Global Perspectives
A New Balance of Risks
Reducing liquidity and increasing regulation present
a new balance of risks for rates globally. Plans are
being made to remove liquidity and increase its cost.
This is causing unsynchronized moves in rates, with
the AXJ region using the blunt instrument of rate
hikes while the developed economies’ approach is
more tacit: first increase regulation and allow the
various support facilities to run off to tighten liquidity.
An opportunity to seize upon: If 2009 was about
adding liquidity accommodation, then 2010 is about
removing it, increasing its cost and adding regulation
to the mix. The liquidity-driven leg of the risky asset
rally is thus nearing an end. Rate markets can
become dislocated by cross-asset class hedgers
insuring against higher rates. High payor skews in
USD and yen rate vols are evidence of this.
Increased regulation: New international liquidity
standards for banks are coming. As a result, we
expect banks to continue buying government bonds
in the UK and Europe, and GSE paper in the US.
Volatility: The risk of higher rates has manifested in
a richening of the payer skews in the US, Europe
and the UK. We look for value in the skew in the
context of implied versus ‘realised’ skew in a sell-off.
EUR Sovereign Spreads: Into the end of 2009,
micro themes of supply and liquidity should drive
government bond spreads. Spreads are no longer a
one-way bet, and a tactical approach is required.
USTs: Positioning for a change in Fed language.
Carry-neutral trades that profit during hikes.
Inflation: We are tactically long US inflation
Breakevens versus EUR, especially in shorter
maturities where the market is implying US inflation
will remain below euro inflation for several years.
Mortgages: Fed purchase program has not
necessarily reduced convexity hedging needs.
Japan: Staying short, fiscal concerns and JGB
issuance uncertainty to extend into Novembe