sector pension schemes
next fiscal year to CPI (at least on an ongoing basis and potentially for future accrual of existing liabilities).
To encourage this market to develop we would expect the DMO to issue CPI-linked bonds
by next fiscal year, in addition to continued issuance of RPI linkers. It seems highly likely that
future long-term indexation will also become CPI-based. The most important new example
of this is likely to be nuclear decommissioning liabilities for the proposed new generation of
power plants. We would not be surprised to see a switch of indexation for regulated utilities
the next time sectors come up for regulatory review.
Birth of CPI market should not All in all, we see the government proposals hastening the start of a CPI-linked market but
mean death of RPI not the death of the RPI-linked market. Private sector RPI liabilities have barely been
growing in recent years other than through accretion of existing positions, with ever fewer
defined benefit schemes still open to new members, if at all, while many of those remaining
are offering LPI (0,2.5%) accrual, so little RPI exposure. Nonetheless, this is the first time
that there has been a proposal that cuts into existing liabilities. We expect that the
uncertainty that this produces will limit allocations into the long end of the inflation market,
9 July 2010 23
which may make long-dated gilt linker supply more challenging to absorb, even though we
do not expect any significant imminent selling as RPI is still a notably better hedge for CPI
than no hedge at all. The impact on swaps may be more even across the curve. The danger
is that there will be some schemes that will be overhedged on inflation after the change
because of the lower discount function and hence will have an incentive to sell, but pinning
down the magnitude of such a position is very difficult without a well defined CPI curve.
From a broader asset allocation perspective, at the margin we see the announcement as
slightly positive for UK financial assets other than RPI linkers. Some companies will gain a
notable windfall as their pension situation swings into an unanticipated surplus. Insurance
companies could gain particular windfalls if they have conducted buyouts for which their
liability is significantly reduced (though in many cases pension scheme terms may have
been locked at this point). In aggregate, we would expect the equities market to benefit
even if it is hard to identify the precise winners at this stage. In the medium term, we see the
move as positive for bonds and potentially less positive for equities, as the improved
funding status may well encourage a de-risking strategy though, this is likely to occur only
once the situation has become clearer and the CPI market better defined.
IL22 auction may be well The IL22 is set to reopen on Thursday 15 July for £1.2bn notional and this auction is likely to
supported, despite uncertainty be more challenging than it would otherwise have been given the announcement discussed
above. While not a large auction in duration terms, it is the largest-ever auction in cash
terms, with the potential to raise as much as £1.6bn if post auction options are exercised.
The bond has cheapened on the curve in recent weeks; indeed, we noted in last week’s
edition of Global Rates Weekly that it was already cheap, which we expect to support the
auction. However, the UK linker market typically has more difficulty absorbing large
amounts of cash than large amounts of duration, partly because long auctions produce
index extension bids. The previous (£1.1bn) reopening of the IL22 in May is a classic
example: in this case the bond itself rallied into the auction and cleared above mid market,
but linkers cheapened sharply in the afternoon, both outright and in breakeven, even as the
bond held onto its relative outperformance versus its neighbours. We expect a relative value
bid in this auction, too, and the bond is also likely to attract demand in asset swap. In
addition, we would not be surprised if investors wary of the potential negative impact on
long linkers from the pension reforms shorten duration by selling the long end into the IL22.
The supply shortens over 5y indices by 0.04 years and all linker indices by 0.02 years.
Figure 1: IL22 very cheap on curve Figure 2: IL22 very cheap in outright and relative asset swap
0.35 IL22 versus IL17+IL32 real yield barbell 70

IL22 proceeds asset swap
0.30 IL17+IL32 breakeven barbell versus IL22 60 IL22 relative z-spread asset swap
0.25 50
0.20 40
0.15 30
0.10 20
0.05 10
0.00 0
-0.05 -10
Nov 09 Jan 10 Mar 10 May 10 Jul 10 Jul 09 Oct 09 Jan 10 Apr 10
9 July 2010 24
UNITED KINGDOM: RATES STRATEGY
The irresistible force

Moyeen Islam We discuss the recent performance of the 10y sector on the curve and cross market.
+44 (0) 20 7773 4675 While the curve valuation looks stretched, the fundamentals support further cross-
moyeen.islam@barcap.com market outperformance versus Europe.
The external environment has In the aftermath of the emergency budget and the £20.2bn downward revision to gilt
been highly supportive for 10y issuance for the current fiscal year, we have seen a continuation of the strong bullish price
gilts both on the curve and action in gilts that characterised the post-election aftermath of the election. As can be seen
cross market in Figure 1, having peaked at around 6% in the early part of the year, Gilt 5y5y fwd has now
rallied close to 80bp since mid-April to currently sit at around 5%. The rally has been driven
by four specific factors:
structural short positions after the cessation of the QE asset purchase programme
around issue of fiscal and political risk associated with the election;
a more dovish-than-expected May Inflation Report from the Bank of England essentially
endorsing a “lower for longer” term structure of rate expectations in the OIS market;
a more ambitious medium fiscal plan outlined in the emergency Budget on 22 June
which is widely viewed as leaving the MPC little alternative but to keep its policy stance
accommodative;
increasing sovereign risk perception in the Eurozone leaving gilts as a “safe haven” in
the eyes of investors
The flow in non-resident gilt The degree of short covering from international investors relative to domestic investors can
holdings has reached record perhaps best be understood by looking at Figure 2. This shows the rolling 3-month net
levels as shorts have been cut change in non-resident holding of gilts which currently stands at just over £35bn, by some
and gilts have assumed safe- considerable distance a record level for this series (which goes back over 20 years). Having
haven status been large sellers of gilts in 2008-09, the international investor base has not only largely
closed its short position that was originally driven by the first factor listed above, but the
latter three factors have driven a more positive outlook for gilts.
Figure 1: Gilt 5y5y fwd hits the lows of the year (%) Figure 2: Overseas purchases of gilts at record levels (£ mn)
6.0 Gilt 5yr 5yr fwd 40,000

rolling 3m net change in non-
resident holdings of gilts
30,000
5.5
20,000
5.0
10,000
4.5
0
4.0
-10,000
3.5 -20,000
Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10
Source: Barclays Capital Source: Bank of England, Barclays Capital
9 July 2010 25
The perception of the improved fiscal outlook for the UK can also be seen by looking at the
relative change in 1y ahead budget deficit expectations taken from the mean expectation
from Consensus Economics (Figure 3). The chart essentially shows the relative change in
deficit expectations with a positive change indicating that a UK deficit expectations are
deteriorating more quickly that those for either the US or Germany.
Figure 3: Budget deficit expectations are improving in the UK relative to others
2.5 UK vs Germany
relative change in UK vs USA
2.0 1yr ahead budget
1.5 deficit (% GDP)
1.0
0.5
0.0
-0.5
-1.0
-1.5
Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10
Source: Consensus Economics, Bloomberg, Barclays Capital
Deficit expectations and net As can be seen, there has been a steady improvement in the expectation for the UK as the
issuance dynamics support nadir of expectations was probably seen in the first half of 2009. Note that the latest survey
continued outperformance data were taken before the emergency Budget. The forecast PSNB for FY 11/12 is £115bn,
versus Bunds in the 10y sector some £15bn lower than the Consensus economics figure. However, as can be seen, it is rare
for the relative differential to be any less than -1%. So if anything, we would expect that the
improvement in UK expectations stabilise here and any further progress is likely to be a
function of a worsening in the international leg of the spread. Figure 4 shows the recent
development in the 10yr gilt/bund spread versus the short end of the curve. As can be seen,
there has been a decoupling between the 10y spread and the short end and so the recent
retightening of the gilt-bund spread can be viewed as a “catch-up”. In contrast, the spread
versus the US has been more orderly (Figure 5).
Figure 4: GBP/Euro 10y spreads vs 1y1y spread (bp) Figure 5: GBP/USD 10y spreads vs 1y1y spread (bp)
140 200 140 250

120 120
100 150 100 200
80 80
100 150
60 60
40 40
50 100
20 20
0 0 0 50
-20 -20
-40 -50 -40 0
Jan-07 Sep-07 May-08 Jan-09 Sep-09 May-10 Jan-07 Oct-07 Jul-08 Apr-09 Jan-10
10yr Gilt/Bund (bonds) 10yr Gilt/UST (bonds)
10yr GBP/Euro spread (swaps) 10yr GBP/USD spread (swaps)
GBP/Euro 1yr 1yr fwd spread (RHS) GBP/USD 1yr 1yr fwd spread (RHS)
9 July 2010 26
Deficit expectations and net We have previously found that a key driver of the spread in bonds has been the net issuance
issuance dynamics support profile for gilts. This is illustrated in Figure 6, which shows our forecasts for net issuance for
continued outperformance the remainder of the calendar year based on the DMO’s revised remit published alongside
versus Bunds in the 10tyr sector the Budget papers. As can be seen, it suggests that in the medium term there is further
scope for a continuation of the trend of gilt outperformance with a potential move to 50bp
towards the end of the year. If we look at the net balance of issuance between gilts and
bunds (with the bund cash flows converted to sterling at the prevailing spot exchange rate)
and as can be seen in Figure 7, the net balance of issuance is not likely to see git issuance
materially outstrip bund issuance. Cumulatively, it is only £8bn higher for the remainder of
this calendar year and it is not out of the question that there might be a further reduction in
issuance later this year at the Pre-Budget Report, although this is also true of Germany but
to a lesser degree.
We look for more medium-term So overall, we see little reason to expect a major medium-term correction in the 10y gilt-
performance for gilts versus bund spread and fundamentally any widening would likely be seen as an opportunity to
bunds in the 10y sector… .but reset spread tightening trades. Given the relative cheapness of the long end on the curve
the spread in the 30y sector may and cross market versus Europe (the GBP/EUR 10/30s box remains close to its historical
well also begin to turn having highs) and with the proposed changes in the indexation of pension liabilities likely (in the
reached historical extremes medium term at least) to leave institutional demand for long dated nominal paper broadly
unchanged, in the medium term we may also see 30y spread also come under tightening
pressure and correct back from its recent wides which remain at historical extremes. Please
see the UK Inflation-linked section for a complete discussion of the proposed changes to the
indexation of pension liabilities.
Figure 6: 10y gilt/bund spread (bp) vs net gilt issuance (£ bn) Figure 7: 10y gilt/bund spread (bp) vs net issuance balance (£ bn)
25 100 40 100
20 90 30 90
80 80
15 20
70 70
10 10
60 60
5 0 50
50
0 40
40 -10
-5 30
30 -20
-10 20
20 -30 10
-15 10
-40 0
-20 0 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11
Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11
Gilt vs bund supply (currency adjusted)
Net supply gilts (inc BOE APF) 10yr gilt/bund (RHS) 10yr gilt/bund (RHS)
Source: Barclays Capital Source: UK Debt Management Office , GFA, Bloomberg, Barclays Capital
9 July 2010 27
COVERED BONDS
Relative value thoughts on the Nordic covered

bond market
(This is an edited extract from The AAA Investor, published 8 July 2010)
Leef Dierks Over the course of previous months, covered bonds from issuers located in the Nordic
+49 (0) 69 7161 1781 countries, ie Denmark, Norway, Finland, and Sweden, have been among the most resilient
leef.dierks@barcap.com against any form of spill-over effects from their respective government bond markets. Instead,
with investors unwilling to abandon their flight-to-quality strategies as of late, swap spreads of
Fritz Engelhard Nordic covered bonds actually tightened and, at the time of writing, traded on tighter levels
+49 69 7161 1725 than those of comparable French common law covered bonds, a development last observed in
fritz.engelhard@barcap.com June 2009. This, at first glance, might appear as something of a paradox as, in contrast, to
French papers, covered bonds from the Nordic region (except for issues out of Finland) did not
Michaela Seimen benefit from the €60bn covered bond purchase programme set up by the Eurosystem.
+44 (0) 20 3134 0134
A closer look at the Nordic market unveils that Finnish covered bonds trade on the relatively
Michaela.Seimen@barcap.com
tightest levels, which we believe is attributable to the relative scarcity of Finnish covered
bonds. Swedish covered bonds, in contrast, trade slightly dearer than their peers, which, in
our view, is because of a more diverse issuer spectrum and partly also because of the higher
issuance volumes (Figure 1).
Figure 1: Credit term structures on the Nordic covered bond market
OAS swap spread (bp)

80
60
40
20
term-to-maturity (yrs)
0
0 2 4 6 8 10 12 14
Denmark Norway Finland Sweden

Denmark With only one issuer active with regards to EUR-denominated benchmark covered bonds,
namely Danske Bank (DANBNK), the analysis of the Danish market is relatively
straightforward. On average, Danish papers trade in between those of Norwegian and
Swedish issuers, which, in our view, is little surprising as the collateral pool backing Danish
EUR-denominated benchmark covered bonds consists of residential property in Norway and
Sweden. Also, Danish covered bonds benefit from a relatively faster swap-spread
adjustment process as a result of the slightly higher liquidity due to a higher amount
outstanding – and the fact that the domestic (DKK-denominated) covered bond market is
among the world’s most liquid ones. Thus, we understand the condition of the Danish
9 July 2010 28
covered bond market to be attributable both to the sound underlying fundamentals and the
relatively good liquidity endowment.
Norway With merely two active issuers of benchmark EUR-denominated covered bonds at the time
of writing, DnB Nor (DNBNOR) and Sparebanken Boligkredit (SPABOL), the characteristics
of the Norwegian covered bond market can best be compared with the Danish market.
Generally, with largely similar issuance volumes and a comparable asset quality, SPABOL
tends to trade slightly dearer than the generally rich DNBNOR. What is more, in light of
virtually no sovereign debt issuance, covered bonds currently appear to be the only
alternative when seeking exposure to AAA-rated, EUR-denominated Norwegian debt.
Finland With only one active issuer (OP Mortgage Bank – OPMBK) of benchmark covered bonds
(Sampo Bank (SAMPO) was acquired by DANSKE as per 1 February 2007) at the time of
writing, the Finnish covered bond market still benefits from a degree of scarcity appeal.
This, as illustrated in Figure 1, is reflected in relatively rich swap-spread levels, which
indicate that on average, Finnish covered bonds trade on slightly richer levels than their
peers from other Nordic countries. Whereas we do not expect this situation to materially
change in the near term, we also highlight that apart from liquidity aspects, there is little
reason for the respective covered bonds to trade at a premium (discount) vis-à-vis its peers.
Figure 2: The Swedish covered bond market
OAS swap spread (bp)

60
50
40
30
term-to-maturity (yrs)
20
2 3 4 5 6 7 8
NBHSS SCBCC SEB SPNTAB LANSBK SHBASS
Sweden With regards to the Swedish market, which clearly is the dominating force in terms of
outstanding volume among the other Nordic markets, things appear to be slightly different.
The Swedish covered bond market is less homogeneous, as within the same maturity
bracket, Swedish covered bonds trade nearly 20bp apart (Figure 2). Whereas the 4.250%
NBHSS February 2014 traded at mid-swaps plus 25bp at the time of writing, the 4.125%
SPNTAB June 2014 traded at mid-swaps plus 43bp, a difference we believe is difficult to
justify through liquidity or related issues. Instead, we understand this differentiation to be a
signal for the investors’ perception of different qualities. In other words, on the Swedish
market, the price of a covered bond appears to be strongly related to the perceived quality
of the collateral pool and an issuer’s exposure vis-à-vis potential headline news.
CDS mirrors covered bonds’ Also, at least partly, the above seems to be reflected in the development of the issuers’ five-
swap spread difference year senior CDS. Despite having significantly contracted (from 200bp) since summer 2009, the
difference between the five-year senior CDS of Nordea Bank and Swedbank still amounted to
approximately 20bp at the time of writing, ie to precisely the difference we have observed
between the two issuers’ EUR-denominated benchmark covered bonds (Figure 3).
9 July 2010 29
Figure 3: Five-year senior CDS of selected Swedish covered bond issuers
350 bp
300
250
200
150
100
50
0
Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10
Nordea SEB Swedbank
What is more, as outlined below, the correlation between an issuer’s five-year senior CDS
and its covered bonds with a comparable term-to-maturity is rather low – except for
Swedbank Hypotek (SPNTAB) where the R² amounts to 0.92. Generally, however, CDS do
not appear to be a reliable proxy for EUR-denominated covered bonds on the Swedish
market (Figure 4).
Figure 4: 12-months correlation between selected 5-yr Senior CDS and covered bonds
Covered bond OAS swap spread (bp)

125
100 y = 26.609Ln(x) - 76.008

y = 60.393Ln(x) - 233.82
R2 = 0.0955
R2 = 0.9235
75
50 y = 84.137Ln(x) - 352.24
R2 = 0.5392
25
5-yr Senior CDS (bp)
0
0 50 100 150 200 250 300 350
NORDEA SEB SPNTAB
Broadly homogeneous cover In a subsequent step, we analyse the composition and quality of the Swedish covered bond
pool quality issuers’ respective collateral pools (Figure 5). Whereas we note that, on average, Swedish
covered bond issuers are rather transparent in terms of providing collateral pool-related
data, we also highlight that the composition of the collateral pools does not justify swap
spread differences of up to 20bp. Instead, in light of broadly homogenous collateral pools
(we do not see any major outliers), we believe that swap spread differences are instead
attributed to potential headline risks. In other words, as in an optimal case, the respective
collateral pools need to be evaluated on an isolated basis, ie in a manner which assigns an
only moderate value to potential headline risks, we believe that the current situation on the
Swedish covered bond market offers some relative value.
9 July 2010 30
Figure 5: Collateral pool summary of Swedish covered bond issuers

NBHSS SCBCC SEB SPNTAB SHBASS LANSBK
Reporting date (2010) 31 March 31 May 31 March 31 March 31 March 31 March

Collateral pool (SEK bn) 359.20 173.65 267.81 613.00 423.22 68.00
Overcollateralisation 17.2% 5.2% 36.1% 11.0% 14.6%
WA LTV (indexed) 52.1% 56.0% 44.9% 44.0% 49.2% 60%
WA seasoning (months) 46.6 55.2* 55.0 38.0 51.0
Floating interest rate 70.0% 47.1%* 73.0% 51.0% 60.0% 69.0%
Fixed interest rate 30.0% 52.9% 27.0% 49.0% 40.0% 31.0%
Percentage of impaired loans 0.022% <0.01% 0.43% 0.00%
Moody’s Collateral Score 6.1%** 9.0%** - 7.3%** 7.6%** 3.6%**
Note: * 30 June 2009, **September 2009. For a thorough analysis of the Swedish covered bond issuers, please refer to The AAA Handbook 2010.
Source: Company data, Barclays Capital
Conclusion In our view, Nordic covered bond markets are rather homogeneous. Swedbank is basically
the only noteworthy outlier, which is more a result of a somewhat weaker perception
regarding the credit profile of the group, rather than the quality of its collateral pool, which
is comparable to its peers.
9 July 2010 31
EUROPE: SCANDINAVIA
Riksbank commences rate-hiking cycle

Mikael Nilsson We continue to recommend holding small shorts (pay) in Jun ’11 and Sep ’11 3mth FRA
+44 20 7773 6057 and cross-market wideners in the 2s5s10s box versus EUR.
mikael.nilsson@barcap.com
As widely expected, the Riksbank (RB) has begun its long-awaited rate-hiking cycle, raising
policy rates by 25bp to 0.50% at its recent policy meeting. However, the vote was a 4-2
split, with deputies Svensson and, perhaps slightly more surprisingly, Ekholm voting to leave
policy rates unchanged. The RB also revised the path of its own repo rate trajectory, which
is now consistent with a more front-loaded approach until mid-2011 (ie, policy rates at
1.25% by year-end; previously 1.0%) and a more gradual approach thereafter (end point Q4
12 3.5%; previously 3.95%). Indeed, going into the meeting we saw little risk/reward in
challenging the aggressive pricing at the very front end (already priced for 1.0% by year-
end), despite our view that risks are clearly skewed towards a gradual and prolonged rate
hiking cycle on the back of the subdued underlying domestic cost pressure (and clear
potential for SEK appreciation). However, markets were unaffected by the hawkish front-
loaded policy message and instead took tone from the fact that the end point of the RB repo
rate profile had been revised lower and the split vote, which triggered a c.10bp cross-
market rally in 2y swaps versus EUR (c.5bp in 1y1yf).
We maintain our view that the scene is set for a relative gradualist approach from the RB,
but we still worry that the neutral-dovish interpretation of the RB’s recent policy message
might prove too optimistic in the near term. Indeed, during the press conference (and
analysts’ meeting) Governor Ingves seemed to play down the significance of disagreement
within the Board over the decision, saying that differences over the future direction of rates
were relatively marginal. It will be interesting to see if this is reflected in the RB minutes
(released 15 July). More important, going into the September meeting, we would tend to
put more weight on the fact that the RB has sharpened the tone of its front-loaded
message, despite higher uncertainty, than on the downward revision of the terminal rate.
The RB motivated the downward revision of the terminal rate by the fact that economic
growth abroad is expected to be lower. Indeed, Sweden is a highly open economy and will
certainly be affected by developments abroad. However, we have some problem seeing the
Figure 1: Riksbank’s repo rate forecast Figure 2: Will the RB “lean against the wind”?
5.00 25
4.50 20
4.00 15
3.50 10
3.00
5
2.50
0
2.00
1.50 -5
1.00 -10
0.50 -15
0.00 -20
Feb-06 Feb-08 Feb-10 Feb-12 Jan-87 Jan-91 Jan-95 Jan-99 Jan-03 Jan-07
House prices CPI
Repo rate July April Mean houseprices 8.0% Mean CPI 1.4%
Source: Reuters EcoWin, Barclays Capital Source: Reuters EcoWin, Barclays Capital
9 July 2010 32
consistency in this argument, given that the RB at the same time revised its growth
estimates for Sweden significantly higher (ie, GDP growth 2010 from 2.2% to 3.8%). While
the sovereign debt crisis in Europe has brought tail risks to the forefront we also find it
noteworthy that the RB’s euro area forecast is rather pessimistic (2010 0.8% and 1.3%
2011), suggesting room for negative surprises might be relative limited from here.
Interestingly, the RB concluded that the recent rapid increase in house prices (and the concomitant
rise in borrowing) could largely be explained by “strong demand, combined with a limited supply
due to a low level of new construction”. However, the RB also noted the potential impact of the
medium-term tail risk of excessive debt levels and house price inflation. Indeed, in its press release,
it said that the fact “that household indebtedness had increased significantly in recent years” had
been a factor in the decision to hike. As we have argued before the Executive Board’s willingness to
“lean against the wind should not be underestimated. Indeed, history suggests that asset price
developments should be considered not only when assessing the timing, but also the magnitude of
the forthcoming rate hiking cycle. The point that policy rates might be hiked over and above what is
motivated by developments in inflation and the real economy has often been illustrated (perhaps
unfairly to the RB) by the fact that CPI has undershot (1.3%) the RB target (2.0%) since it became a
statutory requirement of monetary policy to maintain price stability in 1999 (Figure 2). And in an
independent evaluation of monetary policy (1995-2005) initiated by the Swedish parliament, the
authors Mishkin and Giavazzi explicitly expressed concern that the RB may put “too much
emphasis on housing prices”.
Although pricing (and the RB’s policy rate path) at the very front end still strikes us as too
aggressive, we continue to see limited risk/reward in challenging this in the near term
(Figure 3). Valuations beyond the very front end, on the other hand, remain very rich relative
to our expectations, the RB’s own policy rate path and given the Board’s apparent
willingness to lean against the wind, even if markets start to rebuild a term premium. We are
still biased towards steepeners in the front end (and 2s5s steepeners), but for now we
continue to prefer holding shorts in Jun 11 and Sep 11 3M FRA outright, as we have
recommended since end May, despite recent headwinds (Figure 4). However, cross market,
we still prefer to hold wideners in the SEK 2s5s10s box versus EUR, which looks tight versus
the front/reds spread. We also maintain our shorts SEK versus EUR rates in 2012 maturities.
Figure 3: Fair value FRA strip with RB policy rate path Figure 4: Hold on to shorts in Jun 11 and Sep 11 3M FRA
4.00 2.4
3.50 2.3
2.2
3.00
2.1
2.50
2
2.00 1.9
1.50 1.8
1.00 1.7
0.50 1.6
Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 1.5
1.4
Live Apr-10 May-10 May-10 Jun-10
Fair value Riksbank, no TP
Fair value BarCap no TP Initiated Jun '11 3M FRA Sep '11 3M FRA
Source: Riksbank, Barclays Capital Source: Barclays Capital
9 July 2010 33
EURO INFLATION-LINKED MARKETS
OAT€i22 cheap ahead of supply

Khrishnamoorthy Sooben We look to go long the OAT€i22 at its reopening, ahead of index-related demand.
+44 (0) 20 777 37514
France will reopen the OATi19 and OAT€i22 for a combined €1.3-1.8bn on Thursday 15
khrishnamoorthy.sooben@
July. In contrast to the recent low activity in the European linker market, the backdrop for
barcap.com
this auction is very positive ahead of coupon and redemption flows at the end of the month.
French linkers will pay out coupons during the last week of July, and even if the BTAN€i10 is
probably mainly held by money market investors, we would nevertheless expect some of
the cash returned to the market to be put back to work in linkers. While recent supply has
had a significant cheapening effect in European linkers as the lack of end-investor buying
likely increased dealers’ risks, we expect the €3.25bn in OAT€is and OATis coupons to be
enough to absorb the French and Italian linkers auctions this month.
Furthermore, the long end should receive support ahead of the drop of the OATi11 from
1y+ linker indices at the end of the month, with the duration extension effect worth 0.43yrs
on the Barclays Euro Govt Inflation-Linked All Maturities based on current data. The 10y
sector is index neutral, but although the OATi19 and OAT€i20 are closest to the average
duration, we expect significantly more interest for the OAT€i22 given its relative cheapness.
The new benchmark was issued at a cheap level versus the OAT€i20 in May, and while the
spread tightened just after its launch, it rewidened during the second half of June despite
the flattening elsewhere on the OAT€i real yield curve. The OAT€i22 has also cheapened
versus the OATi23 over that period. The prospect of specific demand on the bond at month
end is therefore very positive ahead of the OAT€i22 reopening.
Go long OAT€i22 at auction We therefore look to go long the OAT€i22 at the auction on Thursday. While the potential
concession ahead of the supply would create more attractive entry levels, nominal BTAN
coupon payments at the start of the week may be supportive for yields even if the 5y and
shorter maturities should benefit the most. We see the coupon and duration extension
flows in the linker market this month as significant enough for a bullish impetus in real
yields, especially after the sell-off in June. At the margin, we also expect greater focus on the
low valuations of 10y and 5y5y euro HICPx swaps to be positive for 10y cash linkers as this
highlights fundamental value in 10y breakevens.
Figure 1: OAT€i22 value versus neighbouring French issues Figure 2: 10y breakevens fundamentally cheap?
1.8 OAT€i20 real yield 3.0 OAT€i22 breakeven

OAT€i22 real yield 5y5y euro HICPx swaps
OATi23 real yield 2.7 10y euro HICPx swaps
1.6
2.4
1.4
2.1
1.2
1.8
1.0 1.5
Jan 10 Mar 10 May 10 Jul 10 Jan 10 Mar 10 May 10 Jul 10
9 July 2010 34
EUROPE: SOVEREIGN SPREADS
EGB relative value

Huw Worthington EGB spread tightening continued this week and still has further to run, in our view. We
+44 (0) 20 7773 1307 examine some relative value opportunities in peripheral bonds, which should benefit
huw.worthington@barcap.com from some normalisation in spreads.
Last week we highlighted that the negotiation of the LTRO rolls in Europe, coupled with
Cagdas Aksu
favourable cash-flow dynamics for EGBs during July and August, alongside banking system
+44 (0) 20 7773 5788
stress test news, was likely to bode well for risky asset performance and in turn be positive
cagdas.aksu@barcap.com
for EGB spread. This has proved to be the case with continued performance of most issuers
versus bunds this week. Among the highly rated core we recommended longs against
France and Belgium in the 5-7y area and this has performed well as French and Belgian
issues tightened 5-7bp on the week while Dutch bonds were flat versus bunds. Spreads are
more compressed here now than before but with heavy flows in France in particular early
next week we believe there is still a little more to go in the short term.
EGBs have tightened across the Elsewhere peripheral bonds also tightened on the week, with moves in Ireland to the fore at
board this week 35bp-20bp tighter in the 2-5y area. Spain, which has struggled to match previous tightening
moves recently, performed strongly moving 22-16bp cheaper in the 2-5y area, with moves
in longer bonds more muted owing to the issuance of a new 10y bond this week.
We believe spread tightening The stabilisation and nascent tightening seen in EGB spreads recently seems likely to re-
could run a little further though focus markets on RV opportunities across all issuers following the extreme volatility over the
last few months. In this regard the correction seen in the highly rated core described above
should act as a catalyst for moves in the periphery.
Figure 1 illustrates that since the end of June, Portuguese and Irish bonds in up to the 9y
area have richened versus their Spanish counterparts sharply, with bonds outperforming by
40-50bp, while those in the 10y and longer end have seen lower moves overall. Central
bank buying programmes that have been concentrated in the shorter maturity issues have
been a major factor in this, and the moves seen bear this out as initially this was where the
richening was greatest. Subsequently however, the performance of Portugal and Ireland has
also moved out along the curve with 5-9y bonds also benefitting.
Figure 1: Change in ASW since end-June – selected EGB issuers
20
10
-10
-20
-30
-40
-50
Jan 10 Jun 15 Dec 20 Jun 26 Nov 31 May 37 Nov 42
Spain Irish Portugal
9 July 2010 35
As illustrated in Figure 2, Ireland actually trades richer than Spain at the very front end,
although the most extreme valuations seen initially after the buying schemes commenced
have abated somewhat. However the lagging of Spanish bonds more recently in the 4-9y
area means that Irish bonds once again trade as little as 5-10bp cheaper than Spain. The
15y area in Spain has been more resilient and rich and to a lesser extent Portuguese issues
continue to trade much more cheaply versus Spain, with pick-ups of 70-90bp available.
Figure 2: Selected peripheral issuer ASW structures
300
250
200
150
100
50
Jan 10 Jun 15 Dec 20 Jun 26 Nov 31 May 37 Nov 42
Spain Irish Portugal
Supply and flow dynamics At the same time we would highlight that supply and cash-flow dynamics are likely to be
support short Ireland versus supportive of some reversal in these valuations. First, Spain will tap its 15y bond next week,
Spain in shorter maturities and if recent experience is repeated a relatively large concession on the Spanish curve is likely,
reversing the trade in 15y area in our view. Similarly, Portugal will tap 2y and 9y bonds next week, while Ireland is scheduled
to auction bonds on 20 July. Given the current richness of the front end we expect that supply
in the 2-6y area will be attractive for the Irish Treasury. Finally, at the end of the month Spain
will pay €16.2bn in redemptions and €5.4bn in coupons, both of which we expect should be
supportive of Spain at the front end. Some commentators seem to have focused on cash
balances at the BoS rather than the overall cash available to the government and have
doubted the ability of Spain to meet this. However, our analysis of the Spanish government’s
current cash reserves when taken alongside this week’s €6bn of issuance means we do not
believe that meeting July redemptions will be problematic in the least.
As such, we recommend that investors should look to switch out of rich Irish and Portuguese
bonds in the 2-6y area in favour of cheap Spanish issues, while reversing the trade in longer
Irish 15y bonds.
Next week’s cash flows

Tuesday sees Holland auction between €2-3bn of the 10y DSL, while on Wednesday,
Portugal comes to the market with 2y and 9y supply for up to €1.5bn alongside Germany,
which will issue €5bn of its 5y OBL and Italy, which will tap 5y, 13y and 30y bonds. On
Thursday, Spain will tap its 15y issue, while France issues 2y, 3y and 5y conventional bonds
and 9y and 12y linkers for a total of up to €10bn. Support for the market is likely to be
substantial however, with heavy redemption and coupon flow from France and Holland.
9 July 2010 36
Figure 3: Barclays Capital’s cash flow expectations for week beginning 12 July (€bn)
Beginning Auction Date Issuance Redemptions Coupons Net Cash Flow
28-Jun-10 26.96 Germany 5.00 0.00 0.00 5.00
Weekly 05-Jul-10 -19.98 France 10.00 20.39 3.11 -13.49
Net 12-Jul-10 -14.62 Italy 7.00 1.02 0.06 5.92
Cash flow 19-Jul-10 2.51 Spain 2.50 0.00 0.00 2.50
26-Jul-10 -18.19 Belgium 0.00 0.00 0.00 0.00
Greece 0.00 0.00 0.03 -0.03
Net Cash Flow is issuance minus redemptions minus Finland 0.00 0.00 0.00 0.00
coupons. Negative number implies cash returned to the
Ireland 0.00 0.34 0.01 -0.36
market.
Holland 3.00 10.65 5.41 -13.06
Austria 0.00 0.00 2.09 -2.09
Total issuance 28.50 Portugal 1.00 0.00 0.00 1.00
Total redemptions 32.40 Total 28.50 32.40 10.719 -14.62
Total coupons 10.72
Net cash flow -14.62
9 July 2010 37
EUROPE: VOLATILITY
Protection against higher money-market rates

with a €1y cap condor
This article was previously published as Buy a condor with EUR1y caps, 8 July 2010.
Marek Sasura We recommend buying a cheap €1y cap condor (with ATM, ATM+25bp, ATM+50bp and
+44 (0) 20 7773 9657 ATM+75bp strikes) for about 5 cents to protect against higher money-market rates once
marek.sasura@barcap.com liquidity surplus in the euro area is gradually withdrawn in the coming months. A 60bp-wide
cap condor would cost about 4 cents while a 45bp-wide condor would be about 3 cents.
Last week brought a significant reduction in liquidity surplus in the euro zone with the
maturity of the first 1y LTRO operation (€442bn). Only €243bn was rolled via the 3m and 6-
day operations. This has caused a decline in liquidity surplus and a reduction of the average
maturity of the outstanding operations fuelling volatility in money-market rates.
At the end of September three operations will mature (the second 1y LTRO from September
2009 for €75bn, a 6mth tender from March 2010 for €18bn and the 3mth operation from
the last week for €132bn). This could create potential for a further decline in liquidity
surplus which would push Eonia and Euribor rates up.
For those who are concerned by this outlook, we recommend buying a protection with 1y
caps (QTR, ACT/360) on the 3mth Euribor rate. In particular, we recommend buying a
€100mn 1y ATM/ATM+25bp/ATM+50bp/ATM+75bp cap condor for about 5 cents (ie,
buying ATM and ATM+75bp caps and selling ATM+25bp and ATM+50bp caps with the
same notional amount). At the time of writing, the 3mth Euribor rate is 0.81% and the €1y
forward is 1.15%.
The trade benefits from an attractive entry level (Figure 1) as a result of expensive high-
strike cap skew (ie, volatility of OTM caps versus volatility of ATM caps because we are
buying an ATM and an OTM cap but selling two OTM caps in a condor).
Figure 1: Entry level for a cap condor benefits from expensive cap skew
8 €6m caplet, ATM vol - ATM+25 vol - ATM+50 vol + ATM+75 vol, bp
7
6
5
4
3
2
1
0
-1
Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10
9 July 2010 38
The trade will make a profit if for each of the three caplets (with 3mth, 6mth and 9mth
expiries) the 3mth Euribor rate will fix in the ATM+6.5bp to ATM+68.5bp range. This means
for the current forward rate of 1.15%, the range would be about 1.22% to 1.83%. If we
assume that in coming months the spot Eonia can drift closer to the ECB refi rate at 1% with
the 3mth Euribor rate 20-30bp above the Eonia, then we would have a fixing inside the
profit generating range.
Figure 2: Payoff for an ATM/ATM+25/ATM+50/ATM+75 condor with ATM = 1.15%
25.0
22.5
20.0
17.5
15.0
12.5
10.0
7.5 Payoff from a single caplet, bp
3m
5.0 Euribor
2.5 Payoff in EUR = Payoff in bp * 0.25 * Notional rate, %
0.0
1.0 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2.0
9 July 2010 39
JAPAN: RATES STRATEGY
Correction in progress in the rich futures sector

Chotaro Morita Bond markets have entered a temporary correction phase that looks set to continue for
+81 (3) 4530 1717 some time. Last week, we recommended shorting futures (7y) in a 5s7s10s butterfly,
chotaro.morita@barcap.com assuming futures would weaken during the market downturn, as is the typical pattern.
Surprisingly, however, the sector strengthened over the past week and is now rich.
Reiko Tokukatsu Nevertheless, we expect flattening over the medium term and continue to recommend a
+81 (3) 4530 1532 short 7y position.
reiko.tokukatsu@barcap.com
Risk asset markets have turned around on optimistic hopes for the European bank stress
tests and a sense that the US economic downturn has been sufficiently discounted. Still, the
Kiyoko Ikuta
accompanying uptrend in bond yields has been markedly slow. This trend is true not only in
+81 (3) 4530 1346
yen bond markets but in the US and Europe as well. Current 10y yields in both the US and
kiyoko.ikuta@barcap.com
Japan look extremely low relative to equity prices (Figure 1).
Shorting yields along with Stocks also plunged around the time of the Bear Stearns rescue in March 2008 and in the
stocks, rather than simply immediate aftermath of the Lehman Brothers collapse in October-December 2008, but this
shorting long-term yields was outpaced by an even steeper decline in bond yields. This was clearly attributable to a
flight to quality. In comparison, the current low level of bond yields relative to share prices is
striking. It is difficult to judge whether this is a sign that yields have stabilized at structurally
low levels or that a correction in this balance is imminent. Rather than a simply shorting
bond yields, we believe shorting yields along with stocks would offer lower risk.
Recommend shorting futures As we noted last week, we believe investors anticipating a short-term rise in bond yields
(7y) and going long the 10y and should seek a short futures position. Even if we expect the yield curve to flatten over the
longer sectors medium term, led by cash bonds, we would still recommend shorting futures (7y) and going
long the 10y and longer sectors. As of last week, we felt that a short futures position would
be attractive for either a bullish or bearish scenario.
However, this week, the futures sector surprisingly outperformed as yields rose (Figure 2).
One explanation may be that dip buying from overseas investors during the correction
concentrated first on futures, with futures positions increasing by nearly 4,000 contracts
Figure 1:The gap of regressing US and Japanese bond yields Figure 2: JGB curve 2 July and 9 July
on share prices
40 120 2.5 (%) (bp) 12

(bp) (bp)
30 90 10
2.0
20 60 8
10 30 1.5 6
0 0
1.0 4
-10 -30
2
-20 -60
0.5
-30 -90 0
-40 -120 0.0 -2

Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 1 4 7 10 13 16 19 22 25 28
TOPIX vs 10y JGB (LHS)
S&P 500 vs 10y US Tresury (RHS) chg (RHS) 09 Jul 10 (LHS) 02 Jul 10 (LHS)
Source: Bloomberg, Barclays Capital Source: Barclays Capital
9 July 2010 40
over the preceding week. Also, if the yield downtrend does not necessarily have to be led by
futures, the correction need not be driven by this sector either.
Figure 3: 7s10s20s butterfly when 7y20y curve is at approximately 126-127bp

Date 7s20s (bp) 7s10s20s (bp) 10y (%)
8-Jul-10 -127.4 -24.6 1.13

24-Jun-10 -126.3 -30.4 1.13
3-Jun-10 -128.2 -24.6 1.26
16-Apr-10 -126.3 -28.8 1.34
3-Feb-10 -126.9 -31.3 1.36
8-Dec-09 -126.8 -29.9 1.29
The current richness of futures can be gleaned from the 7-20y segment of the JGB curve.
We look at this segment versus the 10y yield at Thursday’s closing 7y20y spread of
126-127bp (Figure 3). Compared with 24 June, when the cheapness in the 10y sector
experienced its greatest correction, the 7y20y spread and 10y yield were precisely the same,
whereas the 7s10s20s spread was 6bp cheaper.
At the same time, on the 5-20y segment, the cheapness in the 10y sector has corrected
since this week’s 10y auction, and the sector is now about average or slightly rich (Figure
4). The difference in the 10y position in these butterfly spreads reflects the richness in the
7y sector even in a 5s7s position.
Continue to recommend a short Within the 5s7s10s butterfly (Figure5), the 7y10y would appear to offer higher potential
7y position in the 5s7s10s returns: 7y-10y is at a historically wide at, 50bp, and the underlying trend is bull flattening.
butterfly and a 7y10y flattener Consequently, we continue to recommend a short 7y position in the 5s7s10s butterfly and a
7y10y flattener.
In addition, the chances of a correction in 10y cheapness at the time of 10y auctions last
month looked slim, but the sector can actually be seen as rich currently, depending on the
view of the curve. The implication is that cheapness and richness on the curve actually
change rapidly now that the direction yields is less clear. Therefore, while volatility overall is
not high, relative value on a small to medium scale might be an effective approach.
Figure 4: 5s10s20s butterfly (bp) Figure 5: 5s7s and 7s10s curve (bp)
10 60
8 50
6
40
4
30
2
0 20
-2 10
-4
0
-6
-10
Mar 10 Apr 10 May 10 Jun 10 Jul 10
Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10
Barcap constant maturity
5s/10s/20s (JS88-JB307-JL117) 5s7s 7s10s
9 July 2010 41
7y short or 7y10y flattener is more As to whether a 7y short or 7y10y flattener is more effective in a 5s7s10s butterfly, another
effective in a 5s7s10s butterfly view is possible. That is, the ongoing slump in lending demand should continue to underpin
bank demand for intermediate-term bonds over the long term.
Expectations of BoJ guidance emerged this week as Tibor again begin to turn downward.
Tibor is not a bank funding rate but an actual offer-side lending rate, meaning that there is
plenty of room for arbitrary factors to enter into the equation. That said, as the basis for
bank lending rates, it is also subject to other important factors, such as the phase of the
credit cycle and corporate loan demand. In fact, over the past few years, Tibor has moved
roughly in tandem with increases and decreases in bank lending (Figure 6). In our view,
there is some connection between the renewed drop in Tibor levels at the start of a new
quarter and the falloff in loan demand. The decline in lending appears to be intensifying,
and with the downward bias in Tibor, a genuine drop in bank demand for intermediate
bonds would appear unlikely.
Figure 6: Bank loans and 3m Tibor trends
420 (JPY tn) (bp) 80

70
410
60
400 50
40
390 30
20
380
10
370 0
04 05 06 07 08 09 10 11
Bank loans (LHS) 3m TIBOR - O/N call rate (RHS)

Source: BoJ, Bloomberg
9 July 2010 42
GLOBAL TRADERS’ GUIDE
Key data and events
US
We forecast a 0.1% m/m decline (+1.2% y/y) in the June CPI (Friday) after -0.2% m/m,
2.0% y/y in May (consensus: 0.0% m/m, 1.2% y/y), bringing the NSA index to 218.3
from 218.178. We and the consensus expect a 0.1% m/m, 0.9% y/y gain in the core
CPI, similar to May. We look for a 0.3% drop in June retail sales (Wednesday; last: -1.2%;
consensus: -0.2%), but for ex-autos sales to be flat (last: -1.1% m/m; consensus: -0.1%
m/m) and core sales to be up 0.1% m/m.
We forecast a 0.2% m/m decline in June industrial production (Thursday) after a 1.3%
m/m gain in May (consensus: 0.0%). We forecast a nominal May trade deficit (Tuesday)
of $41.0bn, up from $40.3bn in April (consensus: $39.2bn).
We look for the June FOMC minutes (Wednesday) to show caution regarding the pace
of economic activity given softness in housing, and less supportive financial market
conditions, and to reflect the view that inflation will remain subdued. We expect little on
the Term Deposit Facility, as the Fed continues to state that its test auctions "have no
implications for the near-term conduct of monetary policy.” There may be some
discussion of potential policy should the economic outlook worsen, though we would
view this as normal contingency planning rather than signalling an expectation that
these measures would actually be used. We expect modestly lower FOMC growth
forecasts for 2010.
Europe
We and the consensus expect the euro area final HICP (Wednesday) to be confirmed at
1.4% y/y in June, down from 1.6% y/y previously. We also expect the HICPx index to
print 109.68, from 109.71 in May. We and the consensus expect euro area industrial
output (Wednesday) to have increased by 1.2% m/m in May from 0.8% m/m in April,
leaving the April-May index 2.7% above Q1, when industrial output rose by 4.1% q/q.
In the UK, we and the consensus expect the final estimate of Q1 GDP (Monday) to confirm
growth of 0.3% q/q in Q1. We look for June's CPI (Tuesday) to have risen by 0.1% m/m
(May: 0.2%, consensus: 0.1%), and expect the RPI to also have risen by 0.1% m/m (May:
0.4%, consensus: 0.1%). We expect the latest labour market statistics (Wednesday) to
show that June's claimant count fell by 26k (May: -30.9k, consensus: -20k).
Japan
We expect the CGPI to rise by 0.8% y/y in June (Last +0.4%, consensus +0.6%, Monday).
For the May index of tertiary industry activity (Friday), we forecast a 0.8% m/m
decrease (last +2.1%, consensus -0.7%).
9 July 2010 43
GLOBAL WEEKLY CALENDAR
Saturday 10 July Period Prev 2 Prev 1 Latest Forecast Consensus

- China: Exports, % y/y Jun 24.2 30.4 48.5 36.0 38.0
Monday 12 July Period Prev 2 Prev 1 Latest Forecast Consensus

- E16: Eurogroup Meeting in Brussels
- Global: Mediterranean Economic and Financial Forum in Milan (to 13/7)
13:00 US: Richmond Fed President Lacker (FOMC non-voter) makes remarks at opening of exhibit at the Richmond Fed
14:00 US: Fed Chairman Bernanke gives opening remarks at a small business forum
21:15 US: Fed Governor Duke (FOMC voter) gives closing remarks at a small business forum
- China: M2 growth, % y/y Jun 23.0 21.0 21.0 18.4 19.0
00:50 Japan: Corporate goods price index, % y/y Jun -1.3 -0.1 0.4 0.8 0.6
07:00 Czech Republic: CPI, % y/y Jun 0.7 1.1 1.2 1.4 1.3
07:00 Romania: CPI, % y/y Jun 4.2 4.3 4.4 4.3 -
08:30 UK: GDP - final, % q/q (y/y) Q1 -0.3 (5.3) 0.4 (-3.1) 0.3 (-0.2) P 0.3 (-0.2) 0.3 (-0.2)
08:30 UK: Current account, £ bn Q1 -6.6 -5.9 -1.7 -6.6 -4.5
09:00 Portugal: HICP, % m/m (y/y) Jun 1.2 (0.6) 0.4 (0.7) 0.2 (1.1) -0.3 (0.6) -
23:01 UK: BRC retail sales monitor, total sales, % y/y Jun 6.6 -0.2 3.0 - -
23:01 UK: RICS housing market survey, price bal Jun 10 19 22 20 -
17:00 US: 3y Note Auction $35bn
Tuesday 13 July Period Prev 2 Prev 1 Latest Forecast Consensus

- Sri Lanka: Interest rate announcement, % - 9.75 9.75 9.75 9.75 -
- EU: Economic & Financial Affairs Council (ECOFIN) in Brussels
- Global: Mediterranean Economic and Financial Forum in Milan (final day)
- Poland: CPI, % y/y Jun 2.6 2.4 2.2 2.1 -
06:45 France: CPI, % m/m (y/y) Jun 0.5 (1.6) 0.3 (1.7) 0.1 (1.6) 0.0 (1.5) -
06:45 France: CPI ex-tobacco index (y/y) Jun 119.58 119.90 120.04 119.99 -
06:45 France: HICP, % m/m (y/y) Jun 0.5 (1.7) 0.3 (1.9) 0.1 (1.9) 0.0 (1.7) 0.1 (1.8)
07:00 Hungary: CPI, % y/y Jun 5.9 5.7 5.1 - 5.1
07:00 Spain: Final HICP, % m/m (y/y) Jun 1.1 (1.6) 0.2 (1.8) (1.5) "flash" 0.2 (1.5) 0.2 (1.5)
07:00 Spain: CPI, % m/m (y/y) Jun 0.7 (1.4) 1.1 (1.5) 0.2 (1.8) 0.2 (1.5) 0.2 (1.5)
07:00 Spain: Core CPI, % y/y Jun 0.2 -0.1 0.2 0.4
08:00 Sweden: AMV Unemployment rate, % Jun 5.2 4.9 4.5 4.7 -
08:30 UK: CPI, % m/m (y/y) Jun 0.5 (3.4) 0.6 (3.7) 0.2 (3.4) 0.1 (3.2) 0.1 (3.2)
08:30 UK: RPI, % m/m (y/y) Jun 0.7 (4.4) 1.0 (5.4) 0.4 (5.1) 0.1 (4.9) 0.1 (4.9)
08:30 UK: RPIX, % m/m (y/y) Jun 0.7 (4.8) 1.0 (5.4) 0.4 (5.1) 0.1 (4.9) (4.9)
09:00 Germany: ZEW economic expectations index Jul 53.0 45.8 28.7 30.0 25.0
12:30 US: Trade balance, $ bn May -40.1 -40.0 -40.3 -41.0 -39.2
18:00 US: Budget balance, $ bn Jun 27.5 ('07) 33.5 ('08) -94.3 ('09) -70.0 -75.0
23:01 UK: Nationwide consumer confidence, index Jun 00:00 00:00 65 - -
02:00 Japan: 5y JGB Auction ¥2400bn
08:00 Netherlands: 10y DSL Auction €3bn
Wednesday 14 July Period Prev 2 Prev 1 Latest Forecast Consensus

- Thailand: Interest rate announcement, % - 1.25 1.25 1.25 1.50 -
- France: Bank holiday
18:00 US: Minutes of June FOMC meeting released
00:00 Singapore: Advance GDP estimate, % y/y Q2 0.9 3.5 13.1 14.5 -
06:00 Finland: HICP, % m/m (y/y) Jun 0.6 (1.5) 0.3 (1.6) -0.2 (1.4) 0.3 (1.3) -
08:00 Austria: HICP, % y/y Jun 1.0 (1.8) 0.2 (1.8) -0.1 (1.7) 0.4 (2.3) -
08:00 Italy: Final CPI, % m/m (y/y) Jun 0.0 (1.6) 0.0 (1.4) 0.0 (1.3) P 0.0 (1.3) 0.0 (1.3)
08:00 Italy: Final HICP, % m/m (y/y) Jun 0.9 (1.6) 0.1 (1.6) 0.0 (1.4) P 0.0 (1.4) 0.0 (1.4)
08:30 UK: Claimant count, change k Jun -32.7 32.0 -30.9 -26.0 20.0
08:30 UK: ILO unemployment rate, % May 8.0 8.0 7.9 7.8 7.9
08:30 UK: Average weekly earnings, % 3m y/y May 2.5 4.3 4.2 3.1 3.0
08:30 UK: Core average weekly earnings, % 3m y/y May 1.7 2.0 1.9 1.9 1.9
Note: All times reported in GMT. Some data or events are boxed to indicate their importance to financial markets. Market events are highlighted in light blue.
9 July 2010 44
Wednesday 14 July Period Prev 2 Prev 1 Latest Forecast Consensus

09:00 E16: HICP, % m/m (y/y) Jun 0.5 (1.5) 0.1 (1.6) (1.4) "flash" 0.0 (1.4) 0.0 (1.4)
09:00 E16: HICP ex tobacco, index (2005 = 100) Jun 109.09 109.58 109.71 109.68 R -
09:00 E16: 'Eurostat' core (HICP x fd, alc, tob, ene), % m/m (y/y) Jun 0.8 (1.0) 0.3 (0.8) 0.1 (0.8) 0.0 (0.9) -
09:00 E16: 'ECB' core (HICP x unproc.fd, ene), % m/m (y/y) Jun 0.7 (0.9) 0.2 (0.7) 0.1 (0.8) 0.0 (0.8) -
09:00 E16: Industrial production, % m/m (y/y wda) May 0.8 (4.1) 1.5 (7.8) 0.8 (9.5) 1.2 1.2 (11.0)
12:30 US: Retail sales, % m/m Jun 2.1 0.6 -1.2 -0.3 -0.2
12:30 US: Retail sales ex autos, % m/m Jun 1.2 0.6 -1.1 0.0 -0.1
12:30 US: Core retail sales, % m/m Jun 0.6 -0.2 0.1 0.1 -
12:30 US: Import prices, % m/m (y/y) Jun 0.4 (11.2) 1.1 (11.2) -0.6 (8.6) -0.2 (5.5) -0.3 (5.2)
12:30 US: Nonpetroleum import prices, % m/m (y/y) Jun -0.1 (2.8) 0.5 (3.5) 0.5 (3.7) 0.1 (3.7) -
14:00 US: Business inventories, % m/m May 0.6 0.7 0.4 0.3 0.5
19:00 Argentina: CPI, % m/m Jun 1.1 0.8 0.7 0.7 0.7
09:00 Germany: 5y OBL Auction €5bn
09:00 Italy: 5y, 13y and 30y BTP Auctions €7bn
09:30 Portugal: 2y & 9y PGB taps €1bn
09:30 UK: 2046 Gilt Auction £2.25bn
Thursday 15 July Period Prev 2 Prev 1 Latest Forecast Consensus

08:00 E16: ECB monthly bulletin published Jul
14:00 US: Senate Banking Committee holds confirmation hearing for nominations of Yellen, Raskin, and Diamond to the Fed Board of Governors
16:00 Turkey: Interest rate announcement, % Jul 7.0 7.0 7.0 7.0 -
22:00 Chile: Interest rate announcement, % Jul 0.5 0.5 1.0 1.5 1.5
23:15 US: Richmond Fed President Lacker (FOMC non-voter) speaks on the economic outlook to business leaders
- Peru: GDP, % y/y May 5.9 8.8 9.3 8.8 9.4
- Greece: Unemployment rate, % Apr 11.3 12.1 11.6 - 11.9
01:00 Australia: Inflation expectations, % y/y Jul 4.1 3.6 3.4 - -
02:00 China: Real GDP, % y/y Q2 9.1 10.7 11.9 10.4 10.4
02:00 China: CPI, % y/y Jun 2.4 2.8 3.1 3.4 3.3
02:00 China: PPI, % y/y Jun 5.9 6.8 7.1 6.8 6.8
02:00 China: Industrial production, % y/y Jun 18.1 17.8 16.5 14.5 15.5
02:00 China: YTD, FAI, % y/y Jun 26.4 26.1 25.9 25.1 25.3
02:00 China: Retail sales, % y/y Jun 18 18.5 18.7 18.9 18.8
06:00 E16: New car registrations, % y/y (nsa) Jun 10.8 -7.4 -9.3 - -
08:30 UK: BoE housing equity withdrawal, £ bn Q1 -6.1 -5.1 -4.0 - -
12:30 US: Initial jobless claims, thous (4wma) 10-Jul 459 (463) 475 (467) 454 (466) 435 (456) -
12:30 US: Empire State manufacturing index Jul 31.86 19.11 19.57 18.0 18.00
12:30 US: Producer price index, % m/m (y/y) Jun 0.7 (6.0) -0.1 (5.5) -0.3 (5.3) -0.1 (3.1) -0.1 (3.1)
12:30 US: Core producer price index, % m/m (y/y) Jun 0.1 (0.9) 0.2 (1.0) 0.2 (1.3) 0.1 (1.1) 0.1 (1.1)
13:15 US: Industrial production, % m/m Jun 0.3 0.6 1.3 -0.2 0.0
13:15 US: Capacity utilization, % Jun 72.7 73.1 74.1 74.0 74.2
14:00 US: Philadelphia Fed manufacturing index Jul 20.2 21.4 8.0 12.0 10.0
15:30 Israel: CPI, % y/y Jun 3.2 3.0 3.0 2.6 2.4
08:30 Spain: 15y SPGB tap €2.5bn
09:00 France: BTAN taps €8.5bn
09:30 UK: 2022 UK Linker Auction £1.1bn
10:00 France: Linker taps €1.5bn
Friday 16 July Period Prev 2 Prev 1 Latest Forecast Consensus

14:00 Mexico: Interest rate announcement, % Jul 4.5 4.5 4.5 4.5 4.5
00:50 Japan: Tertiary industry index, % m/m May -0.5 -2.7 2.1 -0.8 -0.7
06:45 New Zealand: CPI, % q/q Q2 1.3 -0.2 0.4 0.4 -
09:00 E16: Trade balance, € bn (sa) May 3.4 0.2 1.6 1.0 0.8
12:30 US: Consumer price index, % m/m (y/y) Jun 0.1 (2.3) -0.1 (2.2) -0.2 (2.0) -0.1 (1.2) 0.0 (1.2)
12:30 US: Core consumer price index, % m/m (y/y) Jun 0.0 (1.1) 0.0 (0.9) 0.1 (0.9) 0.1 (0.9) 0.1 (0.9)
12:30 US: Consumer price index, NSA index Jun 217.631 218.009 218.178 218.3 -
13:00 US: Net long-term TIC flows, $ bn May 47.1 140.5 83.0 - -
13:55 US: University of Michigan consumer sentiment index Jul p 72.2 73.6 76.0 75.5 74.0
Note: All times reported in GMT. Some data or events are boxed to indicate their importance to financial markets. Market events are highlighted in light blue.
9 July 2010 45
GLOBAL KEY EVENTS
Jul Aug Sep Oct Nov Dec

Forthcoming central bank announcement dates
North America
FOMC meeting - 10 21 - 2-3 14
FOMC minutes 14 31 - 12 24 -
Congressional testimony Jul - - - - -
Fed's Beige Book 28 - 8 20 - 1
Bank of Canada 20 - 8 19 - 7
Europe
ECB "policy" meeting 8 5 2 7 4 2
ECB monthly bulletin 15 12 9 14 11 9
ECB "non-policy" meeting 22 19 16 21 18 16
Bank of England 8 5 9 7 4 9
BoE Inflation Report - 11 - - 10 -
BoE minutes 21 18 22 20 17 22
Riksbank 1 - 2 26 - 15
SNB - - 16 - - 16
Norges Bank - 11 22 27 - 15
Asia/RoW
Bank of Japan 14-15 9-10 6-7 4-5,28 15-16 20-21
BoJ minutes 21 13 10 8 2,19 27
Reserve Bank of Australia 6 3 7 5 2 7
RBNZ 29 - 16 28 - 9
Source: Central banks, IMF, European Commission, Reuters, Bloomberg, Market News, Barclays Capital
9 July 2010 46
GLOBAL SUPPLY CALENDAR
Spread to 3 mth Z Score to Spread to 3 mth Z Score

Country Bond Coupon Maturity Size - bn German Spline Germany Swaps to Swaps
Euro Area
Jul-10 Czech New 15y 1.5
13-Jul-10 Holland 10y DSL Auction 3.50% 15-Jul-20 3.00 16.1 -0.09 -4.3 -0.92
14-Jul-10 Germany 5y OBL Auction 2.25% 10-Apr-15 5.00
14-Jul-10 Italy 13yr BTP Auction 4.75% 01-Aug-23 2.50 143.6 0.74 122.4 0.67
14-Jul-10 Italy 5yr BTP Auction 3.00% 15-Jun-15 5.00
14-Jul-10 Italy 30yr BTP Auction 5.00% 01-Sep-40 5.00
14-Jul-10 Portugal 2y PGB tap 5.00% 15-Jun-12 0.5 241.4 0.02 162.8 -0.06
14-Jul-10 Portugal 9y PGB tap 4.75% 15-Jun-19 0.5 274.1 0.78 231.3 0.76
15-Jul-10 Spain 15y SPGB Auction 4.65% 30-Jul-25 2.50 207.9 1.29 176.2 1.26
15-Jul-10 France 2yr BTAN (range ¤7-8.5bn) 0.75% 10-Sep-12 3.0 19.2 -0.65 -57.4 -0.10
15-Jul-10 France 3yr BTAN (range ¤7-8.5bn) 4.00% 25-Apr-13 1.5 18.2 0.09 -53.0 -0.73
15-Jul-10 France 5yr BTAN (range ¤7-8.5bn) 2.00% 12-Jul-15 4.0 31.4 -1.49 -18.5 -1.11
15-Jul-10 France 12y OATei (range €1.3-1.8bn) 1.10% 25-Jul-22 0.75
15-Jul-10 France 9y OATi (range €1.3-1.8bn) 1.30% 25-Jul-19 0.75
20-Jul-10 Ireland 3y Irish 5.00% 18-Apr-13 0.75 240.4 0.47 170.7 0.41
20-Jul-10 Ireland 6y Irish 4.00% 18-Apr-16 0.75 253.6 0.77 204.0 0.77
20-Jul-10 Finland 5y RFGB tap 4.25% 04-Jul-15 1.00 13.1 -0.62 -36.5 -0.86
21-Jul-10 Germany New 30y Bund Auction 04-Jul-42 4.0
26-Jul-10 Belgium 3y BGB 4.25% 28-Mar-14 0.5 57.2 0.25 -2.6 -0.07
26-Jul-10 Belgium 5y BGB 2.75% 28-Mar-16 1.0 68.0 0.34 22.8 0.16
26-Jul-10 Belgium 10y BGB 3.75% 28-Sep-20 1.5 60.5 0.42 39.4 0.26
26-Jul-10 Belgium 15y BGB 4.00% 28-Mar-22 0.50 55.2 0.36 37.6 0.15
27-Jul-10 Holland 2y DSL tap 2.50% 15-Jan-12 0.50 15.4 1.02 -65.4 0.06
27-Jul-10 Holland 9y DSL tap 4.00% 15-Jul-16 0.75 15.3 -0.61 -26.7 -1.10
27-Jul-10 Italy CTZ Auction 0.00% 30-Apr-12 3
28-Jul-10 Italy BTPei Linker Auction 2
29-Jul-10 Italy CCT Auction FRN 2
29-Jul-10 Italy 10yr BTP Auction 4.00% 01-Sep-20 3 143.3 0.88 114.3 0.94
29-Jul-10 Italy 3yr BTP Auction 2.00% 01-Jun-13 3 139.9 -0.57 65.1 -0.38
03-Aug-10 Austria Reserve Auction Date
05-Aug-10 Spain 3y SPGB Auction 2.50% 31-Oct-13 3 232.7 -0.45 158.3 -0.34
11-Aug-10 Germany New 2y Schatz auction 0.50% 12-Sep-12 7
13-Aug-10 Italy 5y BTP Auction 3.00% 01-Jun-15 4 139.9 0.05 85.6 0.45
Japan
13-Jul-10 Japan 5y JGB Auction 2400
16-Jul-10 Japan Liquidity Enhancement Auction 300
22-Jul-10 Japan 20y JGB Auction 1100.00
27-Jul-10 Japan 2y JGB Auction 2600
03-Aug-10 Japan 10y JGB Auction 2200
09-Aug-10 Japan Liquidity Enhancement Auction 300
UK
Jul-10 UK Linker Syndication 20-30y 3-4
14-Jul-10 UK UKT 2046 Auction 4.25% 07-Dec-46 2.25
15-Jul-10 UK UK 2022 Linker Auction 1.25% 22-Nov-22 1.10
20-Jul-10 UK UKT 2016 Auction 4.00% 07-Sep-16 4.50
03-Aug-10 UK 2015 Gilt Auction 2.75% 22-Jan-15 5
10-Aug-10 UK 2034 Gilt Auction 4.50% 07-Sep-34 2
12-Aug-10 UK 2022 Gilt Auction 4.00% 07-Mar-22 4
US
12-Jul-10 US 3y Note Auction 35
14-Jul-10 US 30y Bond Auction 13
10-Aug-10 US 3y Note Auction 32
11-Aug-10 US 10y Note Auction 23
12-Aug-10 US 30y Bond Auction 15
Unconfirmed Barclays Capital Estimate
Rich
Cheap
9 July 2010 47
GLOBAL BOND YIELD FORECASTS
US Treasuries US swap spreads
Fed 3m
funds Libor 2y 5y 10y 30y 10y RY 2y 5y 10y 30y
3Q10 0.00-0.25 0.65 1.10 2.50 3.70 4.60 1.35 3Q10 40 30 5 -20
4Q10 0.00-0.25 0.70 1.40 2.80 3.85 4.70 1.45 4Q10 40 30 0 -30
1Q11 0.00-0.25 0.85 1.80 3.10 4.10 4.80 1.60 1Q11 40 30 -5 -35
2Q11 0.75 1.30 2.10 3.20 4.10 4.80 1.60 2Q11 40 30 -5 -35
3Q11 1.25 1.85 2.30 3.30 4.10 4.80 1.60 3Q11 40 30 -5 -35
4Q11 1.75 2.15 2.40 3.30 4.10 4.80 1.60 4Q11 40 30 -5 -35
Euro government Euro area swap spreads
Refi rate 3m 2y 5y 10y 30y 10y RY 2y 5y 10y 30y

3Q10 1 0.7 1.15 2.4 3.1 3.75 1.25 3Q10 50 40 30 -5
4Q10 1 0.8 1.35 2.55 3.2 3.8 1.35 4Q10 55 40 30 0
1Q11 1 1.25 1.7 2.65 3.35 3.85 1.5 1Q11 55 40 30 5
2Q11 1.25 1.8 2.05 2.9 3.45 3.9 1.6 2Q11 55 40 30 5
3Q11 1.5 2 2.35 3 3.55 3.9 1.7 3Q11 55 40 30 5
4Q11 1.75 2.1 2.55 3.15 3.65 3.95 1.8 4Q11 55 40 30 5
UK government UK swap spreads
Repo rate 3m 2y 5y 10y 30y 10y RY 2y 5y 10y 30y

3Q10 0.50 0.96 1.20 2.80 4.20 4.50 1.05 3Q10 55 5 -30 -40
4Q10 0.50 1.03 1.45 3.15 4.50 4.65 1.25 4Q10 55 5 -40 -40
1Q11 1.00 1.50 1.80 3.40 4.80 4.75 1.50 1Q11 55 5 -40 -35
2Q11 1.50 1.95 2.20 3.80 5.10 4.80 1.80 2Q11 60 10 -40 -35
3Q11 2.00 2.45 2.60 4.25 5.10 4.80 1.80 3Q11 60 10 -40 -35
4Q11 2.50 2.98 3.00 4.50 5.25 4.80 1.95 4Q11 60 10 -40 -30
Japan government Japan swap spreads
Official rate 3m 2y 5y 10y 30y 10y RY 2y 5y 10y 30y

3Q10 0.10 0.20 0.15 0.40 1.15 2.25 1.60 3Q10 28 18 10 0
4Q10 0.10 0.20 0.15 0.40 1.15 2.25 1.60 4Q10 30 20 10 0
1Q11 0.10 0.20 0.15 0.45 1.20 2.20 1.60 1Q11 30 20 10 5
2Q11 0.10 0.20 0.15 0.45 1.25 2.25 1.60 2Q11 30 20 10 5
3Q11 0.10 0.20 0.15 0.50 1.30 2.30 1.60 3Q11 30 20 10 5
4Q11 0.10 0.20 0.15 0.55 1.35 2.30 1.60 4Q11 30 20 10 5
1Q12 0.10 0.30 0.20 0.65 1.40 2.35 1.60 1Q12 30 20 10 5
9 July 2010 48
GLOBAL RATES RESEARCH
US
Ajay Rajadhyaksha Joseph Abate Piyush Goyal James Ma
Head of US Fixed Income and Fixed Income Strategy Fixed Income Strategy Fixed Income Strategy
Securitised Products Strategy +1 212 412 6810 +1 212 412 6793 +1 212 412 2563
+1 212 412 7669 joseph.abate@barcap.com piyush.goyal@barcap.com james.ma@barcap.com
ajay.rajadhyaksha@barcap.co
m
Chirag Mirani Amrut Nashikkar Michael Pond Anshul Pradhan

Fixed Income Strategy Fixed Income Strategy Treasury and Inflation-linked Treasury and Inflation-linked
+1 212 412 6819 +1 212 412 1848 Strategy Strategy
chirag.mirani@barcap.com amrut.nashikkar@barcap.com +1 212 412 5051 +1 212 412 3681
michael.pond@barcap.com anshul.pradhan@barcap.com
Rajiv Setia
Fixed Income Strategy
+1 212 412 5507
rajiv.setia@barcap.com
Europe
Laurent Fransolet Alan James Cagdas Aksu Leef Dierks
Head of European Fixed Global Inflation-Linked European Strategy Fixed Income Strategy
Income Strategy Strategy +44 (0)20 7773 5788 +49 69-7161 1781
+44 (0)20 7773 8385 +44 (0)20 7773 2238 cagdas.aksu@barcap.com leef.dierks@barcap.com
laurent.fransolet@barcap.com alan.james@barcap.com
Fritz Engelhard Moyeen Islam George Karvounis Sreekala Kochugovindan

German Head of Strategy Fixed Income Strategy Fixed Income Strategy Asset Allocation Strategy
+49 69-7161 1725 +44 (0)20 777 34675 +44 (0)20 7773 8578 +44 (0)20 7773 2234
fritz.engelhard@barcap.com moyeen.islam@barcap.com george.karvounis@barcap.com sreekala.kochugovindan@barcap.co
m
Giuseppe Maraffino Mikael Nilsson Marek Sasura Michaela Seimen
Fixed Income Strategy Fixed Income Strategy Fixed Income Strategy SSA & Covered Bond Strategy
+44 (0)20 313 49938 +44 (0)20 7773 6057 +44 (0)20 7773 9657 +44 (0) 20 3134 0134
giuseppe.maraffino@barcap.co mikael.nilsson@barcap.com marek.sasura@barcap.com michaela.seimen@barcap.com
m
Henry Skeoch Khrishnamoorthy Sooben Stuart Urquhart Huw Worthington

Inflation-Linked Strategy Inflation-Linked Strategy European Strategy European Strategy
+44 (0)20 777 37917 +44 (0)20 7773 7514 +44 (0)20 7773 8410 +44 (0)20 7773 1307
henry.skeoch@barcap.com khrishnamoorthy .sooben@ stuart.urquhart@barcap.com huw.worthington@barcap.com
barcap.com
Japan
Chotaro Morita Stefan Liiceanu Kiyoko Ikuta Reiko Tokukatsu
Head of Fixed Income Strategy Senior Fixed Income Strategist Strategist Senior Fixed Income Strategist
Research, Japan +81 3 4530 1554 +81 3 4530 1346 +81 3 4530 1532
+81 3 4530 1717 stefan.liiceanu@barcap.com kiyoko.ikuta@barcap.com reiko.tokukatsu@barcap.com
chotaro.morita@barcap.com
Australia
Gavin Stacey
AU & NZ Rates Strategist
+61 2 933 46128
gavin.stacey@barcap.com
9 July 2010 49
Analyst Certification(s)
We, Alan James, Anshul Pradhan, Ajay Rajadhyaksha, Piyush Goyal, Amrut Nashikkar, Joseph Abate, Michael Pond, Chirag Mirani, Cagdas Aksu, Giuseppe
Maraffino, Moyeen Islam, Leef Dierks, Fritz Engelhard, Michaela Seimen, Mikael Nilsson, Khrishnamoorthy Sooben, Huw Worthington, Marek Sasura,
Chotaro Morita, Reiko Tokukatsu, Kiyoko Ikuta and Fabio Fois, hereby certify (1) that the views expressed in this research report accurately reflect our
personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be
directly or indirectly related to the specific recommendations or views expressed in this research report.
Important Disclosures
For current important disclosures regarding companies that are the subject of this research report, please send a written request to: Barclays Capital
Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer to https://ecommerce.barcap.com/research/cgi-
bin/all/disclosuresSearch.pl or call 212-526-1072.
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INTEREST RATES RESEARCH Global Rates Strategy | 9 July 2010

GLOBAL RATES WEEKLY

Global Traders’ Guide 44

Global Bond Yield Forecasts 49

Volatility: Vol decline likely to persist 14 Rajiv Setia

Euro: Near-term outlook and EUR rates trade ideas 17 Europe

UNITED STATES: TREASURIES

Demand spreading across the curve

Demand spreading across the curve

Demand at auctions: Higher domestic investor participation

1,600 45% % Auction Alloted to Domestic Investment Funds,

Source: Barclays Capital Source: Treasury

June STRIPS report: A pickup in long end net stripping activity

Source: Treasury Source: Barclays Capital

Figure 5: A pickup in net stripping activity in June

Net Monthly Increase in Bond STRIPS of which 25yrs +

Figure 6: Stripping activity in May 40s slow in the cycle

05/15/39 08/15/39 11/15/39 02/15/40 05/15/40

UNITED STATES: SWAPS

Time to dust off bearish spread wideners?

May 2009: The similarities and the differences

5.5 10y rate (%) 50 -1.3

Source: Bloomberg, Barclays Capital Source: Barclays Capital

Is another convexity paying episode likely if rates back up?

Paying may yet occur in a sell-off

Source: Barclays Capital Source: Barclays Capital

We hesitate to express an outright widening view on 10y spreads

However, bearish spread wideners for out-of-the-money strikes are attractive

Figure 5: Details of the trade

Sell put TYU0P 119.0 2.48% 2.91% 2.38% 8/27/2010 9/30/2010

UNITED STATES: MONEY MARKETS

Money funds: Stiffer competition ahead

Net stable funding

Source: Federal Reserve Source: Federal Reserve

The return of pass-book savings

Money fund competitive disadvantage

UNITED STATES: INFLATION-LINKED MARKETS

The concession is done, long live the concession

Chirag Mirani Solid auction

10y Avg (AuctionDateYield - GivenDatesYield), 16 New 10y TIPS Auctions

Days before/after auction

Trade idea: Long TIIJan18-Feb40 BE flattener ahead of 30y TIPS reopening

UNITED STATES: VOLATILITY

Vol decline likely to persist

Option supply picks up

Callable zero-coupon notes

Agency callable notes

Smaller demand from hedgers

50.0 1600 Floors Outstanding (notional, $bn)

Dealer hedging of existing callable zeroes

EURO AREA: RATES STRATEGY

Near-term outlook and EUR rates trade ideas

150 1.5 1600 1.0

We still like the variations of EUR curve flattening risks

Keep long the belly on EUR 2s/10s/30s

250 240 270

Source: Barclays Capital Source: Barclays Capital

Also enter EUR 2s/10s 1y fwd flattener vs 1y1y fwd/2y1yfwd steepener

Long/Short/Long: 1y1y fwd/2y1y fwd/10y1y fwd: 1445mn/985mn/60mn

Source: Barclays Capital Source: Barclays Capital

ECB and liquidity update

1.25 200 Excess reserves 40