GLOBAL INVESTMENT STRATEGY, EXECUTION AND RISK MANAGEMENT FOR INSTITUTIONAL INVESTORS

This marketing was prepared by David Sansom, a consultant with Astor Ridge. It is not appropriate to characterize this e-mail as independent investment research as referred to in MiFID and that it should be treated as a marketing communication even if it contains a trade recommendation. A history of marketing materials and research reports can be provided upon request in compliance with the European Commission’s Market Abuse Regulation. Astor Ridge takes no proprietary trading risk, has no market making facilities, and has no position in any security we discuss in this e-mail. The views in this e-mail are those of the author(s) and are subject to change, and Astor Ridge has no obligation to update its opinions or the information in this publication. If this e-mail contains opinions or recommendations, those opinions or recommendations reflect solely and exclusively those of the author, and such opinions were prepared independently of any other interests, including those of Astor Ridge and/or its affiliates. This publication does not constitute personal investment advice or take into account the individual financial circumstances or objectives of the those who receive it. The securities discussed herein may not be suitable for all investors. Astor Ridge recommends that investors independently evaluate each issuer, security or instrument discussed herein, and consult any independent advisors they believe necessary. The value of, and income from, any investment may fluctuate from day to day as a result of changes in relevant economic markets (including changes in market liquidity). The information herein is not intended to predict actual results, which may differ substantially from those reflected. Past performance is not necessarily indicative of future results.

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Astor Ridge LLP is regulated by the Financial Conduct Authority (FCA): Registration Number 579287

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Trades: The USD 10y20y forward swap rate is at multi-year technical levels.

Bottom line: USD 10y20y is at fascinating technical levels and makes a good candidate for a duration long in the US

Trades:
- Simply receive USD 10y20y

- Mid-curve receiver spreads/ladders on 10y20y with 6m or 1y expiries
- Receiver USD 10y20y vs paying EUR 10y20y

See below for candidate structures.

Rationale: I don’t usually take technical analysis as my starting point, but a hat-tip to my colleague Chris Williams for the monthly chart of the USD 10y20y (20y rate, 10y forward) below. He has highlighted the powerful technical signals of the current level, in terms of RSI and 100-month moving average, using data stretching back to 1996.

The technical observations are timely as I am on the lookout for a place to receive on the USD curve. The results of yesterday’s US Mid-term elections have delivered a small Democratic majority in the House of Representatives: my high-level view is that this reduces the chances of further tax cuts and some of the more expansive spending plans for Defence (and certain building projects in the border zone). As a consequence changes on both sides of the budget look more positive in terms of the budget deficit, and lessens somewhat my fears of a ramping of long-end Treasury supply. This allows me to consider trades with a 10-30 flattening exposure, such as receiving 10y20y. Recall that the 10y20y forward rate is essentially one-part 30y outright plus 0.5-part 10y-30y curve: hence a reduction in the prospects for 10-30 steepening make this more of an essentially bullish trade (cf 5y5y, which is equal parts direction and curve).

How best to position for a failure of 10y20y at the 100-month moving average?

Simply receiving the 10y20y forward outright has the merit of ample liquidity and may act as a hedge to portfolios with more bearish positioning at the short end. The US 10y20y rate has got slightly ahead of Fed expectations over the past 6 months: the chart shows the residual of the regression between 10y20y and the 2y1y rate. On this basis, 10y20y looks around 10bp too high given the market’s pricing for short rates (R^2 of 83%). Being long 10y20y rolls negatively by 1.4bp over the first year, but does, of course, offer a long convexity exposure to compensate for this. A hedged spread using realized betas would be 1:1.08 DV01 of 10y20y: 2y1y.

For a non-linear payoff, look at mid-curve receivers on 10y20y as spread structures (or perhaps conditional curve trades vs short rates). The next chart shows the Fibonacci retracement levels for 10y20y, which gives us some idea of where to set breakeven points for receiver spread structures. Within the past six months the low has been in the 2.90% region, while further back the 2.60% level has been a strong support. The first retracement from current levels is around 3.00%, and would be target for a failure of 10y20y to breach the 100-month moving average.

This receiver ladder structure costs around 1.5bp running (mid indic):

Buy 90mm 1y10y20y receiver k=3.30%
Sell 90mm 1y10y20y receiver k=3.05%

Sell 90mm 1y10y20y receiver k=2.85%

(with Atmf = 3.33%)

The structure makes money with 10y20y at expiry from 3.285% to 2.615%, with the maximum P&L of 23.5bp between 3.05% and 2.85%. A break below the 2.615% level would start to incur losses. The trade is short gamma at inception, and slightly long the market.

On a shorter horizon with tighter strikes, this ladder costs 0.5bp running (mid indic)

Buy 90mm 6m10y20y receiver k=3.30%
Sell 90mm 6m10y20y receiver k=3.15%

Sell 90mm 6m10y20y receiver k=3.00%

(with Atmf = 3.34%)

and makes the largest P&L of 14.5 bp on a move to between 3.15% and 3%. The trade starts to lose money at 2.85% (a rally of 50bp in 10y20y over 6m).

Zero-cost 1x2 structures for comparison are (indicatively):
3m10y20y 3.30% / 3.15%, breakeven at 3%

6m10y20y 3.30% / 3.10%, breakeven at 2.90%

1y10y20y 3.30% / 3%, breakeven at 2.70%

Another way to approach the USD 10y20y is in comparison to the EUR 10y20y as in the chart below. The spread is pushing on its highest levels for some time and exceeded only by the period leading into the start of the ECB’s QE (and the substantial flattening of EUR 10y-30y): a situation unlikely to be repeated. Again, the simplest way is to receive USD 10y20y vs paying EUR 10y20y. Given the higher volatility of US rates (and the recent comatose price action in EUR 10y20y) this is essentially a proxy for receiving USD 10y20y outright.

There are many ways to skin a cat … if a different expression fits your needs better please let me know and we can investigate.

Best wishes,

David

David Sansom

image001.jpg@01D21F13.B69A4950">

UK: 14-16 Dowgate Hill, London EC4R 2SU

US: 245 Park Ave, 39^th Floor, NY, NY, 10167

Office: +44 (0) 203 143 4180

Mobile: +44 (0) 7976 204490

Astor Ridge LLP is regulated by the Financial Conduct Authority (FCA): Registration Number 579287

Astor Ridge LLP is Registered in England and Wales with Companies House: Registration Number OC372185

Astor Ridge NA LLP is a member of FINRA/SIPC: CRD Number 282626

Astor Ridge NA LLP is Registered in England and Wales with Companies House: Registration Number OC401796

What has the Bundesbank bought for PSPP2 in October? ML model results including future redemption estimates.

Here are the results of my Maximum Likelihood model for PSPP2 purchases in Germany for October. Once again, the model suggests strong buying in the 10y sector, with the remainder localized around 1y-2y, 5y and 30y (unsurprisingly, as these are the supply points where bonds have been in the programme for a shorter period).

To recap: the redemption flows for the first 3 months of 2019, when new purchases will have ceased, are substantial. For governments the model estimates redemptions of 7.6bn in January, 5.3bn in February and 2.2bn in March: an average of 5bn per month for the first quarter of 2019.

The estimated breakdown of purchasing for September across Govts, KFW and the Lander:

Category	Notional	WAM
German Govt	4.1	10.1
KFW	1.4	6.2
Lander	2.1	7.6
All Purchases	7.5	8.7

Given the model, here’s a chart showing the estimated redemption flows for the year ahead:

And the numbers for that chart:

Redemptions
	Govt	KFW	Lander	Total
Apr-17	0	0	0	0
May-17	0	0	0	0
Jun-17	0	0	0	0
Jul-17	0	0	0	0
Aug-17	0	0	0	0
Sep-17	0	0	0	0
Oct-17	0	0	0	0
Nov-17	0	0	0	0
Dec-17	0	0	0	0
Jan-18	0	6	0	6
Feb-18	606	82	0	688
Mar-18	763	0	150	913
Apr-18	2989	0	63	3051
May-18	0	0	95	95
Jun-18	1668	2002	327	3996
Jul-18	2367	1069	549	3985
Aug-18	0	0	65	65
Sep-18	2202	0	414	2616
Oct-18	2966	1304	649	4919
Nov-18	0	0	853	853
Dec-18	2766	1650	304	4720
Jan-19	7917	1980	930	10828
Feb-19	5280	0	692	5972
Mar-19	2306	3300	374	5980
Apr-19	5280	289	792	6361
May-19	0	0	684	684
Jun-19	2045	0	571	2616
Jul-19	7920	495	99	8514
Aug-19	0	660	370	1030
Sep-19	2009	80	991	3081
Oct-19	5280	1650	2190	9120

For the model itself, here are the estimates for the buying of German Governments in October:

This chart shows the remaining notional available for purchase by the programme given the estimated buying to date and the notional limits in place.

Finally, here’s the issue by issue breakdown of how much of each government bond my model estimates that the Bundesbank has bought:

Bond	Opened	O/S (bn)	Purchasable	Market Yield	Purchased	% Purchased	Remaining	Margin of Error	MV Remaining	Oct-18 Buying
DBR 3.75% 04-Jan-17	Nov-06	0.0	0.0		0.0		0.0		0.0	0.0
OBL 0.75% 24-Feb-17	Jan-12	0.0	0.0		0.0		0.0		0.0	0.0
BKO 0% 10-Mar-17	Feb-15	0.0	0.0		0.0		0.0		0.0	0.0
OBL 0.5% 07-Apr-17	May-12	0.0	0.0		0.0		0.0		0.0	0.0
BKO 0% 16-Jun-17	May-15	0.0	0.0		0.0		0.0		0.0	0.0
DBR 4.25% 04-Jul-17	May-07	0.0	0.0		0.0		0.0		0.0	0.0
BKO 0% 15-Sep-17	Aug-15	0.0	0.0		0.0		0.0		0.0	0.0
OBL 0.5% 13-Oct-17	Sep-12	0.0	0.0		0.0		0.0		0.0	0.0
BKO 0% 15-Dec-17	Nov-15	0.0	0.0		0.0		0.0		0.0	0.0
DBR 4% 04-Jan-18	Nov-07	0.0	0.0		0.0		0.0		0.0	0.0
OBL 0.5% 23-Feb-18	Jan-13	0.0	0.0		0.6		0.0	+/- 3%	0.0	0.0
BKO 0% 16-Mar-18	Feb-16	0.0	0.0		0.8		0.0	+/- 3%	0.0	0.0
OBL 0.25% 13-Apr-18	May-13	0.0	0.0		1.3		0.0	+/- 3%	0.0	0.0
OBLI 0.75% 15-Apr-18	Apr-11	0.0	0.0		1.6		0.0	+/- 3%	0.0	0.0
BKO 0% 15-Jun-18	May-16	0.0	0.0		1.7		0.0	+/- 2%	0.0	0.0
DBR 4.25% 04-Jul-18	May-08	0.0	0.0		2.4		0.0	+/- 2%	0.0	0.0
BKO 0% 14-Sep-18	Aug-16	0.0	0.0		2.2		0.0	+/- 2%	0.0	0.0
OBL 1% 12-Oct-18	Sep-13	0.0	0.0		3.0		0.0	+/- 1%	0.0	0.0
BKO 0% 14-Dec-18	Nov-16	13.0	0.0	-0.646	2.8		0.0	+/- 2%	0.0	0.0
DBR 3.75% 04-Jan-19	Nov-08	24.0	0.0	-0.961	7.9		0.0	+/- 0%	0.0	0.0
OBL 1% 22-Feb-19	Jan-14	16.0	0.0	-0.754	5.3		0.0	+/- 0%	0.0	0.0
BKO 0% 15-Mar-19	Mar-17	13.0	0.0	-0.744	2.3		0.0	+/- 1%	0.0	0.0
OBL 0.5% 12-Apr-19	May-14	16.0	0.0	-0.725	5.3		0.0	+/- 0%	0.0	0.0
BKO 0% 14-Jun-19	May-17	13.0	0.0	-0.694	2.0		0.0	+/- 2%	0.0	0.0
DBR 3.5% 04-Jul-19	May-09	24.0	0.0	-0.677	7.9		0.0	+/- 0%	0.0	0.0
BKO 0% 13-Sep-19	Aug-17	13.0	0.0	-0.677	2.0		0.0	+/- 1%	0.0	0.0
OBL 0.25% 11-Oct-19	Sep-14	16.0	0.0	-0.677	5.3		0.0	+/- 0%	0.0	0.0
BKO 0% 13-Dec-19	Nov-17	13.0	4.3	-0.686	1.7	40%	2.6	+/- 2%	2.6	0.2
DBR 3.25% 04-Jan-20	Nov-09	22.0	7.3	-0.792	7.3	100%	0.0	+/- 0%	0.0	0.0
BKO 0% 13-Mar-20	Feb-18	13.0	4.3	-0.696	1.3	31%	3.0	+/- 2%	3.0	0.2
DBRI 1.75% 15-Apr-20	Jun-09	16.0	5.3		5.3	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 17-Apr-20	Jan-15	20.0	6.6	-0.701	6.6	100%	0.0	+/- 0%	0.0	0.0
BKO 0% 12-Jun-20	May-18	12.0	4.0	-0.667	0.7	18%	3.3	+/- 2%	3.3	0.2
DBR 3% 04-Jul-20	Apr-10	22.0	7.3	-0.679	7.3	100%	0.0	+/- 0%	0.0	0.0
DBR 2.25% 04-Sep-20	Aug-10	16.0	5.3	-0.655	5.3	100%	0.0	+/- 0%	0.0	0.0
BKO 0% 11-Sep-20	Aug-18	12.0	4.0	-0.622	0.1	3%	3.8	+/- 2%	3.9	0.1
OBL 0.25% 16-Oct-20	Jul-15	19.0	6.3	-0.632	6.3	100%	0.0	+/- 0%	0.0	0.0
DBR 2.5% 04-Jan-21	Nov-10	19.0	6.3	-0.621	6.3	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 09-Apr-21	Feb-16	21.0	6.9	-0.572	6.9	100%	0.0	+/- 0%	0.0	0.0
DBR 3.25% 04-Jul-21	Apr-11	19.0	6.3	-0.544	6.3	100%	0.0	+/- 0%	0.0	0.0
DBR 2.25% 04-Sep-21	Aug-11	16.0	5.3	-0.519	5.3	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 08-Oct-21	Jul-16	19.0	6.3	-0.505	6.3	100%	0.0	+/- 0%	0.0	0.0
DBR 2% 04-Jan-22	Nov-11	20.0	6.6	-0.468	6.6	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 08-Apr-22	Feb-17	18.0	5.9	-0.424	4.7	80%	1.2	+/- 1%	1.2	0.3
DBR 1.75% 04-Jul-22	Apr-12	24.0	7.9	-0.396	7.9	100%	0.0	+/- 0%	0.0	0.0
DBR 1.5% 04-Sep-22	Sep-12	18.0	5.9	-0.370	5.9	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 07-Oct-22	Jul-17	17.0	5.6	-0.345	3.1	56%	2.5	+/- 1%	2.5	0.3
DBR 1.5% 15-Feb-23	Jan-13	18.0	5.9	-0.297	5.9	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 14-Apr-23	Feb-18	16.0	5.3	-0.259	1.5	28%	3.8	+/- 2%	3.8	0.3
DBRI 0.1% 15-Apr-23	Mar-12	16.0	5.3		5.3	100%	0.0	+/- 0%	0.0	0.0
DBR 1.5% 15-May-23	May-13	18.0	5.9	-0.260	5.9	100%	0.0	+/- 0%	0.0	0.0
DBR 2% 15-Aug-23	Sep-13	18.0	5.9	-0.222	5.9	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 13-Oct-23	Jul-18	13.0	4.3	-0.173	0.2	4%	4.1	+/- 4%	4.2	0.1
DBR 6.25% 04-Jan-24	Jan-94	10.3	3.4	-0.158	3.4	100%	0.0	+/- 0%	0.0	0.0
DBR 1.75% 15-Feb-24	Jan-14	18.0	5.9	-0.138	5.9	100%	0.0	+/- 0%	0.0	0.0
DBR 1.5% 15-May-24	May-14	18.0	5.9	-0.104	5.9	100%	0.0	+/- 0%	0.0	0.0
DBR 1% 15-Aug-24	Sep-14	18.0	5.9	-0.067	5.9	100%	0.0	+/- 0%	0.0	0.0
DBR 0.5% 15-Feb-25	Jan-15	23.0	7.6	-0.002	7.6	100%	0.0	+/- 0%	0.0	0.0
DBR 1% 15-Aug-25	Jul-15	23.0	7.6	0.049	7.6	100%	0.0	+/- 0%	0.0	0.0
DBR 0.5% 15-Feb-26	Jan-16	26.0	8.6	0.115	8.6	100%	0.0	+/- 0%	0.0	0.0
DBRI 0.1% 15-Apr-26	Mar-15	14.5	4.8		4.7	98%	0.1	+/- 1%	0.1	0.1
DBR 0% 15-Aug-26	Jul-16	25.0	8.3	0.183	8.3	100%	0.0	+/- 0%	0.0	0.0
DBR 0.25% 15-Feb-27	Jan-17	26.0	8.6	0.243	6.9	80%	1.7	+/- 1%	1.7	0.5
DBR 6.5% 04-Jul-27	Jul-97	11.2	3.7	0.231	3.7	100%	0.0	+/- 0%	0.0	0.0
DBR 0.5% 15-Aug-27	Jul-17	25.0	8.3	0.304	4.3	52%	4.0	+/- 1%	4.1	0.4
DBR 5.625% 04-Jan-28	Jan-98	14.5	4.8	0.296	4.8	100%	0.0	+/- 0%	0.0	0.0
DBR 0.5% 15-Feb-28	Jan-18	21.0	6.9	0.366	1.9	27%	5.0	+/- 1%	5.1	0.4
DBR 4.75% 04-Jul-28	Oct-98	11.3	3.7	0.352	3.7	100%	0.0	+/- 0%	0.0	0.0
DBR 0.25% 15-Aug-28	Jul-18	16.0	5.3	0.428	0.3	5%	5.0	+/- 3%	4.9	0.1
DBR 6.25% 04-Jan-30	Jan-00	9.3	3.1	0.440	3.1	100%	0.0	+/- 0%	0.0	0.0
DBRI 0.5% 15-Apr-30	Apr-14	12.1	4.0		3.7	93%	0.3	+/- 2%	0.3	0.2
DBR 5.5% 04-Jan-31	Oct-00	17.0	5.6	0.511	5.6	100%	0.0	+/- 0%	0.0	0.0
DBR 4.75% 04-Jul-34	Jan-03	20.0	6.6	0.695	6.6	100%	0.0	+/- 0%	0.0	0.0
DBR 4% 04-Jan-37	Jan-05	23.0	7.6	0.793	7.6	100%	0.0	+/- 0%	0.0	0.0
DBR 4.25% 04-Jul-39	Jan-07	14.0	4.6	0.853	4.6	100%	0.0	+/- 0%	0.0	0.0
DBR 4.75% 04-Jul-40	Jul-08	16.0	5.3	0.860	5.3	100%	0.0	+/- 0%	0.0	0.0
DBR 3.25% 04-Jul-42	Jul-10	15.0	5.0	0.927	5.0	100%	0.0	+/- 0%	0.0	0.0
DBR 2.5% 04-Jul-44	Apr-12	26.5	8.7	0.992	7.6	87%	1.1	+/- 1%	1.5	0.2
DBRI 0.1% 15-Apr-46	Jun-15	8.0	2.6		1.9	72%	0.7	+/- 1%	0.9	0.1
DBR 2.5% 15-Aug-46	Feb-14	25.5	8.4	1.023	7.3	87%	1.1	+/- 1%	1.5	0.3
DBR 1.25% 15-Aug-48	Sep-17	10.5	3.5	1.060	1.0	30%	2.4	+/- 2%	2.6	0.2

Italic = index-linked								Total	47.2	4.1
Yield below Depo Rate
Yield above Depo Rate									Bund WAM	10.1

Any questions? More than happy to run you through the numbers in detail.

Best wishes

David

David Sansom

image001.jpg@01D21F13.B69A4950">

UK: 14-16 Dowgate Hill, London EC4R 2SU

US: 245 Park Ave, 39^th Floor, NY, NY, 10167

Office: +44 (0) 203 143 4180

Mobile: +44 (0) 7976 204490

Astor Ridge LLP is regulated by the Financial Conduct Authority (FCA): Registration Number 579287

Astor Ridge LLP is Registered in England and Wales with Companies House: Registration Number OC372185

Astor Ridge NA LLP is a member of FINRA/SIPC: CRD Number 282626

Astor Ridge NA LLP is Registered in England and Wales with Companies House: Registration Number OC401796

Friday thought: USD Curve: Mode of curve is changing: Time for bear-steepeners?

Bottom Line: The moves in equities and the breakout of long-dated Treasury yields have asserted a bear-steepening dynamic on the curve. The implied volatility markets for mid-curves do not yet reflect this, opening up the opportunity for low-cost steepeners. Love it? Hate it? Too soon? It would be great to hear your thoughts.

Trade:
Sell USD 1,110mm 6m3y1y mc payer atmf (k=3.168%)

Buy USD 249mm 6m5y5y mc payer atmf (k=3.287%)
For a premium take out of 0.9bp running (mid indic)

Fwd strike at 11.9bp vs spot at 10bp

(Equivalent to USD 100k/bp on underlying at expiry)

Rationale: It is not an earth-shattering observation to note that the US yield curve is very flat. However the path to this point has come from bear-flattening, as the Fed laced on its hiking boots. In recent weeks, this mode has become weaker, and curve directionality has become vague at best. The reversal in US equity markets, and the President’s novel interpretation of Fed independence has provoked more volatility in the belly of the curve.

As usual, I’ve been looking at forward rates, and I’m drawn to 3y1y (1y, 3y forward) vs longer rates (eg 5y5y). The point about 3y1y is that tail is pretty much the peak of the implied volatility surface for mid-curve options, so is a good candidate on which to sell options versus shorter or longer rates.

The USD 3y1y/5y5y curve over the past two years is shown in the first chart.

The rolling 3m beta of the 5y5y vs 3y1y. A beta of more than 1.0 suggests that 5y5y realized volatility is higher and curve is bear-steepening / bull-flattening.

If we look at just the last month of realized data, the picture is even more stark. The last one month of datapoints are shown in red, with the previous two years in green.

Street analysts (eg some in-depth pieces from Deutsche) have suggested that the change in dynamic has come from the closing of a window for tax relief on pension investments. Previously (the argument goes) the combination of a tax benefit and massive repatriation flows have driven corporate pension injections and given a bias for curve flattening. With the closing of this window on 15^th September, sponsorship of the US Treasury long-end has wilted and yields have broken out to new highs. Hence the recent bear-steepening dynamic on the curve.

The volatility markets have yet to reflect this recent move, so there is an opportunity to set bear-steepeners at zero cost (or maybe a modest premium take-out). The sharp repricing of equities has focused interest on the belly /long-end of the curve and away from the Fed reaction function, and reintroduced term premium. This trade plays for this to continue. Hence the risk is that the Fed takes over the headlines and the short-end starts to drive the curve again: however in a strong bull-steepening move the trade would have positive mark-to-market. It is only a bear-flattening (from already flat levels) that would provoke a loss.

I would love to hear your thoughts on this!

Best wishes

David

David Sansom

image001.jpg@01D21F13.B69A4950">

UK: 14-16 Dowgate Hill, London EC4R 2SU

US: 245 Park Ave, 39^th Floor, NY, NY, 10167

Office: +44 (0) 203 143 4180

Mobile: +44 (0) 7976 204490

Astor Ridge LLP is regulated by the Financial Conduct Authority (FCA): Registration Number 579287

Astor Ridge LLP is Registered in England and Wales with Companies House: Registration Number OC372185

Astor Ridge NA LLP is a member of FINRA/SIPC: CRD Number 282626

Astor Ridge NA LLP is Registered in England and Wales with Companies House: Registration Number OC401796

More on PSPP2 for 2019: Bias is for France-Germany wideners in 2y and 10y sectors next year

In Friday’s note (let me know if you didn’t see it), I presented my model estimates of redemption flows from the PSPP2 portfolios for Germany and France. What was clear is that for 2019, German redemptions run well ahead of French and by more than the capital key differential. For 2019, I estimate 39bn of Bund redemptions and only 23.2bn of OATs, a ratio of 1.68: 1 compared to the capital key ratio of 1.27:1. If I look at all purchases (including KFW, CADES, Lander and other agencies) the picture is even starker: 56bn of redemptions in Germany and 27.2bn in France giving a ratio of 2.05:1.

As I mentioned in the note, the profile of available bonds for purchase in Germany is very different from that of France. According to my estimates, Germany not only has fewer bonds available for purchase in notional terms, but these bonds are far more concentrated around the 2y,5y,10y and 30y supply points than in France.

If we look at the same numbers as a percentage of the available stock for purchase (not taking into account coming supply), the picture is even starker. On current issue sizes, over 25% of Bund purchases in 2019 could come in the 1y-2y bucket, compared to just over 10% in OATs. In the 10y sector it is a similar picture.

Hence not only could we see larger Bund buying compared to the capital key, but this buying will be concentrated in a smaller number of issues than for OATs. This very much suggests that it makes sense to go into the new year with an overweight of Germany vs France in the 2y and 10y sectors.

Does this sound plausible? All and any comments welcome!

Best wishes,

David

David Sansom

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UK: 14-16 Dowgate Hill, London EC4R 2SU

US: 245 Park Ave, 39^th Floor, NY, NY, 10167

Office: +44 (0) 203 143 4180

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Astor Ridge LLP is regulated by the Financial Conduct Authority (FCA): Registration Number 579287

Astor Ridge LLP is Registered in England and Wales with Companies House: Registration Number OC372185

Astor Ridge NA LLP is a member of FINRA/SIPC: CRD Number 282626

Astor Ridge NA LLP is Registered in England and Wales with Companies House: Registration Number OC401796

PSPP2 redemption/reinvestment flows for Bunds and OATs in 2019: Bunds should get a boost in Q1 19

Hi,

As many of you will know, I have been running my model for PSPP2 buying specifically for Germany (Bunds, KFW, Lander). After finally beating the French bond size data into submission, I have done the same with France (OATs, CADES & others).

What are the key observations, given my model estimates?

The first 4 months of 2019 will see over EUR 20bn of Bund redemptions compared to just EUR 5.7bn for France.
Taking 2019 as a whole, Bunds should see 18.1bn vs France’s 12.8bn. This is a ratio of 1.67 : 1. The capital key ratio is 1.27 : 1. This means that Germany will see considerably more buying relative to France than might be expected from the capital key.
Bear in mind also that German purchases are likely more concentrated in specific issues (since the 33% ownership limit has been reached on many older issues). Currently purchases are being focused on the supply points: 5y, 10y and 30y.
Ahead into 2020 the reinvestments are much closer to the capital key ratio.

Taken together, this suggests that Germany-France spreads should (all things being equal) come under widening pressure in 5y,10y and 30y sectors in the first quarter of next year.

Of most interest for the coming months is the pattern of redemption/reinvestment flows, and this is shown in the chart using last month’s data. Hence the redemption sizes will increase slightly as we still have three months of (reduced) purchases of new assets. I am assuming that government redemptions are reinvested into governments while agency/Lander debt is also reinvested in the same bond class.

And here are the numbers (as of end-Sept 18), with the annual totals. Bear in mind that the redemption can be reinvested over subsequent months, rather than immediately.

Month	Bunds	OATs
Apr-17	-	427
May-17	-	-
Jun-17	-	-
Jul-17	-	1,389
Aug-17	-	-
Sep-17	-	-
Oct-17	-	1,693
Nov-17	-	-
Dec-17	-	-
2017 Total	-	3,509
Jan-18	-	-
Feb-18	592	598
Mar-18	750	-
Apr-18	3,446	2,522
May-18	-	2,153
Jun-18	1,652	-
Jul-18	2,312	1,777
Aug-18	-	-
Sep-18	2,164	-
Oct-18	4,535	3,012
Nov-18	-	2,712
Dec-18	2,659	-
2018 Total	18,111	12,775
Jan-19	7,596	-
Feb-19	5,280	1,248
Mar-19	2,206	-
Apr-19	5,280	4,453
May-19	-	3,765
Jun-19	1,973	-
Jul-19	7,920	2,847
Aug-19	-	-
Sep-19	1,937	-
Oct-19	5,280	5,976
Nov-19	-	4,948
Dec-19	1,485	-
2019 Total	38,957	23,236
Jan-20	7,260	-
Feb-20	-	959
Mar-20	1,079	-
Apr-20	11,880	6,719
May-20	-	4,419
Jun-20	482	-
Jul-20	7,260	5,068
Aug-20	-	-
Sep-20	5,328	-
Oct-20	6,270	7,530
Nov-20	-	3,945
Dec-20	-	-
2020 Total	39,558	28,638

David Sansom

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UK: 14-16 Dowgate Hill, London EC4R 2SU

US: 245 Park Ave, 39^th Floor, NY, NY, 10167

Office: +44 (0) 203 143 4180

Mobile: +44 (0) 7976 204490

Astor Ridge LLP is regulated by the Financial Conduct Authority (FCA): Registration Number 579287

Astor Ridge LLP is Registered in England and Wales with Companies House: Registration Number OC372185

Astor Ridge NA LLP is a member of FINRA/SIPC: CRD Number 282626

Astor Ridge NA LLP is Registered in England and Wales with Companies House: Registration Number OC401796

What has the Bundebank bought for PSPP2 in September? ML model results including future redemption estimates.

Here are the results of my Maximum Likelihood model for PSPP2 purchases in Germany for September. This month the model suggests strong buying in the 10y sector, with the remainder localized around 1y-2y, 5y and 30y (unsurprisingly, as these are the supply points where bonds have been in the programme for a shorter period).

The redemption flows for the first 3 months of 2019, when new purchases will have ceased, are substantial. For governments the model estimates redemptions of 7.6bn in January, 5.3bn in February and 2.2bn in March: an average of 5bn per month for the first quarter of 2019. As a consequence the ending of new purchases may hardly be noticed.

The estimated breakdown of purchasing for September across Govts, KFW and the Lander:

Category	Notional	WAM
German Govt	4.8	9.2
KFW	1.2	6.0
Lander	2.5	6.4
All Purchases	8.5	7.9

Given the model, here’s a chart showing the estimated redemption flows for the year ahead:

And the numbers for that chart:

Redemptions
	Govt	KFW	Lander	Total
Apr-17	0	0	0	0
May-17	0	0	0	0
Jun-17	0	0	0	0
Jul-17	0	0	0	0
Aug-17	0	0	0	0
Sep-17	0	0	0	0
Oct-17	0	0	0	0
Nov-17	0	0	0	0
Dec-17	0	0	0	0
Jan-18	0	5	0	5
Feb-18	592	83	0	674
Mar-18	750	0	151	901
Apr-18	3446	0	70	3516
May-18	0	0	97	97
Jun-18	1652	2036	329	4017
Jul-18	2312	1081	561	3954
Aug-18	0	0	71	71
Sep-18	2164	0	423	2587
Oct-18	4535	1650	643	6828
Nov-18	0	0	847	847
Dec-18	2659	1650	303	4612
Jan-19	7596	1980	880	10456
Feb-19	5280	0	676	5956
Mar-19	2206	3300	349	5855
Apr-19	5280	272	784	6336
May-19	0	0	664	664
Jun-19	1973	0	563	2536
Jul-19	7920	495	99	8514
Aug-19	0	660	369	1029
Sep-19	1937	78	951	2966
Oct-19	5280	1650	2179	9109
Nov-19	0	0	520	520
Dec-19	1485	0	574	2059
Jan-20	7260	3300	1870	12430
Feb-20	0	121	680	801
Mar-20	1079	0	1369	2447
Apr-20	11880	0	395	12275
May-20	0	0	388	388
Jun-20	482	1786	653	2922
Jul-20	7260	0	2186	9446
Aug-20	0	0	560	560
Sep-20	5328	0	957	6285
Oct-20	6270	495	942	7707
Nov-20	0	0	1125	1125
Dec-20	0	0	783	783
Jan-21	6270	3630	1102	11002

For the model itself, here are the estimates for the buying of German Governments in September:

This chart shows the remaining notional available for purchase by the programme given the estimated buying to date and the notional limits in place.

Finally, here’s the issue by issue breakdown of how much of each government bond my model estimates that the Bundesbank has bought:

Bond	Opened	O/S (bn)	Purchasable	Market Yield	Purchased	% Purchased	Remaining	Margin of Error	MV Remaining	Sep-18 Buying
DBR 3.75% 04-Jan-17	Nov-06	0.0	0.0		0.0		0.0		0.0	0.0
OBL 0.75% 24-Feb-17	Jan-12	0.0	0.0		0.0		0.0		0.0	0.0
BKO 0% 10-Mar-17	Feb-15	0.0	0.0		0.0		0.0		0.0	0.0
OBL 0.5% 07-Apr-17	May-12	0.0	0.0		0.0		0.0		0.0	0.0
BKO 0% 16-Jun-17	May-15	0.0	0.0		0.0		0.0		0.0	0.0
DBR 4.25% 04-Jul-17	May-07	0.0	0.0		0.0		0.0		0.0	0.0
BKO 0% 15-Sep-17	Aug-15	0.0	0.0		0.0		0.0		0.0	0.0
OBL 0.5% 13-Oct-17	Sep-12	0.0	0.0		0.0		0.0		0.0	0.0
BKO 0% 15-Dec-17	Nov-15	0.0	0.0		0.0		0.0		0.0	0.0
DBR 4% 04-Jan-18	Nov-07	0.0	0.0		0.0		0.0		0.0	0.0
OBL 0.5% 23-Feb-18	Jan-13	0.0	0.0		0.6		0.0	+/- 3%	0.0	0.0
BKO 0% 16-Mar-18	Feb-16	0.0	0.0		0.8		0.0	+/- 4%	0.0	0.0
OBL 0.25% 13-Apr-18	May-13	0.0	0.0		1.3		0.0	+/- 3%	0.0	0.0
OBLI 0.75% 15-Apr-18	Apr-11	0.0	0.0		2.1		0.0	+/- 2%	0.0	0.0
BKO 0% 15-Jun-18	May-16	0.0	0.0		1.7		0.0	+/- 2%	0.0	0.0
DBR 4.25% 04-Jul-18	May-08	0.0	0.0		2.3		0.0	+/- 2%	0.0	0.0
BKO 0% 14-Sep-18	Aug-16	0.0	0.0		2.2		0.0	+/- 2%	0.0	0.0
OBL 1% 12-Oct-18	Sep-13	17.0	0.0	-0.688	4.5		0.0	+/- 1%	0.0	0.0
BKO 0% 14-Dec-18	Nov-16	13.0	0.0	-0.602	2.7		0.0	+/- 2%	0.0	0.0
DBR 3.75% 04-Jan-19	Nov-08	24.0	0.0	-0.733	7.6		0.0	+/- 1%	0.0	0.0
OBL 1% 22-Feb-19	Jan-14	16.0	0.0	-0.659	5.3		0.0	+/- 0%	0.0	0.0
BKO 0% 15-Mar-19	Mar-17	13.0	0.0	-0.644	2.2		0.0	+/- 2%	0.0	0.0
OBL 0.5% 12-Apr-19	May-14	16.0	0.0	-0.631	5.3		0.0	+/- 0%	0.0	0.0
BKO 0% 14-Jun-19	May-17	13.0	0.0	-0.619	2.0		0.0	+/- 2%	0.0	0.0
DBR 3.5% 04-Jul-19	May-09	24.0	0.0	-0.638	7.9		0.0	+/- 0%	0.0	0.0
BKO 0% 13-Sep-19	Aug-17	13.0	0.0	-0.633	1.9		0.0	+/- 2%	0.0	0.1
OBL 0.25% 11-Oct-19	Sep-14	16.0	5.3	-0.617	5.3	100%	0.0	+/- 0%	0.0	0.0
BKO 0% 13-Dec-19	Nov-17	13.0	4.3	-0.618	1.5	35%	2.8	+/- 2%	2.8	0.2
DBR 3.25% 04-Jan-20	Nov-09	22.0	7.3	-0.697	7.3	100%	0.0	+/- 0%	0.0	0.0
BKO 0% 13-Mar-20	Feb-18	13.0	4.3	-0.599	1.1	25%	3.2	+/- 2%	3.2	0.2
DBRI 1.75% 15-Apr-20	Jun-09	16.0	5.3		5.3	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 17-Apr-20	Jan-15	20.0	6.6	-0.609	6.6	100%	0.0	+/- 0%	0.0	0.0
BKO 0% 12-Jun-20	May-18	12.0	4.0	-0.578	0.5	12%	3.5	+/- 3%	3.5	0.2
DBR 3% 04-Jul-20	Apr-10	22.0	7.3	-0.601	7.3	100%	0.0	+/- 0%	0.0	0.0
DBR 2.25% 04-Sep-20	Aug-10	16.0	5.3	-0.576	5.3	100%	0.0	+/- 0%	0.0	0.0
BKO 0% 11-Sep-20	Aug-18	8.0	2.6	-0.553	0.0	2%	2.6	+/- 7%	2.6	0.0
OBL 0.25% 16-Oct-20	Jul-15	19.0	6.3	-0.564	6.3	100%	0.0	+/- 0%	0.0	0.0
DBR 2.5% 04-Jan-21	Nov-10	19.0	6.3	-0.552	6.3	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 09-Apr-21	Feb-16	21.0	6.9	-0.509	6.9	100%	0.0	+/- 0%	0.0	0.1
DBR 3.25% 04-Jul-21	Apr-11	19.0	6.3	-0.474	6.3	100%	0.0	+/- 0%	0.0	0.0
DBR 2.25% 04-Sep-21	Aug-11	16.0	5.3	-0.450	5.3	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 08-Oct-21	Jul-16	19.0	6.3	-0.441	6.2	99%	0.0	+/- 1%	0.0	0.3
DBR 2% 04-Jan-22	Nov-11	20.0	6.6	-0.403	6.6	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 08-Apr-22	Feb-17	18.0	5.9	-0.365	4.3	72%	1.6	+/- 1%	1.7	0.3
DBR 1.75% 04-Jul-22	Apr-12	24.0	7.9	-0.336	7.9	100%	0.0	+/- 0%	0.0	0.0
DBR 1.5% 04-Sep-22	Sep-12	18.0	5.9	-0.313	5.9	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 07-Oct-22	Jul-17	17.0	5.6	-0.285	2.8	50%	2.8	+/- 2%	2.8	0.3
DBR 1.5% 15-Feb-23	Jan-13	18.0	5.9	-0.242	5.9	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 14-Apr-23	Feb-18	16.0	5.3	-0.200	1.2	23%	4.1	+/- 2%	4.1	0.3
DBRI 0.1% 15-Apr-23	Mar-12	16.0	5.3		5.3	100%	0.0	+/- 0%	0.0	0.0
DBR 1.5% 15-May-23	May-13	18.0	5.9	-0.206	5.9	100%	0.0	+/- 0%	0.0	0.0
DBR 2% 15-Aug-23	Sep-13	18.0	5.9	-0.169	5.9	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 13-Oct-23	Jul-18	10.0	3.3	-0.124	0.1	3%	3.2	+/- 7%	3.2	0.1
DBR 6.25% 04-Jan-24	Jan-94	10.3	3.4	-0.105	3.4	100%	0.0	+/- 0%	0.0	0.0
DBR 1.75% 15-Feb-24	Jan-14	18.0	5.9	-0.089	5.9	100%	0.0	+/- 0%	0.0	0.0
DBR 1.5% 15-May-24	May-14	18.0	5.9	-0.058	5.9	100%	0.0	+/- 0%	0.0	0.0
DBR 1% 15-Aug-24	Sep-14	18.0	5.9	-0.021	5.9	100%	0.0	+/- 0%	0.0	0.0
DBR 0.5% 15-Feb-25	Jan-15	23.0	7.6	0.041	7.6	100%	0.0	+/- 0%	0.0	0.0
DBR 1% 15-Aug-25	Jul-15	23.0	7.6	0.091	7.6	100%	0.0	+/- 0%	0.0	0.0
DBR 0.5% 15-Feb-26	Jan-16	26.0	8.6	0.151	8.6	100%	0.0	+/- 0%	0.0	0.0
DBRI 0.1% 15-Apr-26	Mar-15	14.0	4.6		4.6	99%	0.1	+/- 1%	0.1	0.2
DBR 0% 15-Aug-26	Jul-16	25.0	8.3	0.212	8.3	100%	0.0	+/- 0%	0.0	0.0
DBR 0.25% 15-Feb-27	Jan-17	26.0	8.6	0.267	6.3	73%	2.3	+/- 1%	2.3	0.5
DBR 6.5% 04-Jul-27	Jul-97	11.2	3.7	0.252	3.7	100%	0.0	+/- 0%	0.0	0.0
DBR 0.5% 15-Aug-27	Jul-17	25.0	8.3	0.323	3.8	46%	4.5	+/- 1%	4.5	0.4
DBR 5.625% 04-Jan-28	Jan-98	14.5	4.8	0.315	4.8	100%	0.0	+/- 0%	0.0	0.0
DBR 0.5% 15-Feb-28	Jan-18	21.0	6.9	0.383	1.5	22%	5.4	+/- 1%	5.5	0.4
DBR 4.75% 04-Jul-28	Oct-98	11.3	3.7	0.368	3.7	100%	0.0	+/- 0%	0.0	0.0
DBR 0.25% 15-Aug-28	Jul-18	13.0	4.3	0.443	0.1	3%	4.2	+/- 6%	4.1	0.1
DBR 6.25% 04-Jan-30	Jan-00	9.3	3.1	0.451	3.1	100%	0.0	+/- 0%	0.0	0.0
DBRI 0.5% 15-Apr-30	Apr-14	12.1	4.0		3.6	91%	0.4	+/- 2%	0.4	0.1
DBR 5.5% 04-Jan-31	Oct-00	17.0	5.6	0.525	5.6	100%	0.0	+/- 0%	0.0	0.0
DBR 4.75% 04-Jul-34	Jan-03	20.0	6.6	0.700	6.6	100%	0.0	+/- 0%	0.0	0.0
DBR 4% 04-Jan-37	Jan-05	23.0	7.6	0.793	7.6	100%	0.0	+/- 0%	0.0	0.0
DBR 4.25% 04-Jul-39	Jan-07	14.0	4.6	0.853	4.6	100%	0.0	+/- 0%	0.0	0.0
DBR 4.75% 04-Jul-40	Jul-08	16.0	5.3	0.862	5.3	100%	0.0	+/- 0%	0.0	0.0
DBR 3.25% 04-Jul-42	Jul-10	15.0	5.0	0.927	5.0	100%	0.0	+/- 0%	0.0	0.0
DBR 2.5% 04-Jul-44	Apr-12	25.0	8.3	0.997	7.7	93%	0.6	+/- 1%	0.8	0.3
DBRI 0.1% 15-Apr-46	Jun-15	8.0	2.6		1.8	68%	0.8	+/- 2%	1.1	0.1
DBR 2.5% 15-Aug-46	Feb-14	25.5	8.4	1.025	7.1	84%	1.4	+/- 1%	1.8	0.3
DBR 1.25% 15-Aug-48	Sep-17	10.5	3.5	1.064	0.8	24%	2.6	+/- 2%	2.7	0.1

Italic = index-linked								Total	47.5	4.8
Yield below Depo Rate
Yield above Depo Rate									Bund WAM	9.1

Any questions? More than happy to run you through the numbers in detail.

Best wishes

David

David Sansom

image001.jpg@01D21F13.B69A4950">

UK: 14-16 Dowgate Hill, London EC4R 2SU

US: 245 Park Ave, 39^th Floor, NY, NY, 10167

Office: +44 (0) 203 143 4180

Mobile: +44 (0) 7976 204490

Astor Ridge LLP is regulated by the Financial Conduct Authority (FCA): Registration Number 579287

Astor Ridge LLP is Registered in England and Wales with Companies House: Registration Number OC372185

Astor Ridge NA LLP is a member of FINRA/SIPC: CRD Number 282626

Astor Ridge NA LLP is Registered in England and Wales with Companies House: Registration Number OC401796

Three: that's the magic number. Time-sensitive OTC trade ideas in EUR, USD and GBP

Hello … here are three trades (one each in EUR, USD and GBP) that are interesting me right now. I’ve kept the write-ups brief, but they will give a flavour of my thinking. All are very timely given Draghi’s comments in Europe, the imminent FOMC meeting and the ultra-long supply coming in the UK over the next week or so. All and any comments welcome as usual!

1. EUR: Buy 1m5y straddles, sell 1m30y straddles: Changing ECB expectations will drive the curve in the near-term

Buy EUR 203mm 1m5y atmf straddle (k=0.443%)
Sell EUR 42.2mm 1m30y atmf straddle (k=1.595%)

Strike entry at 115.2 bp vs 117.1 spot

For a premium of 0.4bp running (mid indic)

EUR 100k/bp equivalent at expiry

The recent Draghi comments on a “vigorous pick-up in underlying inflation” yesterday (Monday) drove a sharp sell-off in EUR rates. Praet’s attempt to dampen the market’s hawkish reading have not stemmed the move, with 2y1y almost 10bp higher than Friday’s close. The belly of the curve has underperformed as 5y/10y rates have led the way, with the 5y-30y spot curve bear-flattening and taking it out of the becalmed directionless range of the summer.

The theme of this trade is therefore momentum-based: in the near-term, ECB speculation will continue to increase the volatility of 5y rates compared to 30y. The chart shows how gamma on 30y tails is still decreasing, while 5y gamma has found a floor.

Source: CitiVelocity

So with 5y leading 30y, I see the curve bull-steepening back in a relief rally, or bear-flattening further if the hiking genie escapes from the bottle. Either way, the trade then is to buy 1m5y straddles, funded by selling 1m30y. The 1-month expiry takes us up to the next ECB meeting on 25^th October, and spans the next release of the ECB minutes.

2. USD: Buy 1y1y1y receiver ladders: Position for a modest reduction in Fed expectations

Buy USD 1.05bn 1y1y1y mid-curve receiver k=3.25%
Sell USD 1.05bn 1y1y1y mid-curve receiver k=3.00%
Sell USD 1.05bn 1y1y1y mid-curve receiver k=2.75%

Atmf at 3.23%

For premium take out of 1bp running (mid indic)
USD 100k/bp equivalent at expiry

In the past month the market has added almost another 25bp hike to the terminal rate for US Libor, which had been stalled at 3%. The US economy is doing fine, so I am not saying this is unwarranted, but it does make me look for low-cost trades for a mild reversal. This suggests mid-curve receiver ladders, with relatively wide strikes. There are numerous combinations of expiry, forward rate and strikes, but as an example, I’ve priced 1y expiry ladders on 1y1y fwd with 25bp strike intervals.

The bottom line is that as long as the 1y1y rate in a year’s time expires above 2.50% (ie fewer than three hikes have been taken out of the Fed hiking path) the trade at least nets the premium taken out at inception, with a maximum profit of 25bp. In the meantime, if expectations remain steady the trade will show positive mark-to-market as the out-of-the-money strikes become less valuable. The risk is that there is a catastrophic reversal in the fortunes of the US economy and the Fed only hikes once or even reverses course.

3. GBP: Flattener on 10y20y/30y20y in swaps: Forthcoming ultra-long supply will be well-received at these yield levels

Pay GBP 68mm 10y20y fwd swap (20y rate, starting in 10y)
Recv GBP 90.5mm 30y20y fwd swap (20y rate, starting in 30y)
at -26.5bp

DV01 of EUR 100k/bp

As I mentioned in my latest portfolio update, the steepening of the 30y-50y sector of the UK curve has pushed the 30y20y forward rate to its historical highs (absent ‘08/’09). This is tied up inextricably with the forthcoming ultra-long supply.

Chart of the spread (yellow) of the 10y20y / 30y20y rates in GBP:

The steepening is closely connected to the UKT 30y – 50y Gilt curve, as we approach the re-opening syndication of the UKT 1.625% 2071 conventional Gilt on or around 9^th October (our estimate). Before that we the possible sale by Prudential of 33NC13 and 50NC30 paper, maybe as early as tomorrow (Weds) and the size of these books will be a good guide to ultra-long demand. Our anticipation is that the 71 supply will be oversubscribed by real-money investors given the high absolute yield levels after a 30bp sell-off since the summer.

UK 30y-50y conventional Gilt curve has been steepening into the supply event, and yields are now close to their historic peaks:

For the technically-minded, the RSI of the 10y20y/30y20y is into overbought territory (thanks to Chris Williams for this observation).

If any, or all of these trades are of interest, please get in touch!

Best wishes,

David

David Sansom

image001.jpg@01D21F13.B69A4950">

UK: 14-16 Dowgate Hill, London EC4R 2SU

US: 245 Park Ave, 39^th Floor, NY, NY, 10167

Office: +44 (0) 203 143 4180

Mobile: +44 (0) 7976 204490

Astor Ridge LLP is regulated by the Financial Conduct Authority (FCA): Registration Number 579287

Astor Ridge LLP is Registered in England and Wales with Companies House: Registration Number OC372185

Astor Ridge NA LLP is a member of FINRA/SIPC: CRD Number 282626

Astor Ridge NA LLP is Registered in England and Wales with Companies House: Registration Number OC401796

Shadow OTC Portfolio 24th Sept

YTD P&L: USD +1148k

Summary: The portfolio P&L has edged ahead since the last update (13^th Sept) as today’s Draghi comments send short-dated EUR rates higher, helping the EUR 1x2 payer spread on 3y2y. The GBP curve has steepened a shade, and I am closing out the GBP 2y-10y vs USD CMS Caps trade for a loss: the USD strike is well out of the money, while the GBP strike (which I am short) is getting uncomfortably close. As a new trade I have added a long in EUR 2y3y 6s3s basis vs 5y5y (see previous write-up).

Other trades on the radar:

I’m certainly not alone in nothing the wide SEK/EUR spread in forward space (eg 1y2y). This widened out on the latest Riksbank comments, making the spread attractive given the very sizeable rolldown. Having peaked at 24bp, this spread has come back to 21.5 so it looks like I have missed the boat on this for now.

Elsewhere, EONIA-BOR basis has come in sharply, taking forwards (eg 2y3y in the chart) down to revisit the lows since the GFC. I’m not in a huge rush to get long here, preferring to revisit if the basis touches 9bp.

The long-end of the GBP curve has been getting some attention, as the 30y-50y spread in swaps steepens. We have the UKT 1f 71s syndication on the horizon (probably on Tues 9^th Oct) which could prove the catalyst for a reversal, given the relatively high absolute yield on the bond. The swap curve is still steepening: I’ve been tracking the 10y20y / 30y20y spread (orange line in chart) which is more leveraged version (currently around -27bp): if this move continues (to say -20bp) before the syndication I’d be looking at the flattener (not least for the positive convexity).

Changes:
- Closed GBP vs USD CMS 10-2 cap spread for 3bp loss

- Opened EUR 6s3s 2y3y vs 5y5y basis spread

Trade Idea	Entered	Level	Size	Status	Exit/Current Level	Exit Date	P&L k USD
US 2-10 steepener via CMS caps	28-Dec-17	0 bp	USD 25 k/bp	CLOSED	0 bp	15-Jan-18	0
RX/UB ASW Box	28-Dec-17	-6.1 bp	EUR 50 k/bp	CLOSED	-5.2 bp	06-Mar-18	-56
EUR 1y3y/5y5y Mid-curve flattener	28-Dec-17	13.7 bp	EUR 20 k/bp	CLOSED	29 bp	31-Jan-18	380
GBP 1y1y1y MC Payer spread	28-Dec-17	0.7 bp	GBP 25 k/bp	CLOSED	-1 bp	31-Jan-18	-60
EUR 9m1y1y/9m1y5y Bear Flattener	28-Dec-17	4.2 bp	EUR 25 k/bp	CLOSED	0 bp	30-Jan-18	-130
Receive GBP/USD 5y5y xccy basis	28-Dec-17	1 bp	GBP 40 k/bp	CLOSED	6.4 bp	28-Feb-18	-297
EUR 2-5-10 weighted swap fly	28-Dec-17	-28.1 bp	EUR 40 k/bp	CLOSED	-25 bp	25-Jan-18	-154
GBP 2y-10y Bull-steepener	05-Jan-18	0 bp	GBP 20 k/bp	CLOSED	2.5 bp	31-May-18	66
EUR 2y2y/5y10y Bull-Steepener	30-Jan-18	0 bp	EUR 25 k/bp	CLOSED	4 bp	05-Mar-18	123
USD 2y-10y, 1y fwd steepener	02-Feb-18	22 bp	USD 25 k/bp	CLOSED	20.5 bp	21-Feb-18	-38
GBP/USD 2y-10y 1y fwd Swaps	21-Feb-18	-25.5 bp	GBP 25 k/bp	CLOSED	-10.8 bp	23-Mar-18	521
GBP 2y-10y vs USD CMS Caps	21-Feb-18	0 bp	GBP 25 k/bp	CLOSED	-3 bp	24-Sep-18	-99
EUR 3y1y/10y10y flattener	06-Mar-18	124 bp	EUR 25 k/bp	CLOSED	120 bp	08-Mar-18	123
*EUR CMS 10-5 collar*	06-Mar-18	0.5 bp	EUR 40 k/bp	OPEN	-0.3 bp		-38
GBP 10-30 vs 2y1y	27-Mar-18	29 bp	GBP 40 k/bp	CLOSED	33.8 bp	09-Apr-18	271
EUR 3y1y/5y5y bear steepener	12-Apr-18	0 bp	EUR 40 k/bp	CLOSED	0 bp	14-Jun-18	0
GBP/USD 2y-10y, 1m Floors	20-Apr-18	0.6 bp	GBP 25 k/bp	CLOSED	0 bp	21-May-18	-20
EUR 2y1y/10y10y Bear Flattener	20-Apr-18	-0.5 bp	EUR 25 k/bp	CLOSED	4 bp	04-Jun-18	132
EUR 2y1y/5y5y Bull Steepener	17-Jun-18	0 bp	EUR 40 k/bp	CLOSED	4 bp	13-Sep-18	187
*EUR 3y2y 1x2 Midcurve Payers*	27-Jun-18	0 bp	EUR 25 k/bp	OPEN	5.4 bp		159
*GBP 6m2y1y Payer Ladder*	28-Aug-18	2.5 bp	GBP 20 k/bp	OPEN	2.9 bp		11
*GBP 3m CMS 10-2 Cap Fly*	28-Aug-18	4.5 bp	GBP 25 k/bp	OPEN	7.5 bp		99
*EUR 6m 2y3y/5y5y Bull Steepener*	30-Aug-18	-1.25 bp	EUR 25 k/bp	OPEN	-0.7 bp		16
*USD 2y-30y / 5y-10y Steepener*	11-Sep-18	0 bp	USD 50 k/bp	OPEN	-0.6 bp		-30
*EUR 6s3s 2y3y vs 5y5y*	11-Sep-18	0 bp	EUR 250 k/bp	OPEN	0.1 bp		-20
						Total YTD	1148

Note on trade sizing: Each trade is sized to generate approx. USD 150k 2y 99% hist. VaR at inception with no netting

David Sansom

image001.jpg@01D21F13.B69A4950">

UK: 14-16 Dowgate Hill, London EC4R 2SU

US: 245 Park Ave, 39^th Floor, NY, NY, 10167

Office: +44 (0) 203 143 4180

Mobile: +44 (0) 7976 204490

Astor Ridge LLP is regulated by the Financial Conduct Authority (FCA): Registration Number 579287

Astor Ridge LLP is Registered in England and Wales with Companies House: Registration Number OC372185

Astor Ridge NA LLP is a member of FINRA/SIPC: CRD Number 282626

Astor Ridge NA LLP is Registered in England and Wales with Companies House: Registration Number OC401796

USD Curve: Opportunity for low-cost steepeners via CMS caps

Bottom Line: This trade is a way of getting low-cost synthetic steepening exposure to the US curve without exposure to further flattening. The 2y-30y curve is unsurprisingly more volatile than the 5y-10y curve, but the market pricing of CMS spread options is out of line with the recent moves in the curve. Hence we can create a structure with a good correlation to the 2y-10y curve but at a significantly lower cost than buying an outright curve cap.

Trade:

Buy USD 1bn 1y-expiry Cap on CMS 30-2 atmf (k=+6.8bp)
Sell USD 2.33bn 1y-expiry Cap on CMS 10-5 atmf (k=+6.2bp)
For approx zero cost.

Index struck at -7.6bp vs spot index at +1.5bp.

Bloomi CIX: 100 * (USSW30 Curncy - USSW2 Curncy - 2.33 * (USSW10 Curncy - USSW5 Curncy))

Rationale: US curves are cyclically flat, and it is hard to look beyond steepeners as the way forward for the curve. The near-complete absence of term premium is out of kilter with the looming risks for the US and global economies: be they tariffs, EM weakness or growing deficits. However the history of the 2004-2007 period in US rates suggest that while curves may not flatten further from here, steepening is a slow-burn process. Forward curves are not meaningfully steeper than spot slopes so the roll-down benefits even on paper are not compelling.

In the best of all worlds I’d just like to own 1y caps on the 30y-5y CMS spread, but even though CMS spread vol is historically low these still cost around 17bp. Other alternatives are bull-steepeners through receiver swaptions, but the volatility surface is flattening and the bull/bear directionality is weakening, making the economics less attractive.

So the situation requires some creativity. In short, I am proposing buying CMS caps on the 2y-30y slope and a weighted amount of 5y-10y caps to generate a zero-cost structure. The current weighting (from cap pricing in the market) is a notional ratio of 30-2: 10-5 of 1:2.33. If I use this ratio in a CIX:

100 * (USSW30 Curncy - USSW2 Curncy - 2.33 * (USSW10 Curncy - USSW5 Curncy))

the result is in the chart. I have overlaid the US 2y-10y curve to show how the index is still steepens and flattens in line with the 2y-10y curve.

Or if you prefer, the two measures set 1y forward:

Why is this? Quite simply the realized beta between 2y-30y and 5y-10y is higher (at around 2.8x) than that given by the ratio of premia on the CMS caps. As a consequence a cap on 2y-30y can be fully funded by 5y-10y caps while retaining the steepening exposure. The chart shows the past year’s beta between the two curves.

Is this a free lunch? No. First, past regressions are not necessarily a guide for the future relative evolution of the curve sectors. Also, a large increase in volatility, with short rates anchored could lead to the 5y-10y sector steepening faster relative to 2y-30y than implied by the 2.33x weighting (cf 1-factor curve models). In addition, the CMS convexity adjustment is much larger for the Cap on 2y-30y than on 5y-10y. Thus the ATMF strike on the 1y cap on 2y-30y is around 4bp higher than the 2y-30y, 1y fwd spread in vanilla swaps. Thus the ATMF strikes put the index (2y-30y – 2.33x 5y-10y) at -7.6bp compared to -10bp using vanilla forwards. That said there is still positive roll to the spot index at +1bp. There is also the concern in the case of the 5y-10y cap that one is selling a historically cheap option, though in mitigation the same cheapness exists in the 2y-30y: the final chart at the bottom of this piece shows that the ratio of implied vols has been very constant.

One final aspect to being long the 2y-30y curve versus 5y-10y is the wildcard of increased 30y issuance. The US tax cuts have not been matched by spending curbs in the budget and Debt/GDP is increasing. It is not my central expectation, but I prefer to be long the tail risk of higher 30y rates rather than lower. As an aside, this is why I have avoided paying the 2y-10y-30y fly via spreads of caps (as it requires me to short the 10-30 cap).

I’d love to hear what you think … especially if I am missing something! I’ve added some background historical analysis of the US curve sectors below.

Best wishes,

David

Appendix: More detail on the evolution of 2y-30y and 5y-10y curves.

The following chart shows the USD 2y-30y slope and the intermediate 5y-10y slope. It is unsurprising that the two sectors are well correlated (on daily changes in slope, with a 1 year rolling window). It is also empirically apparent that correlation increases as curves flatten.

The next chart shows the historical regression of changes in the 2y-30y and 5y-10y curves. The 20-year average regression is around 2.8 (ie daily changes on 2y-30y are, on average 2.8 times those on 5y-10y). The current historical regression of the past 1 year of data is shown together with the current ratio of the implied vol from the market (the orange horizontal line).

When it comes to CMS spread options, the valuations are based on the implied volatilities of the two legs, and the correlation between them. Generally the implied correlation in the option market is very close to the realized correlation for the same horizon. The chart leads to two (again not counterintuitive) observations that the correlation between 2y and 30y rates is much lower and more variable than that between 5y and 10y rates. Currently the 2y/30y correlation has locally peaked towards the high of the historical range.

Finally, here is the estimated history of the 30y-2y and 10y-5y implied curve volatilities, using implied volatilities on the vanilla swaptions (1y2y, 1y5y etc) and the historical realized correlation. The ratio of implied volatilities has been remarkably stable for the past two years as vol has subsided.

David Sansom

image001.jpg@01D21F13.B69A4950">

UK: 14-16 Dowgate Hill, London EC4R 2SU

US: 245 Park Ave, 39^th Floor, NY, NY, 10167

Office: +44 (0) 203 143 4180

Mobile: +44 (0) 7976 204490

Astor Ridge LLP is regulated by the Financial Conduct Authority (FCA): Registration Number 579287

Astor Ridge LLP is Registered in England and Wales with Companies House: Registration Number OC372185

Astor Ridge NA LLP is a member of FINRA/SIPC: CRD Number 282626

Astor Ridge NA LLP is Registered in England and Wales with Companies House: Registration Number OC401796