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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Trade: EUR flattener via CMS collars on 5y-10y

Bottom line: My previous piece on EUR 5-10-30 went through the reasons that I like EUR flatteners, this trade is another expression. The high skew on curve caps compared to floors offers an interesting risk/reward on a zero-cost structure.

Trade:

Buy EUR 1bn 1y floor on CMS 10-5 k=33bp

Sell EUR 1bn 1y Cap on CMS 10-5 k=80bp

for zero-cost (indicative mid)

equivalent to EUR 100k/bp of the 5y-10y curve.

Atmf at 52.4bp. Spot vanilla 5y-10y at 61bp.

Rationale: It won’t have escaped notice, but I like EUR flattening exposure, for all the reasons I have gone into previously. This collar structure is a more leveraged way to position for a flattening. The cap is struck 27.6bp OTM, while the floor that you are long is only 19.4bp OTM, due to the high skew on otm caps compared to floors (implied vol: 23.8 bp/y on the cap vs 18.6 on the floor). The curve will probably not steepen enough to reach the lower boundary, however the value of the structure will increase if the curve flattens.

The risk is that the curve steepens through 80bp at expiry. This would be a significant reversal in the current dynamic and require a move back to Jul-14 levels. One scenario could be a large sell-off in the US while Europe stagnates (and hence short rates do not join in the sell-off).

Love to hear your thoughts,

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

Trade: A tactical proposal to re-enter EUR flatteners ahead of Thursday's ECB

Summary: I’m making a highly tactical case to be in flattening positions over this week’s ECB meeting. For the past two meetings the market has taken a bearish read of ECB statements, triggering moves higher in short rates. Recent comments from the more hawkish Governing Council members have done nothing to suggest this view is misplaced. I have a long-term flattening view, so this may be the best opportunity to reset that after the re-steepening of early Feb.

Trade:
Pay EUR 1bn 3y1y
Recv EUR 123mm 10y10y

EUR 100k/bp equivalent.

Enter at 124bp. Near-term target 114bp. Stop 127bp. Rolldown of -3.5bp over one month.

Rationale: My underlying view is that the EUR curve should bear-flatten as the ECB moves towards an exit from QE (or at least new purchases) and the eventual raising of rates. The chart shows the long history of the 3y1y/10y10y spread (orange) together with the ECB target rate. Back in 2005, the curve flattened in anticipation of rising rates, and continued to flatten as the first hikes took place. The difference in tenors between 3y1y and 10y10y has been chosen deliberately to highlight the move: short rates react much more rapidly to central bank action while long-term rate expectations are slower to respond.

In recent months (again perhaps unsurprisingly) ECB meetings and minutes releases have coincided with bearish moves in rate expectations. Even though at first read the statement and minutes have not been particularly hawkish, the market has taken them as a green light to re-assess the future path of rates.

This table shows the change in rates between the day before and the day after recent ECB events. The biggest movers have, on average, been the 3y1y moving higher while 10y10y and 10y20y moved lower. Even on the release of the Jan minutes in February, where the market took a bullish tone, the 3y1y rate rallied less than the 10y10y rate and the curve still flattened.

		Spot				Fwds
Event		2y	5y	10y	30y	1y2y	1y5y	1y10y	1y30y	2y2y	2y5y	2y10y	2y30y	1y1y	2y1y	3y1y	4y1y	2y3y	5y5y	10y10y	10y20y

14-Dec-17	Meeting	2.8	0.4	-2.0	-4.7	0.6	-0.8	-2.4	-5.2	0.2	-1.3	-3.0	-5.5	0.2	1.2	-0.4	-0.3	-0.2	-3.5	-6.1	-6.9
11-Jan-18	Minutes	1.9	6.4	4.1	0.7	6.8	6.4	3.5	-0.4	8.2	6.6	2.9	-0.6	3.9	10.1	9.3	8.2	8.0	4.4	-2.6	-2.9
25-Jan-18	Meeting	2.4	6.9	3.1	-4.4	4.9	7.6	2.1	-4.7	9.3	8.0	1.3	-5.2	2.2	7.3	13.5	10.7	9.8	0.6	-9.6	-9.2
22-Feb-18	Minutes	0.1	-4.3	-4.1	-6.0	-1.9	-3.9	-4.9	-4.5	-3.6	-5.0	-5.4	-4.6	-0.3	-3.5	-3.2	-7.5	-4.3	-8.0	-4.4	-4.5

	Average	1.8	2.4	0.3	-3.6	2.6	2.3	-0.4	-3.7	3.5	2.1	-1.0	-4.0	1.5	3.8	4.8	2.8	3.3	-1.7	-5.7	-5.9

Focusing on the 3y1y/10y10y spread:

	3y1y / 10y10y
14-Dec-17	-5.7
11-Jan-18	-12.0
25-Jan-18	-23.2
22-Feb-18	-1.3

The simplest way to position for a repeat of this move would be to pay the 3y1y vanilla rate and receive 10y10y.

Too speculative? All feedback welcome!

Best

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

PSPP2 data for Germany suggests a significant lengthening of purchases in February

I’ve put today’s PSPP2 data for Germany through my Maximum Likelihood Model, and here are the main conclusions:
- A significant increase in the WAM of Germany buying in February, up from 6.3y to 9.1y;

- A larger than usual buying of Lander paper (up to an estimated 2.2 bn vs 1.3bn previously);

- Thus the percentage on non-Bund purchases was 48% (from 34% in Jan);

- I estimate an extra 0.96bn of buying from redemption flows in Feb (in Bunds and KFW);

- The largest buying came in the Aug-26, Feb-27 and Aug-27;

- More buying of Bunds in 10y and 30y sectors;

- The new Bobl Apr-23 which was issued in February was bought (it appeared in the repo list) though my model only suggests 20mm of buying.

The model’s results in detail:

The estimate for the WAM for purchases in January for the various categories of paper are as follows:

Category	Notional	WAM
German Govt	3.0	9.3
KFW	0.6	9.4
Lander	2.2	8.7
All Purchases	5.8	9.1

The per-issue charts for monthly purchases, and available notional left to purchase:

Given the model’s estimates for purchasing, here is how I see the redemption flows in Bunds currently. Numbers for Mar-19 onwards will continue to rise as more purchases are made.

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	2	189	78	269
Oct-17	7	279	0	286
Nov-17	0	231	123	354
Dec-17	0	0	0	0
Jan-18	82	185	0	267
Feb-18	653	311	0	964
Mar-18	708	0	144	852
Apr-18	6832	0	78	6910
May-18	0	0	106	106
Jun-18	1593	2970	342	4905
Jul-18	3457	1650	581	5688
Aug-18	0	0	85	85
Sep-18	2088	0	473	2561
Oct-18	4108	1650	668	6426
Nov-18	0	0	867	867
Dec-18	2540	1650	324	4514
Jan-19	6840	1980	892	9712
Feb-19	5210	0	629	5839
Mar-19	1948	3300	302	5550
Apr-19	5260	274	753	6287
May-19	0	0	558	558
Jun-19	1281	0	487	1768
Jul-19	7324	495	96	7915
Aug-19	0	660	332	992
Sep-19	695	0	623	1318
Oct-19	5280	1650	1863	8793
Nov-19	0	0	349	349
Dec-19	101	0	493	594
Jan-20	6920	3300	1568	11789
Feb-20	0	7	592	599
Mar-20	0	0	1285	1285
Apr-20	11577	0	98	11675
May-20	0	0	330	330
Jun-20	0	1650	535	2185
Jul-20	7176	0	1497	8673
Aug-20	0	0	471	471
Sep-20	5252	0	696	5948
Oct-20	5165	495	520	6180
Nov-20	0	0	1063	1063
Dec-20	0	0	741	741
Jan-21	6270	3630	928	10828

Or, in chart form:

Finally, here are the per-issue estimates for Bunds:

Bond	Opened	O/S (bn)	Purchasable	Market Yield	Purchased	% Purchased	Remaining	Margin of Error	MV Remaining	Feb-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	+/- 72%	0.0	0.0
OBL 0.5% 13-Oct-17	Sep-12	0.0	0.0		0.0		0.0	+/- 31%	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		0.1		0.0	+/- 8%	0.0	0.0
OBL 0.5% 23-Feb-18	Jan-13	0.0	0.0		0.7		0.0	+/- 3%	0.0	0.0
BKO 0% 16-Mar-18	Feb-16	13.0	0.0	-0.750	0.7		0.0	+/- 5%	0.0	0.0
OBL 0.25% 13-Apr-18	May-13	17.0	0.0	-0.837	2.1		0.0	+/- 2%	0.0	0.0
OBLI 0.75% 15-Apr-18	Apr-11	15.0	0.0		4.7		0.0	+/- 1%	0.0	0.0
BKO 0% 15-Jun-18	May-16	14.0	0.0	-0.707	1.6		0.0	+/- 3%	0.0	0.0
DBR 4.25% 04-Jul-18	May-08	21.0	0.0	-0.710	3.5		0.0	+/- 1%	0.0	0.0
BKO 0% 14-Sep-18	Aug-16	13.0	0.0	-0.683	2.1		0.0	+/- 2%	0.0	0.0
OBL 1% 12-Oct-18	Sep-13	17.0	0.0	-0.687	4.1		0.0	+/- 2%	0.0	0.0
BKO 0% 14-Dec-18	Nov-16	13.0	0.0	-0.682	2.5		0.0	+/- 2%	0.0	0.0
DBR 3.75% 04-Jan-19	Nov-08	24.0	0.0	-0.717	6.8		0.0	+/- 1%	0.0	0.0
OBL 1% 22-Feb-19	Jan-14	16.0	0.0	-0.696	5.2		0.0	+/- 1%	0.0	0.1
BKO 0% 15-Mar-19	Mar-17	13.0	4.3	-0.673	1.9	45%	2.3	+/- 2%	2.4	0.1
OBL 0.5% 12-Apr-19	May-14	16.0	5.3	-0.671	5.3	100%	0.0	+/- 1%	0.0	0.0
BKO 0% 14-Jun-19	May-17	13.0	4.3	-0.652	1.3	30%	3.0	+/- 2%	3.0	0.1
DBR 3.5% 04-Jul-19	May-09	24.0	7.9	-0.665	7.3	92%	0.6	+/- 1%	0.6	0.1
BKO 0% 13-Sep-19	Aug-17	13.0	4.3	-0.652	0.7	16%	3.6	+/- 3%	3.6	0.1
OBL 0.25% 11-Oct-19	Sep-14	16.0	5.3	-0.626	5.3	100%	0.0	+/- 0%	0.0	0.0
BKO 0% 13-Dec-19	Nov-17	13.0	4.3	-0.623	0.1	2%	4.2	+/- 14%	4.2	0.1
DBR 3.25% 04-Jan-20	Nov-09	22.0	7.3	-0.622	6.9	95%	0.3	+/- 1%	0.4	0.1
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	-0.546	6.3	95%	0.3	+/- 1%	0.3	0.1
DBR 3% 04-Jul-20	Apr-10	22.0	7.3	-0.533	7.2	99%	0.1	+/- 1%	0.1	0.1
DBR 2.25% 04-Sep-20	Aug-10	16.0	5.3	-0.503	5.3	99%	0.0	+/- 1%	0.0	0.0
OBL 0.25% 16-Oct-20	Jul-15	19.0	6.3	-0.474	5.2	82%	1.1	+/- 1%	1.1	0.1
DBR 2.5% 04-Jan-21	Nov-10	19.0	6.3	-0.444	6.3	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 09-Apr-21	Feb-16	21.0	6.9	-0.393	4.7	68%	2.2	+/- 1%	2.2	0.1
DBR 3.25% 04-Jul-21	Apr-11	19.0	6.3	-0.355	6.3	100%	0.0	+/- 0%	0.0	0.0
DBR 2.25% 04-Sep-21	Aug-11	16.0	5.3	-0.316	5.3	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 08-Oct-21	Jul-16	19.0	6.3	-0.298	3.9	63%	2.3	+/- 1%	2.4	0.1
DBR 2% 04-Jan-22	Nov-11	20.0	6.6	-0.256	6.6	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 08-Apr-22	Feb-17	18.0	5.9	-0.206	2.2	37%	3.8	+/- 2%	3.8	0.1
DBR 1.75% 04-Jul-22	Apr-12	24.0	7.9	-0.190	7.9	100%	0.0	+/- 0%	0.0	0.0
DBR 1.5% 04-Sep-22	Sep-12	18.0	5.9	-0.143	5.9	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 07-Oct-22	Jul-17	17.0	5.6	-0.115	0.9	16%	4.7	+/- 2%	4.7	0.1
DBR 1.5% 15-Feb-23	Jan-13	18.0	5.9	-0.053	5.9	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 14-Apr-23	Feb-18	4.0	1.3	-0.002	0.0	2%	1.3	+/- 27%	1.3	0.0
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	-0.004	5.9	100%	0.0	+/- 0%	0.0	0.0
DBR 2% 15-Aug-23	Sep-13	18.0	5.9	0.047	5.9	100%	0.0	+/- 0%	0.0	0.0
DBR 6.25% 04-Jan-24	Jan-94	10.3	3.4	0.096	3.4	100%	0.0	+/- 0%	0.0	0.0
DBR 1.75% 15-Feb-24	Jan-14	18.0	5.9	0.126	5.9	100%	0.0	+/- 0%	0.0	0.0
DBR 1.5% 15-May-24	May-14	18.0	5.9	0.162	5.9	100%	0.0	+/- 0%	0.0	0.0
DBR 1% 15-Aug-24	Sep-14	18.0	5.9	0.199	5.9	100%	0.0	+/- 0%	0.0	0.0
DBR 0.5% 15-Feb-25	Jan-15	23.0	7.6	0.262	7.6	100%	0.0	+/- 0%	0.0	0.0
DBR 1% 15-Aug-25	Jul-15	23.0	7.6	0.314	7.6	100%	0.0	+/- 0%	0.0	0.0
DBR 0.5% 15-Feb-26	Jan-16	26.0	8.6	0.386	8.6	100%	0.0	+/- 0%	0.0	0.0
DBRI 0.1% 15-Apr-26	Mar-15	13.0	4.3		3.5	82%	0.8	+/- 2%	0.9	0.1
DBR 0% 15-Aug-26	Jul-16	25.0	8.3	0.451	7.0	84%	1.3	+/- 1%	1.2	0.2
DBR 0.25% 15-Feb-27	Jan-17	26.0	8.6	0.508	3.0	35%	5.6	+/- 2%	5.5	0.3
DBR 6.5% 04-Jul-27	Jul-97	11.2	3.7	0.512	3.7	100%	0.0	+/- 0%	0.0	0.0
DBR 0.5% 15-Aug-27	Jul-17	25.0	8.3	0.568	0.9	11%	7.3	+/- 2%	7.3	0.2
DBR 5.625% 04-Jan-28	Jan-98	14.5	4.8	0.569	4.8	100%	0.0	+/- 0%	0.0	0.0
DBR 0.5% 15-Feb-28	Jan-18	11.0	3.6	0.623	0.0	1%	3.6	+/- 20%	3.6	0.0
DBR 4.75% 04-Jul-28	Oct-98	11.3	3.7	0.607	3.7	100%	0.0	+/- 0%	0.0	0.0
DBR 6.25% 04-Jan-30	Jan-00	9.3	3.1	0.700	3.0	99%	0.0	+/- 1%	0.0	0.0
DBRI 0.5% 15-Apr-30	Apr-14	9.5	3.1		3.1	99%	0.0	+/- 1%	0.0	0.1
DBR 5.5% 04-Jan-31	Oct-00	17.0	5.6	0.774	5.6	100%	0.0	+/- 0%	0.0	0.0
DBR 4.75% 04-Jul-34	Jan-03	20.0	6.6	0.942	6.6	100%	0.0	+/- 0%	0.0	0.0
DBR 4% 04-Jan-37	Jan-05	23.0	7.6	1.028	7.6	100%	0.0	+/- 0%	0.0	0.0
DBR 4.25% 04-Jul-39	Jan-07	14.0	4.6	1.093	4.6	100%	0.0	+/- 0%	0.0	0.1
DBR 4.75% 04-Jul-40	Jul-08	16.0	5.3	1.109	5.1	96%	0.2	+/- 1%	0.4	0.1
DBR 3.25% 04-Jul-42	Jul-10	15.0	5.0	1.175	5.0	100%	0.0	+/- 0%	0.0	0.0
DBR 2.5% 04-Jul-44	Apr-12	23.5	7.8	1.225	6.5	84%	1.2	+/- 1%	1.6	0.1
DBRI 0.1% 15-Apr-46	Jun-15	7.0	2.3		1.3	57%	1.0	+/- 2%	1.2	0.1
DBR 2.5% 15-Aug-46	Feb-14	23.0	7.6	1.242	5.5	73%	2.1	+/- 1%	2.7	0.2
DBR 1.25% 15-Aug-48	Sep-17	5.5	1.8	1.280	0.2	10%	1.6	+/- 6%	1.6	0.1

Italic = index-linked								Total	56.2	3.0
Yield below Depo Floor
Yield above Depo Floor									Bund WAM	9.3

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

UK to play catch-up to the US? Trades on USD vs GBP 2y-10y curve box

Bottom line: The US curve (however it is viewed) is at, or close to its flattest for the last 20 years, as the Fed hikes rates. At the same time, though the GBP curve has flattened somewhat it is still significantly steeper than before the financial crisis of 2008, despite the market pricing hikes from the MPC. Thus in isolation we would independently favour a steepener in the US and a flattener in the UK. Given the relatively high realized correlation between the US and UK on certain curve sectors, there is a good case to be made for looking at the box trade.

Trade(s):

In vanilla swaps:

Recv USD 525mm 1y2y
Pay USD 116mm 1y10y
Pay GBP 365mm 1y2y

Recv GBP 77mm 1y10y

Equivalent to USD 100k/bp on the box

Enter at -25.5bp. Target flat (0bp). Stop at -32bp. Rolldown over first 3m: -0.8bp.

In CMS spread caps:

Buy USD 1bn 1y expiry CMS 10y-2y cap atmf + 5bp (k=25.1bp)
Sell GBP 718mm 1y expiry CMS 10y-2y cap atmf + 10bp (k=54.8bp)

For zero cost (indicative mid)

Forward entry at -29.7bp.

The chart:

Rationale: The market is pricing two to three more hikes from the FOMC over the next 12 months. Over the same period, the MPC is forecast to hike once or maybe twice. For the ECB, the EONIA market is not even pricing one hike.

This chart shows the CPI history of the US and UK. The reflation in the UK since 2015 is matching, if not outpacing the US, and on this metric the MPC looks to be a little late to the hiking party. Of course, the elephant in the room is BREXIT with all its associated uncertainties: a ill-controlled departure from the EU could weaken Sterling and import further inflation while the apparent contraction in the labour force (from falling numbers of EU nationals) could continue to push wages higher. Or not, if some accommodation is thrashed out with the EU 27. That is not to say the US does not have inflationary pressures of its own, from rising wages to possible increased infrastructure (and other) spending.

The next chart shows the differential between US and UK refi rates, overlaid with the history of the US-GBP 2y-10y, 1y forward curve box. The policy rate spread, at 100bp is the highest for the last 20 years. Beneath this is the spread between the Eurodollar and Short Sterling strips, which shows the rate differential forecast to increase to 150bp by Q2 19 before starting to narrow gradually. Effectively the market is pricing that the Fed will be pretty done a year to 18 months from now, while the BoE will still be on a hiking path (albeit a shallow one). The empirical history of the curve box from the 2004 – 2006 period saw the US curve flattening faster than the GBP in the early stages of the hiking cycle, before the box sharply changed direction in early ’06 as the MPC vacillated between cutting and hiking. It was at this point that the UK curve started flattening in earnest. Even though the short rate differential between the Fed and BoE was still widening, the box level rose.

Taking each country in turn, this chart shows the US side of things: the Fed target rate vs USD 2y-10y, 1y fwd. The ’04-’06 period in the US saw the curve flattening classically as the belly of the curve could not keep pace with rising short rates. This process continued until roughly halfway through the hiking cycle, which is arguably where we are in the current cycle with another 4 or so hikes to come as priced by the market. Having flattened to its lows in the 10bp area, the curve held within a choppy range for the next 18 months. Thus the argument for the present day is that, given the forward curve is back to the previous cycle lows and the hiking cycle has matured, the next move from the US curve will be sideways, if not steeper. This is before an increasing US bond term premium is factored in.

The corresponding chart for the UK shows a curve that has yet to embrace the prospect of a tightening rate cycle. The GBP 2y-10y, 1y forward curve is close to its local lows since 2008 (though has steepened back a shade in the past month), but well above the flat/inverted levels observed before the financial crisis. It is fair to note that the term premium in the UK should be higher now given the fog of BREXIT, but we have yet to see the degree of flattening associated with the MPC’s previous hiking period in ’04 to ’07.

Why have I focused on 2y-10y and not other curve segments? The next chart shows three candidate box trades (2-10y, 5y-30y and 10y-30y). All three are very low levels historically. However at around 23bp inverted (on the spot 2y-10y), this sector looks the most stretched compared to the previous range.

There is another reason to prefer 2y-10y for the box. This chart shows the rolling realized 6m correlation between various USD and GBP curve sectors. While 5y-30y and 10y-30y correlations have remained in the 20-year range, the 2y-10y curves have become more correlated since 2011. Correlation is key on cross-market trades, otherwise the box is simply two orthogonal curve trades.

This correlation is visible in the recent history of the US/GBP 2y-10y, 1y forward curves.

An alternative way to vanilla swaps is to use CMS spread options. Re-visiting the recent history of the 2y-10y, 1y forward curves, the box has been directional in terms of curve as the US leg has been more volatile than the GBP side: heading lower as curves flattened. Thus it is interesting to look at the expression via CMS spread caps, buying a USD cap and selling the GBP. If the US curve continues to flatten, with the GBP curve following, then both options expire out of the money. On a steepening move, empirically we might expect the US curve to steepen more than the GBP and so the USD cap would prove to be more valuable than the GBP one.

The other reason to express the trade via caps rather than floors is that GBP curve implied volatility is higher than in USD, which is the opposite of relative realized volatilities (see table). The 1y expiry offers the greatest implied volatility pick-up in bp/y.

	2y-10y implied volatility				Realized Vol
	3m	6m	1y	2y	3m
USD	39	38	37	35	36
GBP	41	41	40	37	33
Ratio USD/GBP	0.95	0.93	0.93	0.95	1.08

This differential allows us to improve the entry level on the box versus the vanilla swap structure. As usual, I like to have the option that I am short slightly out-of-the-money compared to the atmf, so this structure is approximately zero cost (mid):

Buy USD 1bn 1y expiry CMS 10y-2y cap atmf + 5bp (k=25.1bp)
Sell GBP 718mm 1y expiry CMS 10y-2y cap atmf + 10bp (k=54.8bp)

Thus the forward entry is at -29.7bp (indicative), beating the vanilla trade by 4bp.

I look forward to any and all comments you might have!

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

How are we doing? Shadow portfolio update

Portfolio since 1^st Feb: USD +256k, Ytd +158k

Summary: It’s been an interesting fortnight since the last update, with an impressive equity sell-off and significant swings on bond yields. The portfolio has benefited from the long-awaited steepening of the US curve, as the market wakes up to the prospects of higher deficits, higher inflation and a possible Fed response. This is the effect that I played for right at the start of the Trump presidency, but which failed to materialize (to the detriment of my 2017 P&L) until last week. However the steepening has not been whole-hearted, so it is a little early to see it as a trend for a wholesale repricing of term premia. The moving-average indicators support holding the US 2y-10y, 1y fwd trade for now, however it might be worth considering using some of the positive P&L to pay the premium for conditional curve trades.

Elsewhere, the EUR forward curve is still a conundrum. My bull-steepening exposure is making some money from the steepening part and roll-down, though clearly this is unlikely to be held to expiry. Over the longer term, my macro view is for bear-flattening as the ECB moves towards ending new PSPP2 purchases and then rate hikes (in 2019?), but that dynamic is the opposite of what is happening now. The chart is EUR 2y3y vs 5y5y, which has steepened as the belly has underperformed in the sell-off.

Looking back (a long way) to the last ECB hiking cycle (circled in the chart) we should expect 2y3y/5y5y to flatten … though even in that cycle the curve was somewhat schizophrenic in the 12 months leading up to the first actual hike. The steepening of 2y3y/5y5y at the start of 2005 (1^st hike in November later that year) is reminiscent of what we are seeing now. So the bottom line is that eventually the bear-flattener will be the right trade, but there’s no rush as the entry level is improving almost daily. Another one for the momentum indicators, but if the spread reaches 100bp (currently 95) it will be hard to ignore.

On other trades, the RX/UB box is be-calmed and slightly offside. I’d look to add if the box touches -4bp again. The GBP/USD 5y5y xccy basis remains elevated and has spent longer in positive territory than on previous spikes. The 5y-10y spot curve is steepening, as the 5y basis falls faster than the 10y. It’s a hold for now, but may be a slow burn to profitability.

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	OPEN	-5.1 bp		-64
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	OPEN	2.9 bp		-104
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	OPEN	0.1 bp		3
*EUR 2y2y/5y10y Bull-Steepener*	30-Jan-18	0 bp	EUR 25 k/bp	OPEN	2 bp		62
*USD 2y-10y, 1y fwd steepener*	02-Feb-18	22 bp	USD 25 k/bp	OPEN	31.1 bp		226
						Total YTD	158

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

PSPP2 buying of Germany in Jan-18. Buying rates outside of "high redemption" months should have diminishing impact?

The PSPP2 data for January was out yesterday, and here are the results of my Maximum Likelihood model that estimates how the purchases have been made

- The estimated monthly WAM of purchases of Bunds in January under the reduced purchasing rate is 6.5 years, compared to 5.9 years in December.

- As in previous months, buying in the 10y sector has been limited to the on-the-run issues

- The model suggests that there still has not been any significant buying of the on-the-run 30y

- The percentage of non-Bund purchases in January was 34%, similar to December (30%)

- Redemption reinvestment flows are estimated at EUR 480mm in January

- The largest estimated single purchase was 203mm of the Aug-26, or just 10mm per day. Compare this to the volume of say 500k RX contracts daily, which is 5bn. As purchases in 10y and 30y concentrate more in the on-the-run, liquid issues it suggests PSPP2 will have a diminishing impact there. At the same time, “high redemption” months should see a greater relative impact from Buba buying: eg April when over twice the amount of German paper will need to be bought compared to March, IF all the redeemed principals are invested promptly.

The model’s results in detail:

The estimate for the WAM for purchases in January for the various categories of paper are as follows:

Category	Notional	WAM
German Govt	3.4	6.6
KFW	0.4	7.5
Lander	1.3	5.3
All Purchases	5.0	6.3

The per-issue charts for monthly purchases, and available notional left to purchase:

Given the model’s estimates for purchasing, here is how I see the redemption flows in Bunds currently. Numbers for Feb-19 onwards will continue to rise as more purchases are made.

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	142	88	0	230
Aug-17	0	0	0	0
Sep-17	2	273	124	399
Oct-17	155	369	0	523
Nov-17	0	296	167	462
Dec-17	0	0	0	0
Jan-18	272	209	0	480
Feb-18	1269	588	0	1857
Mar-18	700	0	136	836
Apr-18	6592	0	71	6662
May-18	0	0	108	108
Jun-18	1572	2970	340	4882
Jul-18	3346	1650	592	5588
Aug-18	0	0	90	90
Sep-18	2087	0	478	2566
Oct-18	4000	1650	665	6315
Nov-18	0	0	881	881
Dec-18	2534	1650	326	4510
Jan-19	6727	1980	913	9621
Feb-19	5062	0	630	5693
Mar-19	1909	3300	300	5509
Apr-19	5170	273	751	6194
May-19	0	0	556	556
Jun-19	1237	0	496	1733
Jul-19	7127	495	96	7719
Aug-19	0	660	330	990
Sep-19	644	0	608	1252
Oct-19	5278	1650	1861	8790
Nov-19	0	0	341	341
Dec-19	38	0	493	530
Jan-20	6726	3300	1562	11588
Feb-20	0	0	592	592
Mar-20	0	0	1284	1284
Apr-20	11388	0	79	11467
May-20	0	0	330	330
Jun-20	0	1650	528	2178
Jul-20	6994	0	1460	8454
Aug-20	0	0	470	470
Sep-20	5158	0	687	5845
Oct-20	5056	495	499	6050
Nov-20	0	0	1062	1062
Dec-20	0	0	741	741
Jan-21	6270	3630	910	10810

Or, in chart form:

Finally, here are the per-issue estimates for Bunds:

Bond	Opened	O/S (bn)	Purchasable	Market Yield	Purchased	% Purchased	Remaining	Margin of Error	MV Remaining	Jan-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		0.1		0.0	+/- 7%	0.0	0.0
BKO 0% 15-Sep-17	Aug-15	0.0	0.0		0.0		0.0	+/- 58%	0.0	0.0
OBL 0.5% 13-Oct-17	Sep-12	0.0	0.0		0.2		0.0	+/- 8%	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		0.3		0.0	+/- 5%	0.0	0.0
OBL 0.5% 23-Feb-18	Jan-13	17.0	0.0	-0.556	1.3		0.0	+/- 2%	0.0	0.0
BKO 0% 16-Mar-18	Feb-16	13.0	0.0	-0.567	0.7		0.0	+/- 4%	0.0	0.0
OBL 0.25% 13-Apr-18	May-13	17.0	0.0	-0.652	2.0		0.0	+/- 2%	0.0	0.0
OBLI 0.75% 15-Apr-18	Apr-11	15.0	0.0		4.6		0.0	+/- 1%	0.0	0.0
BKO 0% 15-Jun-18	May-16	14.0	0.0	-0.658	1.6		0.0	+/- 3%	0.0	0.0
DBR 4.25% 04-Jul-18	May-08	21.0	0.0	-0.683	3.3		0.0	+/- 1%	0.0	0.0
BKO 0% 14-Sep-18	Aug-16	13.0	0.0	-0.653	2.1		0.0	+/- 2%	0.0	0.0
OBL 1% 12-Oct-18	Sep-13	17.0	0.0	-0.695	4.0		0.0	+/- 1%	0.0	0.0
BKO 0% 14-Dec-18	Nov-16	13.0	0.0	-0.662	2.5		0.0	+/- 2%	0.0	0.0
DBR 3.75% 04-Jan-19	Nov-08	24.0	0.0	-0.719	6.7		0.0	+/- 1%	0.0	0.0
OBL 1% 22-Feb-19	Jan-14	16.0	5.3	-0.700	5.1	96%	0.2	+/- 1%	0.2	0.2
BKO 0% 15-Mar-19	Mar-17	13.0	4.3	-0.694	1.9	44%	2.4	+/- 2%	2.4	0.1
OBL 0.5% 12-Apr-19	May-14	16.0	5.3	-0.697	5.2	98%	0.1	+/- 1%	0.1	0.1
BKO 0% 14-Jun-19	May-17	13.0	4.3	-0.667	1.2	29%	3.1	+/- 2%	3.1	0.1
DBR 3.5% 04-Jul-19	May-09	24.0	7.9	-0.673	7.1	90%	0.8	+/- 1%	0.9	0.2
BKO 0% 13-Sep-19	Aug-17	13.0	4.3	-0.620	0.6	15%	3.6	+/- 2%	3.7	0.1
OBL 0.25% 11-Oct-19	Sep-14	16.0	5.3	-0.615	5.3	100%	0.0	+/- 0%	0.0	0.0
BKO 0% 13-Dec-19	Nov-17	13.0	4.3	-0.584	0.0	1%	4.3	+/- 10%	4.3	0.0
DBR 3.25% 04-Jan-20	Nov-09	22.0	7.3	-0.595	6.7	93%	0.5	+/- 1%	0.6	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	-0.522	6.1	93%	0.5	+/- 1%	0.5	0.2
DBR 3% 04-Jul-20	Apr-10	22.0	7.3	-0.497	7.0	96%	0.3	+/- 1%	0.3	0.1
DBR 2.25% 04-Sep-20	Aug-10	16.0	5.3	-0.470	5.2	98%	0.1	+/- 1%	0.1	0.1
OBL 0.25% 16-Oct-20	Jul-15	19.0	6.3	-0.445	5.1	81%	1.2	+/- 1%	1.2	0.1
DBR 2.5% 04-Jan-21	Nov-10	19.0	6.3	-0.408	6.3	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 09-Apr-21	Feb-16	21.0	6.9	-0.350	4.6	66%	2.4	+/- 2%	2.4	0.2
DBR 3.25% 04-Jul-21	Apr-11	19.0	6.3	-0.308	6.3	100%	0.0	+/- 0%	0.0	0.0
DBR 2.25% 04-Sep-21	Aug-11	16.0	5.3	-0.263	5.3	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 08-Oct-21	Jul-16	19.0	6.3	-0.242	3.8	61%	2.5	+/- 1%	2.5	0.2
DBR 2% 04-Jan-22	Nov-11	20.0	6.6	-0.198	6.6	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 08-Apr-22	Feb-17	18.0	5.9	-0.148	2.1	35%	3.9	+/- 2%	3.9	0.1
DBR 1.75% 04-Jul-22	Apr-12	24.0	7.9	-0.127	7.9	100%	0.0	+/- 0%	0.0	0.0
DBR 1.5% 04-Sep-22	Sep-12	18.0	5.9	-0.091	5.9	100%	0.0	+/- 0%	0.0	0.0
OBL 0% 07-Oct-22	Jul-17	17.0	5.6	-0.053	0.8	14%	4.8	+/- 3%	4.8	0.1
DBR 1.5% 15-Feb-23	Jan-13	18.0	5.9	-0.004	5.9	100%	0.0	+/- 0%	0.0	0.0
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	0.045	5.9	100%	0.0	+/- 0%	0.0	0.0
DBR 2% 15-Aug-23	Sep-13	18.0	5.9	0.095	5.9	100%	0.0	+/- 0%	0.0	0.0
DBR 6.25% 04-Jan-24	Jan-94	10.3	3.4	0.145	3.4	100%	0.0	+/- 0%	0.0	0.0
DBR 1.75% 15-Feb-24	Jan-14	18.0	5.9	0.168	5.9	100%	0.0	+/- 0%	0.0	0.0
DBR 1.5% 15-May-24	May-14	18.0	5.9	0.207	5.9	100%	0.0	+/- 0%	0.0	0.0
DBR 1% 15-Aug-24	Sep-14	18.0	5.9	0.243	5.9	100%	0.0	+/- 0%	0.0	0.0
DBR 0.5% 15-Feb-25	Jan-15	23.0	7.6	0.320	7.6	100%	0.0	+/- 0%	0.0	0.0
DBR 1% 15-Aug-25	Jul-15	23.0	7.6	0.370	7.6	100%	0.0	+/- 0%	0.0	0.0
DBR 0.5% 15-Feb-26	Jan-16	26.0	8.6	0.440	8.6	100%	0.0	+/- 0%	0.0	0.0
DBRI 0.1% 15-Apr-26	Mar-15	12.0	4.0		3.5	88%	0.5	+/- 2%	0.5	0.1
DBR 0% 15-Aug-26	Jul-16	25.0	8.3	0.505	6.7	81%	1.6	+/- 1%	1.5	0.2
DBR 0.25% 15-Feb-27	Jan-17	26.0	8.6	0.566	2.7	31%	5.9	+/- 2%	5.7	0.2
DBR 6.5% 04-Jul-27	Jul-97	11.2	3.7	0.583	3.7	100%	0.0	+/- 0%	0.0	0.0
DBR 0.5% 15-Aug-27	Jul-17	25.0	8.3	0.627	0.7	8%	7.6	+/- 4%	7.5	0.2
DBR 5.625% 04-Jan-28	Jan-98	14.5	4.8	0.639	4.8	100%	0.0	+/- 0%	0.0	0.0
DBR 0.5% 15-Feb-28	Jan-18	5.0	1.7	0.681	0.0	0%	1.7		1.6	0.0
DBR 4.75% 04-Jul-28	Oct-98	11.3	3.7	0.686	3.7	100%	0.0	+/- 0%	0.0	0.0
DBR 6.25% 04-Jan-30	Jan-00	9.3	3.1	0.760	3.0	97%	0.1	+/- 1%	0.1	0.0
DBRI 0.5% 15-Apr-30	Apr-14	9.5	3.1		3.1	98%	0.1	+/- 2%	0.1	0.1
DBR 5.5% 04-Jan-31	Oct-00	17.0	5.6	0.832	5.6	100%	0.0	+/- 0%	0.0	0.0
DBR 4.75% 04-Jul-34	Jan-03	20.0	6.6	0.978	6.6	100%	0.0	+/- 0%	0.0	0.0
DBR 4% 04-Jan-37	Jan-05	23.0	7.6	1.062	7.6	100%	0.0	+/- 0%	0.0	0.0
DBR 4.25% 04-Jul-39	Jan-07	14.0	4.6	1.130	4.5	98%	0.1	+/- 1%	0.1	0.1
DBR 4.75% 04-Jul-40	Jul-08	16.0	5.3	1.147	5.0	94%	0.3	+/- 1%	0.6	0.1
DBR 3.25% 04-Jul-42	Jul-10	15.0	5.0	1.215	5.0	100%	0.0	+/- 0%	0.0	0.0
DBR 2.5% 04-Jul-44	Apr-12	22.0	7.3	1.270	6.5	90%	0.7	+/- 1%	0.9	0.1
DBRI 0.1% 15-Apr-46	Jun-15	7.0	2.3		1.3	55%	1.0	+/- 3%	1.2	0.0
DBR 2.5% 15-Aug-46	Feb-14	23.0	7.6	1.290	5.3	70%	2.2	+/- 1%	2.9	0.1
DBR 1.25% 15-Aug-48	Sep-17	5.5	1.8	1.341	0.1	5%	1.7	+/- 10%	1.7	0.0

Italic = index-linked								Total	55.6	3.4
Yield below Depo Floor
Yield above Depo Floor									Bund WAM	6.5

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

Email: .5 ye

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

"The time has come", the Walrus said ... to scale in to USD steepeners on 2y-10y, 1y fwd

Bottom line: In my view it is time to scale into USD steepening positions. There are myriad combinations (see my previous note at the bottom of this one), but I will focus on 2y-10y in swaps as it most closely fits the bear-steepening dynamic that I see evolving as inflation picks up and Treasury issuance increases. We have the quarterly refunding next week, which could be a significant indication of the ongoing demand for US Treasuries, so my suggestion is to scale into the trade now and keep some ammunition for any re-flattening after the auctions.

Many people will already have some US steepening exposure in their book, so in some senses I am late to the party. For any that don’t have the exposure, or are looking to increase it, then this simple version is a candidate. As always, I’d love to hear if you agree, disagree or prefer a different expression!

Trade:
Pay USD 2y-10y, 1y fwd swap curve

Entry at 23bp vs spot at 50 bp.

Target 50bp, Stop at 10bp.

USD 2y-10y, 1y fwd in swaps

Rationale: There have been several events of note since I wrote two weeks ago that it was too early for USD steepeners:

The State-of-the-Union address with the promise of a massive infrastructure programme;
The TBAC report and the increase in Treasury issuance;
A 20bp rise in 10y cash yields (from 19^th Jan);
A similar upward repricing of the market’s expectation of the terminal FF rate (proxy is H0 FF contract);

The spot USD 2y-10y curve in swaps has bear-steepened, as has the curve 1y forward. The 2y-10y, 2y fwd has yet to reflect the move in the shorter forwards.

Why 1y fwd? For the spot 2y-10y, the 100-day moving average has been breached. For the 1y fwd curve, the 50-day level has been crossed. For the 2y fwd curve, the current value has yet to break the 20-day moving average. The momentum on the spot curve is certainly supporting a further steepening, but entry levels are some 15bp above the flattest of the recent past. In contrast, the 2y fwd curve is pretty much at its lows and not far from the low of Feb-06. It is not highly scientific, but that points me to choose 2y-10y, 1y fwd: it is not the best level we have seen, but is showing momentum indicators that are pointing to steeper curves.

Best wishes,

David

As a recap, here’s what I sent out a fortnight ago, entitled: “So you want to put on a USD steepener? Still too early, as I see it.”

Writing as someone who spent most of 2017 looking for the US curve to steepen and was sorely disappointed, I am hesitant to revisit the topic. In retrospect, longer rates could not keep pace with the steady rise in short rates in response to Fed action. In this article, I’m proposing a checklist to assess the timing of various curve structures.

Executive Summary: There seems to be little to recommend steepeners yet on the USD curve. I’ve analysed a variety of common USD curve structures all of which dipped to their lows during the last Fed hiking cycle in 2004/2006. When I compare the levels today to that period, the vast majority of structures are still off those minima, and momentum indicators suggest they still have room to move lower. Most of the curves did not reach their lows until the hiking cycle was almost done: currently we are only halfway on this period of FOMC action. Added to that, the bulk also show a bear-flattening dynamic over the past 3 months (to a greater or lesser degree of statistical certainty) so given my bias is that US rates are heading higher in the short term it is hard to recommend steepeners yet. The rolldown is generally in your favour, but is not enough to compensate for the potential downside of early adoption. The possible exception is paying USD 2-5-10, 3m fwd, but that has already moved some way is rolldown negative.

In more detail:

To set the scene, here’s a chart of the Fed Target Rate and the USD 2y-10y spot slope in swaps. I’ve annotated the chart with the Fed’s and the market’s projection of where the Fed rate is headed over the next two years. The market’s pricing sees the Fed Funds rate as topping out around 2.30% by Q1 2020 ie around three more 25bp hikes from here. On that basis we are roughly half-way through the hiking cycle (if not a little further advanced). At the same stage in the 2004/2006 period, the curve still had further to flatten, though the low was reached first around three hikes before the end of that cycle.

What checklist can we use to determine whether curve relationships have moved far enough?

I’ll use the basis USD 2y-10y swap curve as an example.

1. Where and, equally importantly, when was the minimum in the 2004-2006 cycle? The FOMC first hiked rates in June 2004 and announced what turned out to be the final hike in June 2006. Historically, the USD 2y-10y curve first hit its flattest at around 0bp. This happened around March 2006, so roughly 21 months into a 24 month or 87% of the period. Currently 2y-10y in swaps is 39bp, and it’s reasonable to suggest we are 50% through the current cycle (which I am suggesting started with the Dec-16 hike). On this basis, the spot 2y-10y curve has further to flatten.

2. Is the momentum for flattening showing any signs of relenting? During 2017, the flattening on 2y-10y was remorseless, as the market first unwound the post-Trump steepening (10y rates falling while 2y rates stable) and then priced Fed action which had 2y selling off faster than 10y. The chart for the last 6 months and the moving averages are shown in the chart. I’m using 20-, 50- and 100-day moving averages.

In general, a steepening move would see changes to moving averages in the following time order:

The gap between the 20-day and 50-day moving averages reduces;
The 20-day moving average bottoms out and starts to increase;
The 20-day moving average crosses the 50-day.

As each condition is fulfilled the likelihood of a steepening increases. It’s a trading choice as to how aggressively to target the absolute low, rather than await further confirmation and miss the most extreme entry point. Inspection of the chart shows that the first condition is being satisfied (the moving 20- and 50-day averages are converging), and the second is also (just) being fulfilled. For an “early adopter” this might be sufficient to initiate a steepener, while others might wait for the two moving averages to cross.

3. Will the steepener make any money? Just because the curve has stopped flattening, it does not necessarily follow that the steepener will be a quick win. Back in 2006, the USD 2y-10y curve did bounce 25bp or so off its lows immediately after hitting the Mar-16 low (though it gave all those gains back over the next three months).

4. Is curve rolldown on your side, and is it significant? It is always preferable to have the rolldown on your side (even if the roll is not realized). The 3m fwd 2y-10y curve is 30bp compared to spot 2y-10y at 39bp, so a steepener set 3m fwd will have 9bp of apparent rolldown. To assess whether this roll is significant, we can look at the 3m realized volatility which is currently 2bp/day, or 16bp over a 3m horizon (assuming a normal distribution). As a quasi-Sharpe ratio this comes out at 56%. Whether this ratio is attractive is again a matter for the investor. Books could be written on whether rolldown actually materializes: the Fed hikes seem fairly baked-in, so the spot 2y rate could easily evolve to the 3m fwd market expectation, and the theoretical rolldown would not be captured.

5. What is the realized and anticipated directionality of the trade? The 10y rate has been lagging moves in short rates, and the curve has been bear-flattening. In the event of a large rally in long rates caused by global events, the curve could switch to bull-flattening; conversely increased Treasury supply expectations could drive a bear-steepening if 10y rates start to catch up. This is particularly relevant if you are looking to improve the risk/reward and entry level of the trade by using swaptions or mid-curves in a conditional structure.

Applying these metrics to a selection of US curve measures:

		1. History		2. Momentum	3. Upside	4. Rolldown			5. Directionality
Curve Trade	Current	Minimum ’04-‘06	%age of ’04-’06 cycle	Moving Averages	Move from low (04/06)	3m Rolldown	Realized Daily Vol	Rolldown Sharpe	Recent Mode	R² vs long rate (3m)
2y-5y, 3m fwd	20 bp	-3 bp	86%	üûû	12 bp	3 bp	2.0 bp	19%	Bear flatten	33%
2y-10y, 3m fwd	33 bp	-4 bp	86%	üûû	31 bp	8 bp	2.6 bp	38%	Bear flatten	20%
2y-30y, 3m fwd	41 bp	-6 bp	86%	üûû	42 bp	10 bp	2.8 bp	45%	Bear flatten	2%
5y-10y, 3m fwd	14 bp	-2 bp	86%	üûû	18 bp	2 bp	2.4 bp	10%	Bear flatten	26%
5y-30y, 3m fwd	23 bp	-2 bp	86%	üûû	33 bp	6 bp	2.8 bp	27%	Bear flatten	5%
10-30y, 3m fwd	8 bp	-1 bp	86%	ûûû	15 bp	3 bp	2.0 bp	19%	Bear flatten	14%
2y-10y, 1y fwd	21 bp	1 bp	86%	üûû	29 bp	3 bp	2.4 bp	16%	Bear flatten	36%
2y-10y, 2y fwd	16 bp	0 bp	86%	üûû	38 bp	1 bp	2.6 bp	5%	Bear flatten	43%
2y-10y, 5y fwd	10 bp	2 bp	86%	ûûû	13 bp	1 bp	2.0 bp	6%	Bear flatten	55%
2y3y v 5y5y	19 bp	-2 bp	86%	üûû	32 bp	0 bp	3.0 bp	0%	Bear flatten	33%
5y5y v 10y20y	-1 bp	0 bp	87%	ûûû	12 bp	1 bp	2.3 bp	5%	Bear flatten	76%
2y1y v 3y1y	5 bp	0 bp	62%	üûû	9 bp	1 bp	3.1 bp	4%	Bear flatten	14%
2-5-10, 3m fwd	3 bp	-10 bp	64%	üüü	8 bp	-4 bp	3.5 bp	-14%	Bear steepen	24%

Do you agree with this methodology? Would love to hear your thoughts!

Best wishes,

David

David Sansom

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UK: 60 Cannon Street, London, EC4N 6NP

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

Office: +44 (0) 207 002 1346

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

How are we doing? Shadow portfolio update

Portfolio P&L since 26th January: USD -151k, Ytd -98k

Summary: Once again, my portfolio has suffered from market moves around an ECB meeting. The sell-off worked well one of my EUR bear-flatteners, but not the other: the difference being that the winning trade was focused further out in forward space, while the losing one suffered from the relative lack of movement of rate closer into spot. I have closed out both: the winning trade (1y3y/5y5y) has had a great run from its initial inception at the start of November last year, but we’ve seen a pause in the flattening so I am booking the profit; while on the losing trade (1y1y/1y5y) I’ve had a rethink on the EUR curve dynamic and want to avoid the front of the curve now as the betas are changing. Elsewhere, the general rally has provoked a sharp move in the GBP short-end: 2y1y is up around 40bp from the start of the year: that wasn’t my call, and the exposure on the 1x2 1y1y1y mid-curve payer spread is just too great now (even though it has 9 months left to run) as the at-the-money has already reached the high strike.

In terms of open trades, the RX/UB box has tightened this week as the 10y sector led the sell-off, but it’s a longer-term view so I am holding it. The GBP/USD 5y5y xccy basis has returned to positive territory as the USD FX has weakened, and I’m slightly offside, but again the long-term chart is optimistic for a reversal. The GBP bull-steepener on 2y-10y is unchanged.

One new trade: a EUR 2y2y/5y10y bull-steepener to play for a relief rally after the bearish moves of the past week, and a reversal of the bear-flattening.

Looking ahead the USD curve is firmly on my radar. The USD 2-10, 1y fwd is equivocating: the price action has been range-bound in January, and the short-term 20-day moving average is trending higher. Intra-day the curve has breached the 50-day MVA. We have the US Treasury quarterly refunding next week, we should get some indications of where the curve is headed from here, and that may be the time to pull the trigger on steepeners.

Changes:
- Closed EUR 1y3y/5y5y mid-curve flattener for profit

- Closed GBP 1y1y1y MC payer spread for loss

- Closed EUR 9m1y1y/1y5y flattener for loss

- Opened EUR 2y2y/5y10 bull-steepener

Portfolio since 28^th December 2017

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	OPEN	-4.8 bp		-80
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	OPEN	2 bp		-57
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	OPEN	0.1 bp		3
*EUR 2y2y/5y10y Bull-Steepener*	30-Jan-18	0 bp	EUR 25 k/bp	OPEN	0 bp		0
						Total YTD	-98

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

How are we doing? Shadow Portfolio update

Portfolio P&L since 15th January: USD -149k, Ytd +53k

Summary: Quite a volatile past 48 hours for the portfolio, as the market took a strongly hawkish read of the ECB meeting. The curve resumed its bear-flattening, with the belly underperforming sharply. I stopped out of my EUR 2-5-10 after the meeting: the directional hedge proved inadequate to overcome the 5y-10y flattening. On a brighter note, the 1y3y/5y5y flattener (incepted last October) has had a great time. The other trades are still close to their opening levels, though the failure of the 1y1y/1y5y flattener to join the party is evidence that not all EUR flatteners are created equal.

The suddenness and strong directionality of the recent move on EUR 2-5-10 and 5-10-30 has put receiver flies on the radar: eg buy 1y10y receivers vs 1y5y and 1y30y, to play for a modest relief rally and subsequent retracement on the fly. I’ll be sending out a zero-cost structure on Monday, so watch this space.

Changes:
- Stopped out of the weighted EUR 2-5-10 fly for a loss

Portfolio since 28^th Dec 2017:

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	OPEN	-5.8 bp		-17
*EUR 1y3y/5y5y Mid-curve flattener*	28-Dec-17	13.7 bp	EUR 20 k/bp	OPEN	28 bp		356
*GBP 1y1y1y MC Payer spread*	28-Dec-17	0.7 bp	GBP 25 k/bp	OPEN	-0.5 bp		-43
*EUR 9m1y1y/9m1y5y Bear Flattener*	28-Dec-17	4.2 bp	EUR 25 k/bp	OPEN	2.4 bp		-56
*Receive GBP/USD 5y5y xccy basis*	28-Dec-17	1 bp	GBP 40 k/bp	OPEN	1.5 bp		-28
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	OPEN	-0.2 bp		-6
						Total YTD	53

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