Global Rates Weekly
Global Strategy
2 December 2016 | TD Securities | New York
No Rest For the Weary
Global Rates
Treasury-Bund Spread: At Historical Wides But Not Time to Fade Just Yet
New York
Priya Misra
[email protected]
1 212 827 7156
Gennadiy Goldberg
[email protected]
1 212 827 7180
Cheng Chen
[email protected]
1 212 827 7183
4
We don’t recommend buying Treasuries against Bunds just yet. Treasury rates have more
room to move higher as the Trump fiscal easing package gets priced in. Meanwhile, the
Italian referendum and the ECB meeting might keep Bunds relatively anchored.
US Rates
No Rest For the Weary
7
The 5s30s curve should steepen further. The Fed is already priced in and duration supply
is likely to pick up significantly in 2017. Pension demand occurs at higher funded status.
MBS Convexity Risk Resurfaces Again
9
With the sharp move higher in rates, convexity heading needs should emerge. We
estimate $10bn in 10yr equivalents for every 10bp higher in rates. This should exacerbate
the selloff. Swap spreads are affected more by deficit fears and may not widen, however.
GSEs: Political Risk Comes to the Forefront Again
14
Toronto
Andrew Kelvin
[email protected]
1 416 983 7184
Even as the Trump administration can seek to end conservatorship for the GSEs, we don’t
see how the implied government guarantee for debt and MBS can be removed.
Across the Curve
17
London
Renuka Fernandez
[email protected]
44 20 7786 8408
Tidying Up in the Front-end
18
Singapore
Prashant Newnaha
[email protected]
65 6500 8047
Canadian Rates
The broader move higher in rates has weighed on the front-end of the Canadian curve,
causing the 0-2 year segment to bear steepen. We continue to view front-end bonds as
cheap at these levels, but with more supply still to come and several top-tier risk events on
the horizon the front-end could remain heavy for another few weeks.
European Rates
Target Hit on GE 5s30s Steepener
20
We hit our target on the GE 5s30s steepener and take it off. We see less scope for a much
further steepening. While we continue to expect the ECB to taper in 2017, the sell-off has
brought time thereby further complicating the timing (or delaying) of an ECB taper.
Australia / New Zealand Rates
Why Aussie 10yr Bond Futures are Heavy
22
ACGBs have underperformed USTs despite a string of weak data. We analyse SFE 10yr
futures data and uncover that the market is caught long. We believe there is strong
resistance in the 10s around 97.32-37, reinforcing our call to sell fixed income on strength.
Market Views
Model Portfolio—Open Trades
Government Auction Calendar
Cross Currency Dashboard
Model Portfolio—Closed Trades
Forecasts
Recent Research
Global Strategy Team
2
3
23
24
25
30
31
32
Global Rates Weekly
2 December 2016 | TD Securities | New York
Market Views
X-Mkt
Australia & New Zealand
EU & UK
Canada
United States
Market
Direction
View
Trade
Front end
Higher Libor
The money fund reform date has passed, but we think wider
Libor-OIS is likely to persist.
Duration
Short
We expect fiscal easing, inflation risk and convexity hedging
to put upward pressure on rates.
Curve
Steepener
Fed hikes have been perfectly priced in, inflation risk is rising
5s30s steepener
and we expect significant duration supply. Risk of ECB taper.
TIPS
breakevens
Widener
BEs appear too low given underlying components of realized
Long 10yr and 5yr BEs;
inflation and likely fiscal easing in an economy that is close to
5s30s BE steepeners
full employment. Dollar strength is a risk.
Swap spreads
Front end
wideners
We think 5yr spreads could be biased wider due to convexity.
5s30s swap spread flattener
Tighter 30yr spreads due to prospect of greater UST supply.
Agencies/SSAs
Tighter vs
Treasuries
SSA spreads should tighten vs GSEs. Resurfacing of GSE
reform story could create additional spread volatility.
Long 4-5yr SSAs vs Treasuries. Swap
core 2yr EUR SSAs into USD
Front end
Long
Front-end is cheap, but we want to wait for December Fed
meeting before entering longs.
Own 6-month T-bills, May18/F18
Flatteners
Duration
Short
Markets have not fully adjusted to more US supply and higher
Long CAD 30s versus US
inflation. Treasuries will weigh on CGBs.
Curve
Steeper
Higher US rates will drive a steeper curve in Canada—
especially if domestic growth falls below 2%.
5s10s steepener
RRB
breakevens
Neutral
We will look more closely at RRBs following next week’s
$700m auction.
Neutral
Swap spreads
Flatter
Decline in 2-year spreads looks overdone.
Buy 2-year swap spreads versus 5-year
spreads
Front end
Flatter slopes
Tightening built into the EUR and UK curves is unwarranted.
Looking to enter into 1y1y-1y swap
Continue to expect 1 more cut from the BoE and for the ECB
flatteners in UK and EUR
to remain on hold through 2018.
Duration
Short Bunds
Short vs. Gilts. Bias to long Gilts via 10y swap spreads.
Curve
2s5s GE
flattener
Schatz yields too low—expect ECB to address the scarcity in
2s5s GE flattener
repo markets
Spreads
Flatter front end Wider 3y cross currency basis swaps in GBP on rise Brexit
x-ccy GBPUSD risks. Pay 1y to lock in carry
3s1s GBPUSD x-ccy flatteners
Front end
Mixed
Better receivers of RBA OIS and payers of RBNZ OIS
Rec RBA OIS, pay RBNZ OIS for mid next
year dates
Duration
Short
Not chasing duration. ACGBs underperforming USTs on sell
off, market caught long ACGBs.
Short >10yrs
Curve
Steeper
Curve appears stretched, but can remain so given ongoing
global inflation trade and potential for a RBA cut
ACGB 10/18 - 05/21 steepener
ACGB 03/19– 04/27 steepener
Swap spreads
Neutral
Largely a directional trade on the outright. 3s trading at the
bottom end of range.
Trading mid range at the moment, but see
scope for box to 3s10s box to steepen.
SSAs/Semis
Long
Semis running ahead on pro-rata issuance run-rate. AA
names attractive.
Maintain long WATC and QTC to bond
positions.
AU-NZ Spread
Neutral
Stuck in a 20-50 range. Risk upside is hit first.
Look at spread closer to 50bps to position
for contraction.
10yr UK-GE, UK
-US linker BE,
Tighten
30yr CA-UST,
10yr ACB-UST
Short Dec FRA-OIS, Long Mar FRA-OIS
Long 3m10y payer spreads
10y Gilt-Bund tighteners. 10y UK swap
spread tighteners
UK rates should rally on Brexit, while bunds can sell off on
Buy UK against GE, buy US BEs against
taper, TIPS should benefit from fiscal easing as UK linker BEs
UK, buy 30yr CA against UST, buy 10yr
are already high. CA rates to decline on economic weakness,
ACG against UST
while AU rates have already priced in additional supply.
2
Global Rates Weekly
2 December 2016 | TD Securities | New York
Model Portfolio—Open Trades
Entry
Level
Target
Stop
Current
P&L (k)
-80bp
-95bp
-72bp
-83bp
75
121bp
145bp
110bp
120.1bp
-195
$605k
$1mn
$450k
$672.5k
68
-57.3bp
-65bp
-52bp
-50.3bp
-330
149bp
170bp
140bp
188.7bp
993
25-May-16 161bp
16-Mar-16 150.5bp
180bp
130bp
192.3bp
1846
17-May-16
0
$2mn
-
-$1.11m
0
Sell $60.5mn 5yr BE, buy
$10mn 30yr BE
16-Mar-16
23.8bp
35bp
18bp
44.1bp
508
$130m 2y2y, $57m 5y5y
21-Nov-16
90bp
118bp
73bp
90.5bp
12
GE 2s5s Flattener
$25K DV01
01-Dec-16
33bp
19bp
38bp
33bp
0
10y BTP-Bund Tightener
$25K DV01
23-Nov-16
187bp
125bp
197bp
171bp
400
$25K DV01
23-Nov-16
7bp
0bp
10bp
5bp
50
$25k DV01
20-Oct-16
-4bp
12bp
-11bp
-5bp
-25
5-Oct-16
8bp
20bp
4bp
37.4bp
735
5-Oct-16
51bp
70bp
40bp
96bp
675
3-Jun-16
23.5
15
28
17
144
13-May-16
-12.5
-20
-8
12
-245
Open Trades
Notional
Entry
Date
Cross-Market
Long CAD 30yr vs US
$10m CAD 3.50% Canada Dec
2045s, $9.7m USD 3% UST 21-Nov-16
Nov 2045s
United States
5s30s Steepener
3m10y Payer Spread
5s30s Swap Spread Curve
Flattener
Long 5yr TIPS Breakevens
Long 10yr TIPS Breakevens
1yr 5s30s Bear Steepener
5s30s Breakeven Curve
Steepener
Buy $108mn 5s, Sell $26mn
21-Nov-16
30s
$50mn
21-Nov-16
$108mn in 5yr, $26mn in 30yr 21-Nov-16
Buy $107mn 5yr TIPS, sell
$52mn 5yr UST
Buy $26mn 10yr TIPS, sell
$28.4mn 10yr UST
Buy $25mn 10yr TIPS, sell
$27.5mn 10yr UST
Sell $208.7mn 1y5y 1.455%
payer, buy $43.3mn 1y30y
2.1725% payer.
Expiry is 5/17/17
30-Sep-16
Canada
Receive 2y2y, Pay 5y5y
Europe/UK
Rec 3y GBPUSD crosscurrency basis vs. pay 1y
GBPUSD cross-currency basis
Pay 10y UK swap Spreads
(Long UKT 1.5% 2026)
Australia/New Zealand
Long ACGB 10/18 and short
ACGB 05/21
Long ACGB 03/19 and short
ACGB 04/27
Buy A$124m ACGB 10/18 and
sell AU$52m ACGB 05/21
Buy A$59m ACGB 03/19 and
sell AU$14m ACGB 04/27
Buy AU$43mn IBRD 03/22
Long IBRD/QTC 22s
and sell US$39m QTC 07/22
Rec 10yr swap EFP / Pay 3yr
3s10s Bond/swap box inversion
swap EFP
Note: All trades marked as of 11am on Friday in NY, Toronto and London, and Friday close for Australia/NZ. For a list of closed
trades over the past 12 months please the back of this publication. Click on individual trades for the trade initiation note.
3
Global Rates Weekly
2 December 2016 | TD Securities | New York
Global Rates Strategy
Treasury-Bund Spread: At Historical Wides
But Not Time to Fade Just Yet
 The 10y Treasury-Bund spread has widened to historical
wides in recent weeks. This has been driven by optimism
regarding Trump’s policies about fiscal stimulus in the US
and greater Treasury supply which moved Treasury rates
higher along with concern about the Italian referendum and
European politics, which is keeping Bunds bid.

We are not convinced that it is time to fade the spread just
yet. We think that Treasury rates have room to reprice higher
and convexity hedging can exacerbate the flows. Meanwhile
a “no” at the Italian Referendum on Sunday can bring some
more support for Bunds. In addition, any attempts by the
ECB to delay tapering would also support Bunds. We would
target a spread closer to 250bp to consider fading it.

Historically, rising rates episodes have been driven by
President elect Trump’s policies about fiscal stimulus and
greater Treasury supply. Our view is an additional $500bn in
deficit in 2017, due to a combination of tax cuts ($275bn) and
infrastructure spending ($225bn). Higher duration supply,
stronger growth and inflation risk with fiscal easing at a time
when the economy is close to full employment should argue
for higher Treasury rates. We look for the 10y to peak around
2.75% in the next few months. See here for more discussion.
widening in the Treasury-Bund spread, with the exception of
May-June 2015 when ECB tapering was suspected. Any
hints by the ECB of tapering the pace of QE will make
owning Treasuries against Bunds look attractive.

The cost of FX hedging of that position (i.e. buying
Treasuries versus Bunds with a 3m FX forward hedge) will
also affect the spread. The yield pick up currently is only
around 20bps, however the yield pick up has been as high
as 70bps earlier this year. This is because of the recent
demand for USD, likely due to year end funding concerns. A
rise in UST yields along with a tightening in the basis should
bring back this flow, further supporting a UST-Bund spread
tightener.
Wide, wider...
The 10y Treasury-Bund spread has widened to historical wides
since the US election. It has far surpassed the 173bp highs seen
just after the ECB QE when 10y Bunds rallied to around 8bps. In
the past we have faded such widening successfully. After all, the
reach for yield theme has been a significant one in a low rate
environment, which should bring demand for higher yielding
Treasuries and away from Bunds. However, we are not fading
this move just yet. This is because this recent move has been
driven by 2 factors that may have more to run:

Treasuries pricing in a Trump fiscal stimulus plan: The
rise in Treasury rates was driven by optimism regarding

Italian referendum: Concern about the Italian referendum
and European politics, in general with the Dutch, French and
German elections next year and the rise of Euro-sceptic
parties has kept Bunds bid. However, in our view much of the
noise around the Italian referendum is already priced in. Not
only have spreads to Bunds reached extreme wides across
the curve, but 10y Bono-Bund spreads are close to the lows
seen during the sovereign debt crisis which is unwarranted in
our view. Given this we hold the view that the market has
fully priced in a ‘no’ outcome, and we see little potential for
spreads to widen significantly on a ‘no’ announcement. We
continue to hold 10y BTP-Bund spread tighteners (at
187bps). We would look to add to tighteners if that spread
widens out to around 200bps. This could happen on a knee
jerk response to a “no” outcome.
ECB and Fed ahead could also affect the spread
The ECB meeting next week also poses risks to the trade. While
our macro strategists continue to expect the ECB to taper in 2017
and to ‘gently’ signal this in December, the recent sell-off in bonds
has brought the ECB both time and flexibility on the speed of any
4
Global Rates Weekly
2 December 2016 | TD Securities | New York
Global Rates Strategy
tapering, thereby further complicating (and possibly delaying) the
exact timing of when the ECB may announce an actual tapering
of purchases. In addition, higher global uncertainty post-Trump
may impact the ECB’s reaction function for this meeting — they
may for now want to keep things as they are and take advantage
of the flexibility that the sell-off has provided them, rather than fuel
the moves we have had thus far. As of now, the ECB can extend
QE for four months without doing anything else. However, the
ECB will likely want to address short end scarcity concerns which
have resulted in a richening of GC repo rates and a sharp move
lower in front end rates. They will likely do this via the securities
lending facility – either by widening the eligible collateral/making
the facility available to a wider pool of counterparties or excepting
cash in exchange for collateral (via term bills). In short, the
potential for surprise from the ECB, on many fronts, is high and
we would wait post the meeting to re-assess directionality on
Euro rates.
Meanwhile, we don’t see the Fed as being a big market event for
Treasuries. The Fed will likely hike but continue to forecast 2
hikes in 2017 in their median dot plot. However the market is 90%
priced for a hike in December and is already pricing in 42bp of
hikes next year.
A directional trade
Further, the Treasury–Bund spread appears to be a directional
trade. Figure 2 shows that since 2001 there is a strong
relationship between weekly changes in Treasury rates and
changes in the Bund Treasury spread. The regression result is
robust and significant; implying that 10bp rise in Treasury rates
would move Treasury-Bund spread wider by 3.7bp. However, the
relationship is not linear in the sense that larger moves higher in
Treasury could widen Treasury-Bunds by more (Figure 3). Since
the US election, for the 53bp rise in Treasury rates, Treasury
Bund spread has widened by 44bp. The exception to this
dynamic occurred during the April-June 2015 when the spread
compressed in a bond market sell-off. This occurred due to fears
of ECB tapering, which moved Bund rates higher.
A volatility perspective
Treasuries and Bunds historically exhibit different levels of
realized volatility (Figure 4). Pre 2009, Treasuries were generally
more volatile than Bunds but due to the European crisis as well
as QE in the US which depressed US rate vol, Bunds have often
times become more volatile than Treasuries. It may make sense
to vol hedge the trade, to adjust for the different level of volatilities.
Figure 2: Relationship Between Weekly Changes
in the 10y Treasury-Bund Spread and Treasury
Yields
40
30
20
10
Bp 0
-10
-20
-30
y = 0.39x + 0.35
R² = 38%
-40
-50
-60
-40
-20
0
20
Bp
40
60
Source: TD Securities, Bloomberg
Figure 3: Asymmetric Risks—Large Moves in USTs Could
Widen the 10y UST-Bund Spread More
Δ 10yr
UST
Δ 10yr
Bund
Δ 10yr UST Bunds Spread
2009 (May - June)
86
38
47
Taper Tantrum (May-Sep 2013)
111
51
60
Bund Tantrum (Apr-Jun 2015)
35
54
-19
Post-Election (Nov 8 - today)
53
9
44
Period
Source: Bloomberg, TD Securities
4.0
Note: All changes in basis points.
Figure 4: 3m Realised Vol of Daily Changes in
USTs and Bunds
European Periphery Crisis
3.5
3.0
ECB QE
2.5
2.0
1.5
1.0
0.5
0.0
2001
3m Realized Vol of Daily Changes in Bunds
3m Realized Vol of Daily Changes in USTs
2004
2007
2010
2013
2016
Source: TD Securities, Bloomberg
Further, the Treasury-Bund spread tends to compress when
general level of vol declines. This would be consistent with the
reach for yield argument, which implies that lower vol argues for
carry trades and preference for higher yielding Treasuries over
Bunds. However, given event risks in the near term and a
5
Global Rates Weekly
2 December 2016 | TD Securities | New York
Global Rates Strategy
paradigm shift in Washington, we think that volatility may remain
elevated for some time.
How does FX hedging affect the trade
Currently there is only about a 20bps pick-up in yield for a
domestic European investor looking to buy Treasuries and
swapping out via the cross-currency basis. A slower rise in US
Libor relative to Euribor should bring back European demand for
Treasuries, and indeed a tighter basis. The current levels of basis
spreads are extreme, with the 3m close to 55bps. We think yearend demand for USD has exacerbated the widening pressure;
thus we expect the basis to correct sharply as we pass over year
-end. Also we are currently at levels where investors will be
incentivised to tap into the 7-day FX swap lines in place with the
ECB and Fed. So we expect hedging demand via treasuries to
resurface, further fuelling the tightening bias on the 10y USTBund spread.
What are we watching to fade the move?
Ultimately this depends on when we believe that the sell-off is
more or less done. We think this occurs closer to 250bp on the
spread, which is when we would look to enter into tighteners.
There are two dynamics which could influence us to initiate the
trade sooner:

0.8
0.7
Figure 5: FX Hedged Yield for a European
Investor Holding 10y USTs and Swapping out via
the Basis
0.6
0.5
0.4
%
0.3
0.2
0.1
0
-0.1
-0.2
Source: TD Securities, Bloomberg
risky. In such a situation, USTs should outperform and the
spread should ultimately tighten.
Priya Misra, Renuka Fernandez
ECB tapering: If the ECB hint at tapering at next week’s
meeting, then we will likely leg into the spread. However, as
we discussed earlier, the risks around a taper announcement
are likely higher due to political risk after the Trump victory.
Longer term, the macro justification for a taper remains, and
we would envisage entering this spread in the first half on
2017.

Lower periphery risk, which can reduce some demand
for Bunds: If the French and Dutch elections turn out to be a
non-event, some of the flight to quality premium for Bunds
should go away. This should help compress the TreasuryBund spread. However, the trade could still work in the
medium term even if the election result in win for the far right
parties. If the French and Dutch elections result in the far
right parties gaining power, then investors will temporarily
react by piling into Bunds. However, both far right parties in
France and the Netherlands have promised their own
Referendums on the EU if they win – so ultimately one could
conceive of a situation where investors avoid European
bonds altogether as break-up risk makes all of them equally
6
Global Rates Weekly
2 December 2016 | TD Securities | New York
US Rates Strategy
No Rest For the Weary
 Rates continued to rise this week, though event risk with the
upcoming Italian Referendum and Austrian elections over the
weekend helped rates retrace a little on Friday. In our view,
the payroll report was largely a non-event and should not
have implications for Fed policy or inflation risk per se. Other
data for November has suggested an ongoing pickup in
economic activity.

The curve has been extremely volatile in the last month.
Following a knee-jerk steepening to nearly 140bp after the
election, the 5s30s curve flattened to 117bp and over the
past week, has managed to steepen again. We believe this
reflects the various drivers at play. We expect the Fed’s tone
to remain steady in December. Meanwhile even though
supply is likely be concentrated in the sub-5yr part of the
curve, duration supply will rise, which should result in higher
long run rates. The pension fund bid for the long end is a risk,
but we think that it materializes only when the funded ratio is
close to 90%. Thus for now, we like the curve steepener.
Payrolls meets the Fed’s threshold for a hike
Treasuries rallied on Friday in the wake of the November payroll
report. While the 178k headline reading was not all that different
from consensus, earnings were weak and the participation rate
dipped again. We do not think that the report moves the needle
for the Fed, which has suggested that the data threshold had
already been met. And indeed, given the low bar for a December
rate hike, the market continues to price in 90% odds of a hike—
even higher than the pricing for liftoff heading into the December
2015 FOMC meeting. The market did react marginally to the
report in pricing out some rate hikes from 2017, but with investors
already pricing nearly 2 rate hikes (45bp) next year, some
moderation is reasonable.

Earnings softer: Average hourly earnings tend to follow a
fairly defined statistical pattern depending upon which day
the survey reference date (the 12th of the month) falls. The
reference date for November fell on a Saturday, which
typically coincides with weaker wages. Of the past 5 payrolls
in which the survey reference date fell on a Saturday, three
came in at zero and the average was a meager 0.1% m/m.

Participation rates slipping: While the decline in the
unemployment rate to 4.6% from 4.9% (and the U6 rate to
9.3% from 9.5%) was encouraging, the slip came largely on
the back of a further decline in labor force participation. Note
that the Fed has used the rise in the participation rate earlier
this year as a poster child of remaining slack in the labor
market. Even though participation declined in November, it
remains higher than the level a year ago. This could prevent
the Fed from delivering too hawkish a message when they
deliver another rate hike at the December FOMC meeting.
Duration outlook
We have been arguing for higher rates in the long end of the
curve since the election as we think that Trump’s fiscal stimulus
plan will increase growth expectations, raise Treasury supply and
increase inflation risk premiums. Rates have re-priced
significantly since the election, but we think that 10yr yields can
rise to 2.75%. In addition, convexity flows are also likely to
exacerbate the move. We would look to fade the move only when
10yr real rates move close to 70bp (about 25bp higher from here)
or if the dollar strengthens considerably from here.
We remain short duration for now, but prefer expressing this view
via payer spreads given how much rates have already risen and
payer skew has richened. Additionally, there is event risk in the
days ahead with the Italian Referendum and Austrian elections
over the weekend and the ECB meeting next week.
Curve ball: what’s next?
The curve has been extremely volatile in the last month.
Following a knee-jerk steepening to nearly 140bp after the
election, the 5s30s curve flattened to 117bp and over the past
week, has managed to steepen again (Figure 1). We believe this
extreme volatility reflects a number of different drivers:

Fed pricing: The market is now pricing in 90% odds of a
December hike, which rose from 60% before the election.
This is reasonable since financial conditions didn't tighten
7
Global Rates Weekly
2 December 2016 | TD Securities | New York
US Rates Strategy
Figure 2: Issuance to Rise in 2017, Steepening the Curve
Year
Bush Tax Cut
2001
2002
Change
Obama
Stimulus
Trump
Stimulus
Notional Coupon Issuance
2-5yr
220
398
178
5yr+
96
82
-14
Total
316
479
163
2008
691
187
878
460
2009
Change
1390
699
705
518
2095
1217
1274
814
2016
2017 Est.
1053
1303
836
936
1889
2239
1317
1506
Change
250
100
350
189
185
188
3
95

Higher deficit to result in significant duration supply: We
expect the deficit to go up from an expected $550bn in 2016
to $900bn in 2017 due to tax cuts, increasing Treasury
issuance needs. Even though we expect much of the
issuance pickup to be concentrated in the sub-5yr sector with
a pickup in bills and higher issue sizes in 2s, 3s and 5s, it still
results in a significant increase in duration supply (Figure 2).
Ultimately, duration supply should pressure term premiums
higher, resulting in a steeper curve. This is similar to what
happened after the Obama stimulus in 2009 when 66% of
the increase in issuance occurred in the sub-5yr sector, but
duration supply still increased from $460bn 10yr equivalents
in 2008 to $1.2tn of 10yr equivalents in 2009.
Global rate curves could steepen more: Even though the
recent move in the US curve has little to do with global rates,
it would be remiss of us to ignore this dynamic. Much of the
steepening in the US curve from August-October coincided
with steepening of global curves—in particular JGBs and
bunds. BOJ policy stabilized the JGB curve but the ECB
policy could have significant implications for the bund curve.
80
75
65
Aug-11 May-12 Feb-13 Nov-13 Aug-14 May-15 Feb-16 Nov-16
Source: Milliman, TD Securities
Note: Excludes bills. 2017 assumes $900bn deficit. All figures in $ billions.

85
70
Source: Treasury, TD Securities
despite the surprising election outcome. More interestingly,
the market has re-priced the pace of hikes in 2017
significantly higher. This coincided with the flattening of the
5s30s curve (Figure 1). At this point, we think that the market
is perfectly priced for the December Fed message. We do
not think that the Fed will suggest a faster pace of hikes just
yet since there is significant uncertainty regarding the size
and scope of the Trump fiscal stimulus package. If the
market does not price in more than 2 hikes in 2017 in coming
weeks, this should help steepen the curve.
Figure 3: Pension Funding Ratio Estimated to
Have Risen Following Rise in Bond Yields
90
Funded Ratio (%)
Program
10yr
Equivalent
Total
Note: November value estimated.
If Draghi hints at taper at Thursday’s ECB meeting, a bear
steepening reaction in European rates could help drive the
US curve steeper in sympathy.

Pension demand to pick up only once funded ratios rise
further: Could demand from the pension community for long
end rates put a ceiling on long end rates, and hence on the
curve? We don’t think so yet. Pension demand is a
significant factor for the long end of the curve, but we think
that the demand for duration will show up when the funded
ratio (market value of assets divided by the projected pension
benefit obligation) is closer to 100%. At that point, pensions
would not be locking in a loss in terms of the funded status
and immunization (or duration hedging) looks a lot more
attractive.

We use the Milliman 100 Pension Funding Index as an
industry average for the funded ratio. The index has risen
from a low of 75.6% during Brexit to 77.3% by the end of
October. With the recent rise in rates and equities we project
the ratio to be around 85% (Figure 3). We do not think this
meets the threshold for significant duration demand just yet.
The funded ratio was 85% during the Bund Tantrum in June
2015, and there wasn't much evidence of duration demand
from the pensions. However, if 30yr rates rise another 5075bp and equities continue to rise, we can see the ratio get
closer to 100%. At that point, we think that the curve would
have peaked due to duration demand from pension funds.
Thus we continue to hold on to our 5s30s steepener trade
and target a spread of 145bp.
Priya Misra, Gennadiy Goldberg, Cheng Chen
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MBS Convexity Risk Resurfaces
(This piece was originally published on November 30, 2016)

Given the 50bp move higher in rates over the last few weeks,
we analyze MBS convexity risks. Even though the structure
of the mortgage market has changed significantly from the
pre-crisis period due to Fed ownership and GSE
conservatorship, we think that there are still some holders of
MBS convexity risk that would need to hedge the duration
extension of their portfolios due to the sharp move higher in
rates.

We estimate paying needs of $46bn 10yr equivalents due to
the 50bp rise in rates since the election. The peak of MBS
convexity is about 50bp higher from here, and we see paying
needs of $10bn in 10yr equivalents for every 10bp rise in
rates until the primary mortgage rate gets to 4.5%. Any
further increase in rates above 4.5% should result in less
convexity selling.
y = 5.76x - 5.77
R² = 0.13
40
Convexity paying should argue for higher rates led by the
belly of the curve, wider 5-10yr swap spreads, higher levels
of implied vol and richening of the payer skew. We suspect
some of this flow has gone through, even though the move in
swap spreads looks counterintuitive. Even though convexity
paying should have move spreads wider, the flow was more
than offset by fears of higher deficits (which should tighten
spreads).
10yr Swap Spread (bp)

50
Figure 2: Since 2008 Crisis, There Has Been No
Spread Rate Directionality
30
20
10
0
-10
-20
1.0
Convexity hedging: a background
As your first bond math class likely explained, a negatively
convex asset extends in duration when rates rise. This would
create duration shedding needs in a rising rate environment.
Some examples of such assets are mortgage backed securities
(MBS), origination pipelines and mortgage servicing rights (MSR).
When rates rise, the homeowner has less incentive to prepay the
mortgage, which would lengthen the duration of the MBS, the
pipeline or the MSR. Investors who need to maintain a certain
asset duration would need to sell duration or pay fixed in swaps.
2.0
2.5
3.0
10yr Yield (%)
3.5
4.0
Source: Bloomberg, TD Securities
Note: The scatter plot shows the relationship since Jan 2009.
1800
Figure 3: Fannie and Freddie Portfolios Have
Continued to Wind Down
1600
Combined Fannie/Freddie Portfolios
1400
Maximum Cap
1200
1000
$ Billion
It has been a while since we thought much about convexity
hedging. But a 50bp rise in rates over a 3 week period is unusual
and should result in some hedging needs. Before we discuss our
estimate of hedging needs and how to position for it, we provide a
refresher on mortgage convexity.
1.5
800
600
$500bn
400
200
0
2008
2010
2012
2014
2016
2018
Source: Fannie Mae, Freddie Mac, TD Securities
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Reasons for less convexity hedging post crisis
Prior to the 2008 crisis, convexity hedging was a fairly common
market event whenever there were significant moves in rates in
either direction. Figure 1 highlights the pre-crisis directionality
between rates and swap spreads, which we attribute to convexity
hedging. A quick move higher in rates such as in 2003 or 2004
created paying needs in swaps, which would widen swap
spreads. However, since the crisis, the directionality has mostly
disappeared (Figure 2). We attribute this to several factors:



Changing structure of the mortgage market: The
mortgage market is significantly different today in terms of the
largest holders. The mortgage portfolios of the housing GSEs
(Fannie Mae and Freddie Mac) have shrunk significantly
since the crisis under the conservatorship agreement. The
portfolios have declined by $977bn since 2008 and are
slated to decline by another $115bn by the end of 2018
(Figure 3). The GSEs were the most active hedgers precrisis since they actively managed the duration gap between
assets and liabilities. Smaller portfolios argue for smaller
hedging needs. In addition, the Fed is a much bigger holder
of MBS and the Fed does not hedge convexity risk. Figure 4
shows the breakdown of MBS holders compared with 2008,
reflecting the decline in the GSEs holdings and the rise in
Fed holdings. We believe that the Fed, foreigner holders and
banks do not hedge convexity. Thus the proportion of MBS
holders who likely hedge as a share of total outstanding has
declined from 68% in mid-2008 to 35% today.
European peripheral crisis from 2010-12: The European
crisis widened swap spreads even as Treasury rates
declined in a classic flight to quality move. Thus swap spread
directionality with rates declined through much of the 20102012 period.
More episodes of sharp rate declines since the crisis,
with an asymmetric response in sharp selloffs: Ultimately
movements in the primary mortgage rate (defined as the rate
Figure 4: Large MBS Holders Have Changed Over the Years
Q2 2008
Q2 2016
Change
Household + Corporate
MBS ($ bn)
332
365
33
Federal, State and Local Govt
195
323
127
Rest of the World
643
758
115
Fed
0
1769
1769
Banks
533
1687
1154
Insurance
197
338
141
Private and public pensions
143
197
54
Mutual Funds
255
476
220
GSEs
854
300
-555
ABS Issuers
341
0
-341
REITS
99
226
126
Broker Dealers
122
95
-28
Total
3714
6531
2817
Potential Hedgers
2539
2318
-221
68
35
Potential Hedgers (%)
Source: Federal Reserve, TD Securities
Figure 5: Sharp Rate Selloffs Are More Troublesome for
Convexity Hedgers
10yr Yield
Chg
Primary
Mortgage Rate
Chg
Primary
Mortgage 10yr Yield
Higher Rates (bp)
Jan - Feb 2009
67
29
-38
May - Jun 2009
69
43
-26
Nov - Dec 2010
80
59
-21
May - Aug 2013
108
123
15
Apr - Jun 2015
56
37
-19
Nov 2016
47
40
-7
Lower Rates (bp)
Jun - Jun 2009
-53
-9
44
Apr - Oct 2010
-155
-81
74
Jul - Sep 2011
-135
-42
93
Mar - Jun 2012
-84
-17
67
Mar - Jul 2016
-63
-27
36
Source: Bloomberg, TD Securities
Figure 6: Post Crisis Sharp Moves Higher in Rates Have Seen Some Signs of Convexity Hedging
Period
Δ 10yr Yield
Δ 2s5s10s Fly
Δ 10yr Swap Spread
Δ 3m10y Swaption
Post QE1 and fiscal stimulus selloff (May - June 2009)
86
55
29
59
Taper Tantrum (May-Sep 2013)
111
62
6
63
Bund Tantrum (Apr-Jun 2015)
35
1
5
13
Trump Tantrum (Nov 8 - today)
45
24
-4
Source: Bloomberg, TD Securities
14
Note: All changes in basis points.
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US Rates Strategy
the borrower pays) will drive prepay behavior and hence, the
shift in MBS durations. This makes the primary-secondary
spread important, and it is driven by capacity constraints,
guarantee fees, servicing fees and other fees imposed by
originators. Typically, rate declines are accompanied by a
widening in the primary-secondary spread. Effectively this
means that primary mortgage rates do not decline as much
as Treasury or secondary MBS rates. This mutes convexity
needs in episodes when rates decline. Since the crisis, we
have had more episodes of sharp decline in rates. However,
when rates rise, even though the primary-secondary spread
tightens, it does not tighten all that much (Figure 5). So
primary mortgage rates rise, albeit not as much as Treasury
rates. This makes a sharp selloff in rates more troublesome
for convexity hedgers than a sharp decline in rates. Servicers
also have an economic offset in a rate decline from their
origination arm, but no such offset exists in an environment
when rates rise. Since 2009 we have seen several episodes
of a sharp increase in rates, which have indeed been marked
by some signs of convexity hedging (wider swap spreads,
widening of 2s-5s-10s, higher vol, Figure 6).
Figure7: Distribution of Unpaid Principal Balance of the 30yr
MBS Universe Net of Fed Holdings
30yr
FN
FG
GN
G2
Total
2.5
7.2
3.2
2.7
10.2
23.3
3.0
244.8
78.5
19.1
228.5
570.9
3.5
321.4
119.3
21.3
355.4
817.4
4.0
218.2
84.8
33.9
164.3
501.2
4.5
108.9
56.7
37.3
76.3
279.2
5.0
59.2
35.1
23.2
36.7
154.2
5.5
46.1
30.9
12.3
13.1
102.4
6.0
32.9
20.6
8.8
8.9
71.2
6.5
13.2
8.1
3.4
3.9
28.6
Source: Bloomberg, FRB, TD Securities
Note: All values in $ billions.
Estimating convexity needs today
We begin by first analyzing the distribution of coupons in the MBS
universe net of Fed holdings. Figure 7 highlights that the highest
outstanding balances are in the 3.5s, though 3s and 4s also have
a significant chunk of outstandings. Note that current coupon
MBS is presently about 3%, which implies that the point of
maximum negative convexity is 50bp higher than here. Thus if
rates rise, as we forecast to occur over several months (as the
Trump stimulus plan gets priced in), we expect convexity hedging
needs to accelerate. Once rates rise more than 100bp (i.e., 4.5s
become close to par), convexity needs should decline.
We subsequently make some assumptions about extent of
hedging:

We assume that most originator pipelines hedge. However
the size of the origination pipelines are not very large since
rates had been in a narrow range since Brexit.

We assume that only 50% of MSR portfolios hedge since
only half the MSR are held by banks, who likely hedge.

We assume that 35% of MBS holders hedge (excluding the
Fed, foreign accounts and banks). We believe that REITS
are likely the most aggressive hedger, while asset managers
only need to hedge to the extent that they are overweight or
underweight their index.
Taking these assumptions into account, we estimate MBS
convexity paying needs of $46bn 10yr equivalents due to the
50bp rise in rates since the election. Further, we estimate paying
needs of $10bn in 10yr equivalents for every 10bp rise in rates.
Market implications of convexity hedging
MBS convexity hedging occurs primarily through a combination of
two strategies:

Delta hedging: In a rising rate environment, this would
involve paying in swaps, selling Treasury futures and selling
MBS (typically TBA). This would argue for higher rates led by
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2 December 2016 | TD Securities | New York
US Rates Strategy
the belly of the curve, cheapening of futures to cash, and
wider MBS basis.

Vol hedging: Investors may hedge the negative convexity of
the MBS by owning gamma. This could involve buying
swaptions, Treasury options or mortgage options. This
results in a higher levels of implied vol and a richening of the
payer skew.
MBS hedging needs depend on the speed, trend and magnitude
of the rate move. A significant move in rates in one direction over
a short period of time would tend to create greater hedging
needs. The move since the election can be categorized as such
an episode. The needs are clearly much smaller than before the
crisis, but in such a sharp selloff, convexity hedging could amount
to some market impact. Figure 8 highlights that the Barclays MBS
index duration extended by more than a year since the election,
which would create some duration shedding needs as discussed
above. Indeed as Figure 6 highlights, the 5yr sector led the
moves higher in rates and implied vol rose. Through much of the
rise in rates, MBS spreads also widened. These are all telltale
signs that some convexity hedging flows did occur. The only
seemingly counterintuitive move has been in terms of swap
spreads. As we argued earlier, convexity hedging episodes tend
to be accompanied by wider spreads in a
higher rate
environment. However, since the election, 10yr swap spreads
have tightened (Figure 6 and Figure 8).
In the past we have argued that tight spreads are the norm due to
regulation that has increased the cost of balance sheet and
effectively cheapened Treasuries to swaps. However, there has
been no change in regulation over the last month. We would
argue that this move tighter in spreads is a function of greater
deficit projections. President elect Trump has brought up the idea
of significant fiscal stimulus in the form of tax cuts and
infrastructure spending, both of which should add to the deficit.
We estimate a $500bn deficit increase in 2017, driven by $275n
in tax cuts and $225bn in infrastructure spending. This would
increase the deficit to GDP from to 5% from 3% currently.
Historically, greater deficits have been associated with tighter
swap spreads as Treasuries cheapen due to greater supply
projections (Figure 10). This is what happened in 2001 during the
Bush tax cuts (which added $1.5tn to the deficit over 10 years) or
the Obama stimulus plan (which added $900bn to the deficit over
10 years). Conversely, the budget surplus in 2000 was
associated with a significant widening in spreads, as Treasuries
began to price in a scarcity premium. We believe that higher
deficit projections this time around can be seen in wider TIPS
breakevens, a steepening of the curve and tightening in swap
spreads. Thus even though convexity flows likely occurred, we
believe that they may have been dwarfed by the deficit-related
tightening in spreads. Any further selloff from here, which sparks
more convexity paying needs, will likely be accompanied by more
talk of deficit increases and hence swap spreads may find it more
difficult to widen.
Positioning for convexity hedging
To summarize our discussion and discuss market implications we
make a few points:
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
While convexity does not actually trigger higher rates, it tends
to exacerbate selloffs. Thus, if fair value argues for 10yr
Treasuries to reach 2.75%, they could very well overshoot to
3.00% due to the convexity flow.

The point of maximum convexity is about 50bp higher from
current levels so convexity needs will be present over the
next 50-100bp rise in rates. They are likely smaller than precrisis, but not insignificant.

Market impact: Convexity selling should argue for the 5-7yr
sector leading the increase in rates, a widening of mortgage
spreads, an increase in implied vol and richening in the payer
skew.

If any further rise in rates is driven by greater deficit
projections (due to a more ambitious fiscal stimulus plan than
the market had expected), then swap spreads will struggle to
widen. We recommend 5s30s spread curve flatteners (i.e.,
receiving 30yr spreads and paying 5yr spreads) since we
believe that convexity paying will occur in the belly of the
curve while the deficit impact will be felt more in the long end
(see Global Rates Outlook for more).
Priya Misra, Gennadiy Goldberg, Cheng Chen
13
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2 December 2016 | TD Securities | New York
US Rates Strategy
GSEs: Politics Come to the Forefront Again
(This piece was originally published on November 30, 2016)

The GSEs have been in the news recently. Their stock prices
have spiked since the election and rose some more today on
speculation of ending the conservatorships. However, we
believe that government involvement is likely in any new
GSE model to prevent mortgage rates from rising too much
and to fulfil affordable housing goals. We would therefore
look to buy any widening in debt spreads due to these
headlines.

Today Trump’s pick for Treasury secretary (Steven Mnuchin)
expressed a desire to end government ownership of Fannie
and Freddie “reasonably fast.” The FHFA landing team is
headed by Timothy Bitsberger and the FTC/FSOC landing
team is headed by Alex Pollock. Both have a GSE
background, hinting at increased focus on reform efforts.
Nevertheless, the potential appointment of Congressman
Jeb Hensarling to head FHFA could trigger investor
nervousness as he has previously been a vocal opponent of
the GSEs.

While the odds of wholesale GSE reform in 2017 remain slim
as Congressional focus remains on tax cuts and
infrastructure spending, we see incremental steps toward
reform. We see the possibility that Fannie and Freddie are
allowed to gradually increase their capital buffers (which are
set to shrink to just $600mn in 2017 and zero by 2018) by
retaining some earnings.

A number of factors could help drive reform ahead of the
rapidly approaching wind-down end date, including declining
GSE capital buffers and the CBO’s release of an estimate on
the cost of a potential recapitalization. Similarly, there is
reason to believe that the private securitization market could
begin to thaw if the Dodd Frank rules around risk retention
could change in the new administration.
the Presidential election (Figure 1)? We believe the jump in
Fannie and Freddie stocks can be attributed to hope that the new
administration will bring change and accelerate GSE reform.
There is particular hope that a more GSE-focused Treasury
secretary and “landing team” (transition team) leaders such as
Steven Mnuchin and Timothy Bitsberger could help create a more
favorable backdrop for reform efforts. Mnuchin’s remarks today
suggesting that Fannie and Freddie should leave government
control and the administration will “get it done reasonably fast,”
encouraged another jump in Fannie and Freddie shares. Further
we discuss the several transition team leaders that could affect
the GSEs:

Steven Mnuchin: The nomination of Mnuchin for Treasury
Secretary triggered another rally in Fannie and Freddie
stocks, and pushed GSE debt spreads modestly wider.
Mnuchin suggested that, “We will make sure that when they
are restructured, they are absolutely safe and don’t get taken
over again. But we’ve got to get them out of government
control.” Similarly, Mnuchin suggested that the incoming
administration will get reform “done reasonably fast.” While
markets were heartened by these statements, we believe
real GSE reform will remain an uphill battle as it will require
Congressional approval.

Timothy Bitsberger: Tapped to lead the FHFA transition,
Bitsberger had previously served as Treasurer and Senior
VP for Funding and Investor Relations at Freddie Mac. With
the FHFA able to deliver some GSE reform by setting goals
for Fannie and Freddie, markets were likely heartened by this
Market pricing in higher odds of reform
At first glance, the prospects for GSE reform in 2017 remain slim.
As Fannie Mae and Freddie Mac continue to wind down their
retained portfolios under the terms of their conservatorship
agreements, legislative attempts at reform have remained
nonexistent since the Johnson-Crapo bill in 2014 and the focus of
the incoming Trump administration remains elsewhere. Why then
have Fannie and Freddie common shares tripled in the wake of
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

Alex Pollock: While technically tapped to lead the transition
team for the Federal Trade Commission and FSOC, Pollock
is a former FHLB Chicago CEO and therefore has a strong
grasp on the GSE space. Pollock has written extensively on
GSE reform, recommending a stop to the Fannie/Freddie net
income sweep, directing Treasury to exercise its warrants on
GSE stock, designating Fannie and Freddie as SIFIs and
having them pay the government for providing an implicit
guarantee.
900
Shrinking capital buffers: We had written previously that
Freddie Mac Portfolio
Maximum Cap
600
500
400
300
$250bn
200
100
0
2008
2010
2012
2014
2016
2018
Source: Fannie Mae, Freddie Mac, TD Securities
Freddie capital buffers will shrink to just $600mn apiece in
2017 and to zero in 2018—increasing the risk that even a
small quarterly net loss could lead them to tap Treasury for
capital support. While the gradual decline in capital buffers
was mandated by the updated PSPAs, a tap of existing
Treasury support could create particularly negative headlines
especially as the government fiscal deficit will already be
rising. We believe headlines about a capital draw from
Treasury would 1) temporarily push GSE spreads wider on
increased uncertainty about their future and Congressional
support and 2) shift additional attention to reform on Capitol
Hill, though not necessarily in the best way.
Incremental reform is the most likely scenario

Fannie Mae Portfolio
700
Jeb Hensarling: While not part of the transition teams yet,
Congressman Hensarling’s name has been floated to lead
FHFA. Hensarling currently chairs the House Financial
Services Committee and has in the past been in favor of
winding down the GSEs. His 2013 GSE reform bill proposed
repealing Fannie and Freddie charters, replacing them with a
smaller entity to securitize mortgages but prevent the utility
from guaranteeing, originating or servicing mortgages. Such
a proposal would be negative for debt and stock.
Despite a potentially GSE-friendly landing team, however, we
believe considerable GSE reform in 2017 may remain a tough
slog. Congress is likely to be focused on tax reform and
infrastructure spending, suggesting that the odds of
Congressionally-driven GSE reform in the coming year remain
slim. Instead, there is some chance that Treasury and FHFA help
advance incremental reform over the coming year. While the
Omnibus Spending Bill of 2015 included a provision barring
Treasury from ending GSE conservatorships or divesting shares
without Congressionally-approved housing finance reform until at
least January 1, 2018, Treasury has the ability to tweak the terms
of the Preferred Stock Purchase Agreements (PSPAs) and allow
Fannie and Freddie to retain some capital. We see several
reasons Treasury may want to proceed down this route:
Figure 2: Projected FNMA/FHLMC Retained
Portfolio Wind Down
800
$ Billion
insider’s appointment to the transition team. In an October
2010 interview, Bitsberger stated that, “I think the idea that
they [the GSEs] could be privatized is laughable…I think
there is going to be some hybrid model.” Note that the FHFA
cannot change terms of the conservatorship agreement. That
requires Treasury involvement and potentially Congressional
approval depending in the change required.

CBO estimate on recapitalization: In October the CBO
published a report analyzing the potential cost of allowing
Fannie and Freddie to gradually rebuild their capital buffers.
With the report suggesting that the government would forego
only modest revenues by allowing GSE recapitalization, we
believe this could draw the attention of Congress and
Treasury, particularly given that recapitalization could actually
help mitigate the risks that the GSEs pose to taxpayer under
their conservatorships. To date, the GSEs have remitted
$256bn in dividends against the $187bn bailout they
received. We believe that allowing the GSEs to retain some
capital in order to rebuild their buffers could be one of the
more likely avenues for progress over the near-term as it
increases the sustainability of the GSEs but does not
necessitate a more complex overhaul.
the mandated decline in Fannie and Freddie capital buffers
could create headline risk for debt and MBS. Fannie and
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US Rates Strategy

of Fannie and Freddie’s portfolio is technically set to end in
December 2018. While the GSEs would not automatically
exit conservatorship if no progress was made toward reform,
we believe Congress may be keen to avoid a situation that
leaves the GSEs in limbo after December 2018.

The Trump impact to private securitization: The impact of
Trump’s electoral victory remains a key unknown for the
GSEs. Private securitization is extremely difficult under Dodd
-Frank, which has left little alternative to Fannie and Freddie.
Given Trump’s promises to repeal (or more likely, ease)
Dodd-Frank constraints, the door to private label MBS could
reopen. While Trump’s actions on regulation will remain to be
seen, an easing of the regulatory environment which could
help bring about private label MBS could clear the path for
GSE reform in the future.
What’s the end game for the Fannie and Freddie?
While comments from the incoming administration and transition
team favor removing government ownership of Fannie and
Freddie, there are two fundamental paths that GSE reform could
take:

Pre-crisis GSE model: This would imply a return to the pre2008 “hybrid” model which include an implied guarantee on
the debt and MBS, but the private sector owns an equity
share in both enterprises. We would expect the private share
to be much smaller than the government’s as the
government currently owns warrants comprising 79% of
Fannie/Fannie stock.

Privatize Fannie and Freddie: This path is preferred by a
vocal group led by Hensarling. The market impact of this
would be wider debt and MBS spreads and higher mortgage
rates. It is somewhat unclear what the impact on the stock
price will be until we have a better idea of the capital
structure.
We believe the former option is far more viable as the
privatization scenario suffers from a number of issues:

adversely affect the housing market and would likely weigh
further on homeownership.
Rapidly approaching wind down end date: The wind down
Higher mortgage rates: With no private label MBS market
available due to Dodd-Frank risk retention constraints, we
believe 30yr mortgage rates could rise as much as 50-100bp
if the implied guarantee to the GSEs is removed. This would

Risks to the 30yr mortgage: Without the GSEs a liquid 30yr
MBS market will likely be a challenge to maintain. This could
change the mortgage finance market significantly and
challenge the very concept of a fixed rate 30yr mortgage loan
(note the US is the only country in the world with a liquid 30yr
MBS market or fixed rate 30y mortgage loan).

Affordable housing: The affordable housing goals of the
GSEs would be impossible to implement in a private
enterprise.
What does this mean for GSE debt spreads?
While reform efforts have remained on the back burner over the
last several years, Fannie and Freddie have continued to shrink
in size, with their balance sheets reaching a combined $615bn as
of September 2016—down from $692bn in 2015 and $1.59tn in
2009 (Figure 2). Their balance sheets are slated to reach a
combined $500bn by end-2018 under the terms of their PSPAs,
suggesting that net issuance will remain negative—a tailwind for
the rate spread product space (please see our 2017 Global Rates
Outlook for more details).
While there is a risk that the plan to allow the GSEs to retain
capital is put into motion in 2017, we believe that this change in
isolation will not lead to considerable movement in spreads.
There has been little reaction in debt spreads to the fear of zero
capital buffer after 2018. However, allowing GSE capital buffers to
increase could actually help remove a potential spread-widening
risk for the GSEs which may have been created if Fannie or
Freddie had tapped Treasury for additional cash. If the plan to
allow an increase in GSE capital buffers comes in conjunction
with broader reform plans, however, markets could react. The
market will ultimately be focused on any change in the implied
government support in the new model.
In the meantime, with negative net issuance likely to remain a
tailwind for the GSE space, we look for GSE spreads to remain
relatively tight in the coming year. While headline risk has
certainly increased given the potential for incoming Trump cabinet
nominees to make further comments on the subject, we continue
to like carry and rolldown in the 4-5yr sector.
Gennadiy Goldberg, Priya Misra
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Canada Rates Strategy
Across the Canadian Curve
Segment
Commentary
Positioning
For all intents and purposes, markets have completely discounted any
chance of easing from the Bank of Canada next year, and in fact are pricing
in a one-in-four chance of a hike at the September 2017 meeting. In the very
near-term, a rate cut in December or January always looked like a stretch,
and the modest upside surprise on Canadian Q3 GDP will push forward the
Bank of Canada’s tracking for closing the output gap ever so slightly. Still, the
Canadian economy remains in a somewhat delicate position, and even before the political uncertainty south of the border is taken into account we see
a material risk of easing policy in mid-2017.
Short-end
Long 6-month T-bills
Consequently, 12-month OIS looks too high, but we will wait until some of the
recent volatility subsides to enter longs that far out the curve. We prefer to
focus on 6-month rates right now; 6-month bills look cheap relative to OIS (6month Z-score: 0.9), and owning BAH7s around 99.05 or 99.06 also looks
We see long-term value in 2s, but given how heavily front-end bonds have
been trading we are wary of outright longs ahead of the BoC meeting and an
expected Fed hike. We prefer micro-flatteners in the 12-18 month part of the
curve where we have seen significant steepening—and we particularly like
May18/F18 flatteners as the roll has moved from essentially flat to 6 bps.
Benchmark 2s look rich relative to F19s, and with the steepening in 2s3s we
see value in owning M20s versus S19s and S20s
Front-end
May18/F18 flattener
Own M20s in S19/M20/S20
fly
The steepening in 2s10s is consistent with the post-election US sell-off, and
to the extent that US rates continue to move higher we are likely to see the
CAD curve steepen further. 2s10s steepeners are too directional for our comfort, but with 5s offering better holding returns than 10s we like steepeners
within the belly. M22s look attractive trading 9 bps wide of benchmark 5s,
while the J23/J22 roll is almost 2 standard deviations wide of its 3-month average.
Belly
J23/J22 steepener
J26/M22 steepener
10s30s are too flat by 5-8 bps in our view, but the December curve extension
should support better performance from the long-end of the curve through the
next few weeks. Moreover, if inflation expectations continue to push higher in
the US, the CAD curve is likely to shift far enough upwards to justify the current slope in the long-end.
Long-end
Preferred Bonds
Sell D48s versus J41s
Government of Canada Bonds, 3-month Rolldown (bps)
Benchmark Bonds
8
6
4
2
0
-2
D64/D48
D48/D45
D45/J41
J41/J37
J37/J33
J33/J29
J29/J27
J27/J26
J26/J25
J25/J24
J24/J23
J23/J22
M22/S21
S21/M21
M21/S20
S20/M20
J20/J19
M20/S19
S19/M19
F19/N18
M19/S18
N18/A18
A18/May18
May18/F18
F18/N17
N17/A17
A17/M17
J17/F17
M17/F17
Source: Bloomberg, TD Securities
17
Global Rates Weekly
2 December 2016 | TD Securities | New York
Canada Rates Strategy
Tidying Up in the Front-end
This note was originally published on December 1st.
Figure 1: The BAX Curve Has Steepened
Materially (bps)
6
Z6/H7
5

The broader move higher has weighed on the front-end of
the Canadian curve, causing the 0-2 year segment to bear
steepen. We continue to view front-end bonds as cheap at
these levels, but with more supply still to come and several
top-tier risk events on the horizon the front-end could remain
heavy for another few weeks.
M7/U7
4
3
2
1
0
-1

With the move higher in rates, we have reached the target on
our M7/U7 BAX steepener, while the stop was triggered on
our long 2-year position. Additionally, we are exiting the Z6/
H7 BAX flattener and 1y1y/1y2y steepener positions in our
model portfolio.
One byproduct of the move higher in front-end rates in Canada
has been a material steepening in the BAX curve with BAU7s
selling off by 15 bps and the red strip steepening by an additional
15 bps. We had been arguing through most of the third and fourth
quarters that the white strip was unsustainably flat, with the curve
either inverting to reflect an easing bias or steepening on a more
benign economic outcome. And while it’s not actually clear that
economic fundamentals have improved, markets are certainly
pricing a better outcome with a hike fully incorporated by the end
of 2018.
Consequently, we have reached our target level for the BAM7/U7
steepener trade we initiated in July, and we are exiting the
position in our model portfolio at 5 bps for a profit of 6 bps ($72k).
We are also exiting the accompanying the BAZ6/H7 flattener
trade that we initiated a few days later; the two trades were
intended to exist as a package, and Z6 volumes are likely to
decline materially once we are past next week’s Bank of Canada
meeting (the contract settles on December 19th). We exit the
trade in our model portfolio at +2 bps for a loss of 3 bps ($38k).
Markets grow ever more complacent
Going forward, our core view on front-end rates has not
changed—risks to the Canadian economy still skew to the
downside, and the positive surprise on September industry level
GDP growth was principally due to rebounding oil and gas
production. The recovery from the Northern Alberta wildfires is
nearly complete, and the over reliance on the household sector
remains a point of concern.
The OIS curve now reflects a slight tightening bias as early as
September 2017 which looks very optimistic, and we continue to
-2
-3
-4
May-16
Jun-16
Jul-16
Aug-16
Sep-16
Oct-16
Nov-16
Souce: Bloomberg, TD Securities
Figure 2: OIS-Implied Overnight Rate by Bank of
Canada Meeting Date (bps)
58
56
54
52
50
48
46
44
7-Dec
18-Jan
1-Mar
12-Apr
24-May
12-Jul
6-Sep
Source: Bloomberg, TD Securities
80
Figure 3: CAD 2-year Yields are at Post Rate Cut
Highs (bps)
70
60
50
40
30
20
Dec-15
Feb-16
Apr-16
Jun-16
Aug-16
Oct-16
Dec-16
Souce: Bloomberg, TD Securities
18
Global Rates Weekly
2 December 2016 | TD Securities | New York
Canada Rates Strategy
see significant value in owning the front-end of the curve—we
especially like May18s, as the May18/F18 roll has moved from a
slight inversion at the start of November to trade above 4.5 bps.
Out of fidelity to our earlier recommendation, we are exiting our
long 2yr model portfolio position (0.50% November 2018s) as it
breached our stop of 71 bps, booking a loss of 6.8 bps when
carry is factored in ($170k).
There is no obvious catalyst for a rally on the horizon, and with Q3
GDP printing 0.3 p.p. above the BoC’s last forecast we would
need to see a pretty significant run of bad data for Poloz to turn
dovish by the time of the January meeting—so from a timing
perspective there is no need to rush into new longs. 2s do offer
some positive carry (0.9 bps per month N18s), but given how
heavily 2s have traded in recent sessions it might be prudent to
wait until the last few top tier risk events of the year (US payrolls
and the FOMC meeting) are out of the way to initiate or add to
positions.
Figure 4: CAD 1y2y/1y1y Spread (swaps, bps)
14
12
10
8
6
4
2
0
Dec-15
Feb-16
Apr-16
Jun-16
Aug-16
Oct-16
Dec-16
Souce: Bloomberg, TD Securities
While we are closing trades in the front-end of the curve, we are
also going to exit our even longer-standing 1y2y/1y1y steepener.
Although the trade is still short of our 15 basis point target, insofar
as we like owning 2-year bonds here it follows that 1s2s should
flatten, and rolldown works against the trade to the tune of 0.4 bps
a month. We exit the position in our model portfolio at 11.7 bps,
for a profit of 6.7 bps ($167k).
Andrew Kelvin
19
Global Rates Weekly
2 December 2016 | TD Securities | New York
European Rates Strategy
Target Hit on GE 5s30s Steepener
1.4
1.3
%1.2
1.1
1
0.9
0.8
Indeed, the curve did steepen around 20bps on taper
speculation. The remaining 10bps of steepening are a
result of 1) A global reflation in term premia following
Trump’s victory in the recent US presidential elections,
and 2) A richening in German GC repo rates on collateral
scarcity concerns, which has led to a recent sharp move
lower in 2y Schatz yields, which has dragged 5y yields
down with it too.
Reasons then for a steepener
In September we were arguing the case for the 5s30s
steepener in Bunds, but had said we would wait for better
levels to enter. Back then, curves globally had steepened
dramatically in the run up to the BoJ, and we expected some
retracement post the meeting on BoJ disappointment. Curves
did retrace, further fuelled by the September Fed meeting
which was taken dovishly by markets. We entered into a
steepener then at 104.5bps.
In our view there were both domestic and global factors that
supported a steepening. On the domestic side we thought the
ECB would likely have to drop the deposit rate threshold,
increase the issue limits on non-CAC bonds, move away from
the capital keys or do a combination of these measures to
allow for a time extension of the QE programme. Most of these
Figure 2: 2y Schatz Reach Historical Lows as
Scarcity Concerns Plague Markets, Richening 3M
German GC Repo Rates
0.4
0.6
0.4
0.2
0.2
0
-0.4
-0.6
-0.8
-1
09/16
06/16
03/16
12/15
09/15
06/15
03/15
12/14
-0.2
09/14
%
06/14
0
03/14
We see less scope for a significant further steepening in
the very near-term. Whilst we continue to expect the ECB
to taper in 2017, the sell-off has brought them both time
and flexibility on the speed of any planned tapering
thereby further complicating (and possibly delaying) the
exact timing of when the ECB may begin a slowing down
of purchases. As such, we choose not to add to the
position here, and will look to re-initiate steepeners once
we have more clarity on what the ECB intends to do going
forward.
Source: Bloomberg, TD Securities
12/13

1.5
09/13

We had expected the curve to steepen significantly in the
run up to the ECB meeting on speculation of a tapering of
ECB purchases. Our view was that even if the ECB did
not actually announce a tapering of purchases this year,
they would need to tweak the parameters around the APP
to allow for a time extension of the programme—which
would result in a technical taper.
1.6
06/13

On the 22nd September we entered into a GE 5s30s
steepener at 104.5bps. We hit our target today, of
135bps, and take off the trade to book a profit of
$762.5K.
03/13

Figure 1: EUR 5s30s Bund Curve Steepens on
Ancipation of a Technical Taper and in a Global
Reflation of Term Premia
%
-0.2
-0.4
3m German GC
Repo Rate
-0.6
2y Schatz Yields
(RHS)
-0.8
-1.2
-1
Source: Bloomberg, TD Securities
’tweaks’ to the programme parameters result in a shortening in
duration of Bund purchases made under the APP—thereby
steepening the Bund curve. Given this, we were calling for a
technical taper, and our view was (and remains) that the ECB
will look to drop the depo condition on bond purchases made
under the APP.
On the global side, we saw risks of a delayed reaction to the
BoJ announcement of curve control, thereby resulting in a
steepening of the JGB curve and through high global bond
correlations on long end rates, a steepening of curves globally.
What has fuelled the steepener recently
On the domestic side, the taper speculation did indeed
steepen the curve, and indeed the prospect of a technical
20
Global Rates Weekly
2 December 2016 | TD Securities | New York
European Rates Strategy
taper has relieved some of the flattening pressure on the long
end.
However, most recently the speculation that the ECB would
look to scrap the depo condition on purchases made under the
APP, has resulted in a further (and sharp) richening in German
GC repo rates, which has dragged down Schatz yields to
historical lows and pressured front end rates lower—fuelling
our 5s30s steepener.
On the global side, BoJ policy action has been overshadowed
by a Trump victory in the recent US presidential elections
which has resulted in a sharp reflation in term premia
globally—also fuelling the trade.
Going forward
We see less scope for a significant steepening in the very near
-term. Whilst we continue to expect the ECB to taper in 2017,
the sell-off has brought them both time and flexibility on the
speed of any tapering thereby further complicating the exact
timing of when the ECB may announce an actual tapering of
purchases. In addition, higher global uncertainty post-Trump
may impact the ECB’s reaction function for this meeting— they
may for now want to keep things as they are and take
advantage of the flexibility that the sell-off has provided them,
rather than fuel the moves we have had thus far. As such, we
choose not add to the position now, and will look to re-initiate
steepeners once we have more clarity on what the ECB
intends to do going forward.
Renuka Fernandez
21
Global Rates Weekly
2 December 2016 | TD Securities | New York
Australia/New Zealand Rates Strategy
Why Aussie 10yr Bond Futures are Heavy
 ACGB 10yrs have generally underperformed USTs
100,000
despite soft data outcomes.
Aussie fixed income has traded with a heavy tone, particularly in
the last week or so. Aussie Data outcomes have generally come
in below expectations. The softer trend in retail Sales,
Employment, today’s weaker Q3 capex print and last week’s soft
Construction Work done number all point to GDP downside.
However these weak data outcomes have failed to generate a
strong bid for ACGBs.
In fact AU-US 10yr spreads have drifted wider on this sell off,
despite weaker Aussie fundamentals and USTs driving global
yields higher. Once again there were S&P headlines that
Australia’s AAA rating remains under question, but we doubt this
was the catalyst for underperformance. ACGB issuance remains
an issue, and this could be weighing on sentiment, given that
60% of ACGB supply is targeted to maturities 10yrs and beyond.
We note that yields at the short end of the curve are drifting
higher too. 3yr ACGBs are 40bps above the current cash rate. In
our 2017 Rates Outlook we highlighted investor interest to buy at
the short end would most likely emerge around 2%, 50bps above
the cash rate. This is the top end of the 25-50bps spread that
3yrs trade above the cash rate during periods when the RBA
adopts a neutral policy stance.
With momentum clearly driving markets there is a risk that 3yrs
can extend higher in yield, trading as much as 70bps above the
cash rate. This did happen for instance during the US Taper
Tantrum. The prospect of higher short end yields necessarily
implies yields at the long end are likely to drift higher as well.
Accordingly we retain our recommendation to keep duration
short. Indeed our colleagues’ call for US yields to drift higher into
early next year argues against buying longer dated ACGBs on an
outright basis just yet as well.
Given that ACGBs have failed to perform on weaker data, we see
no rush to enter an AU-US 10yr spread compression trade. The
spread is currently at 40bps, below our 45bps entry level that we
specified in our 2017 Outlook. Should ACGBs underperform
further on weak data, then perhaps we reassess the AU-US 10yr
spread trade. For now though the 45bps entry level holds.
Volume
80,000
The VWAP on SFE 10yr bond futures (since the US
election outcome) suggests the market is caught long.
Aussie fixed income trades heavy
3
90,000
2.5
- VWAP
70,000
Volume

Figure 1:Volume distribution & VWAP for 10yr
Futures from 7 Nov to 1 Dec 2016
2
60,000
50,000
1.5
40,000
1
30,000
20,000
0.5
10,000
0
97.22
97.32
97.42
97.52
97.62
97.72
0
97.82
Source: Bloomberg, TD Securities
Futures data suggests market is long 10yrs
Our preliminary analysis of 10yr Aussie bond futures shows that
further underperformance could be at hand.
We have taken a limited window, looking at all 10yr futures trades
on the SFE between 7th Nov to 1st Dec. We calculate that the
volume weighted average price (VWAP) of 10yr futures over this
period to be 97.433. One can view this as the average level the
market has gotten itself long. With the current 10yr futures at
97.22-24, it implies the market is sitting on losses.
We had a look at where most of the volume was transacted over
this period and it was around 97.32-97.37 and we note there was
a surge in volume yesterday into month end at the bottom end of
this range.
We suspect this was the market going long and today’s price
action supports that idea, given the outsized 7 tick sell off. So with
most volume transacted around 97.32 or around that level and
the VWAP at 97.433, the market is still likely long futures. This
means there should be strong resistance to 10yr futures trading
above 97.32. The implication here being Aussie fixed income is a
sell on strength.
This negative view on the long end should mean that curves
steepen further. However we did highlight that the moves look
stretched in our Outlook. Nonetheless we will continue to hold
onto steepening trades but may consider taking them off soon as
year-end approaches. Maintain ACGB 10/18 - 05/21 and ACGB
03/19 - 04/27 steepeners.
Prashant Newnaha
22
Global Rates Weekly
2 December 2016 | TD Securities | New York
Government Auction Calendar
United States
Date
Day
Country
EDT
GMT
Auction
Size (bn)
5-Dec
Mon
US
11:30
16:30
13wk bills
USD 34
5-Dec
Mon
US
11:30
16:30
26wk bills
USD 28
6-Dec
Tue
US
11:30
16:30
4wk bills
USD 45*
6-Dec
Tue
US
11:30
16:30
52wk bills
USD 20
Date
Day
Country
EDT
GMT
Auction
Size (bn)
8-Dec
Thu
CA
12:00
17:00
30yr RRB (Dec 47)
CAD 0.7
Canada
Europe & United Kingdom
Date
Day
Country
Local
GMT
Auction
Size (bn)
5-Dec
Mon
FR
13:50
14:50
91-day bills
EUR 3.6
5-Dec
Mon
FR
13:50
14:50
155-day bills
EUR 1.7
5-Dec
Mon
FR
13:50
14:50
336-day bills
EUR 1.6
6-Dec
Tue
UK
10:30
10:30
1.5% 2026 bonds
GBP2.5
7-Dec
Wed
UK
10:30
10:30
1.5% 2047 bonds
GBP 2.25
7-Dec
Wed
GE
10:30
10:30
0% 2018 bonds
EUR 3
9-Dec
Fri
UK
10:30
10:30
28-day bills
GBP 1.5
9-Dec
Fri
UK
10:30
10:30
91-day bills
GBP 1.5
Australia & New Zealand
Date
Day
Country
Local
GMT
Auction
Size (bn)
7-Dec
Wed
AU
10:45
23:45
ACGB 1.75% 11/20
AUD 0.9
8-Dec
Thu
AU
10:15
23:15
T-note 28/04/17
AUD 0.5
9-Dec
Fri
AU
10:45
23:45
ACGB 2.75% 11/27
AUD 0.9
9-Dec
Fri
NZ
14:00
1:00
ILB 2.50% 09/35
NZD 0.1
Source: Local Treasuries and DMOs, TD Securities
Note: * Represents TD Securities estimate.
23
Global Rates Weekly
2 December 2016 | TD Securities | New York
Cross Currency Dashboard
KBN
RENTEN
EDC
BNG
NEDWBK
ONT
Q
MP
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TD
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22
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16
38
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24
IBRD
3
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10
KfW
Cash
14
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EIB
Currency
2yr
Swapped
to USD
3yr
11 9 4 4 0 6 10 12 26
31 27 … … … … … … 43
30 29 23 … … … … … …
24 16 7 11 14 8 … … 32
… 9 … … … 4 … … …
Swapped
to USD
5yr
-21
0
-8
-3
-20
Swapped
to USD
7yr
USD
EUR
CAD
AUD
GBP
Swapped
to USD
Covered Bonds
Swapped
to USD
10yr
Spread Comparisons Across Rates Spread Products
Provies
SSA
Govt
So urce: B lo o mberg, TD Securities
No tes: This analysis pro vides an apples to apples relative value co mpariso n by swapping no n-USD issues into USD via the cro ss currency basis market. Fo r example, a 2yr USD EIB issue can
be purchased at M S+11bp but a 2yr EUR EIB issue can be swapped into USD via the cro ss currency basis market to yield M S+31bp.
A ll spreads are sho wn vs USD swaps and quo ted in basis po ints. Where multiple bo nds are available, an average spread is used.
Benchmark SSA Bonds Swapped to USD
EIB USD Curve vs EIB EUR Curve Swapped
Into USD
55
50
Spread vs Mid Swaps (bp)
Spread vs Mid Swaps (bp)
45
35
25
15
EIB (USD)
5
KfW USD Curve vs KfW EUR Curve Swapped
Into USD
40
30
20
KfW (USD)
10
KfW (EUR -> USD)
EIB (EUR -> USD)
0
-5
0
2
Source: Bloomberg, TD Securities
4
6
Years
8
10
0
2
Source: Bloomberg, TD Securities
4
6
8
10
Years
24
Global Rates Weekly
2 December 2016 | TD Securities | New York
Model Portfolio—Closed Trades: Global
Notional
Entry
Date
Close
Date
Entry
Exit
Target
P&L ($k)
$50mn USD
18-Mar-16
10-Nov-16
167bp
182.6bp
140bp
-780
CAD-US 3m2y Tightener
$112mn CAD
16-Sep-16
21-Oct-16
-10.5 bp
-21.5bp
-21bp
212
Receive Canada 1y1y vs US
$203mn CAD
29-Apr-16
12-Aug-16
1.5bp
-12bp
-29bp
337
10y Tsy-Gilt
25k DV01
22-Jul-16
8-May-16
10-Aug-16
83bp
96.5bp
45bp
-337
Long CAD 30yr Breakevens vs US
$10k DV01
27-Nov-15
19-May-16
-28bp
-20bp
-5bp
106
AU$15m / US$12m
5-Feb-16
6-May-16
71bp
55bp
55bp
225
Pay Canada 5y5y vs US
$53m CAD
26-Feb-16
31-Mar-16
-16.5bp
-8.5bp
-8.5bp
200
Buy CAN M21 vs US D20
$50m CAD
19-Feb-16
24-Mar-16
-64bp
-65.3bp
-90bp
-25
$120m
8-Jan-16
21-Jan-16
-54.5bp
-40.5bp
-100bp
-400
Closed Trades
Cross-Market
Long 10yr Treasuries vs bunds
Long ACGB 04/26 / short T 11/25
Buy Canada 2s vs US
25
Global Rates Weekly
2 December 2016 | TD Securities | New York
Model Portfolio—Closed Trades: US
Notional
Entry
Date
Close
Date
Buying 15bp OTM 2w 5y Receivers
$100mn
3-Nov-16
21-Nov-16
Dec 2016 IMM 6s3s w ideners
$1000mn
7-Sep-16
21-Nov-16
2yr Sw ap Spread Widener
$127mn
6-Apr-16
21-Nov-16
Buy T 1.5% May 2019s vs OIS
$159mn
31-Mar-16
21-Nov-16
Closed Trades
Entry
Exit
Target
P&L ($k)
$65K
0
$733k
-65
34.5bp
27.25bp
50bp
-181
11.5bp
34bp
30bp
562
24.5bp
18bp
10bp
325
US
Buy 3m10y Straddles
Long 10yr Outright
5s30s Flattener
Long 10yr Treasuries
3m1y Payer Spread
2s5s Sw ap Spread Curve Flattener
5s30s Flattener
2yr Sw ap Spread Widener
10s30s Sw ap Spread Curve Flattener
Jun-Sep OIS Steepener
EDZ6-Z7 Steepener
June 2016 6s3s Basis Widener
$25mn
23-Sep-16
16-Nov-16
$660k
$1.395m
$1.2m
735
Buy $28mn in 10yr UST
7-Oct-16
28-Oct-16
1.73%
1.86%
1.55%
-298
Sell $105mn 5s, buy $24mn 30s
21-Sep-16
7-Oct-16
121bp
119.4bp
105bp
63
Buy $27.9mn in 10yr UST
13-Sep-16
27-Sep-16
1.73%
1.57%
1.55%
409
$1bn
17-Jun-16
23-Sep-16
$375K
$829K
$1750K
454
$100mn
1-Sep-16
16-Sep-16
-22.5bp
-23.4bp
-29bp
28
Sell $51mn 5s, buy $11mn 30s
2-Aug-16
1-Jul-16
17-Aug-16
111.9bp
100bp
358
$127mn
6-Apr-16
21-Jul-16
11.5bp
24.2bp
20bp
352
$273mn in 10yr, $117mn in 30yr
24-Jul-16
8-Jul-16
-34.25bp
-31bp
-40bp
-81
$8800mn
1-Mar-16
24-Jun-16
4.5bp
-2.5bp
12bp
-700
1000 contracts
22-Apr-16
13-Jun-16
27bp
18.5bp
45bp
-213
122bp
117.5bp
$1000mn
2-Dec-15
10-Jun-16
12bp
24.25
25bp
613
Buy $27.9mn in 10yr UST
20-May-16
3-Jun-16
1.85%
1.70%
1.65%
385
June 2016 FRA-OIS Widener
$1000mn
2-Dec-15
9-May-16
18.25bp
24.8bp
30bp
164
Receive 1m OIS
$12000mn
1-Mar-16
1-Apr-16
38.25bp
36.2bp
36bp
205
Sell $104mn 5s, buy $25mn 30s
25-Sep-15
16-Mar-16
105bp
160bp
134.1bp
435
Sell $104mn 5s, buy $25mn 30s
3-Mar-15
Buy $100mn 10yr TIPS, sell
$104mn 10yr UST
11-Dec-15
21-Jan-16
8-Feb-16
123.3bp
185bp
-1,872
$134mn
21-Jan-16
8-Feb-16
0.82%
0.68%
1.00%
-345
Long 10yr Outright
5s30s Flattener
Long 10yr Breakevens
Short 2s
Receive 1m OIS
EDH6-H7 Steepener
10yr Sw ap Spread Tightener
5s30s Flattener (reducing size)
Buy Jan-16 Breakevens
149bp
135bp
$3000mn
18-Dec-15
20-Jan-16
34.5bp
34.9bp
30bp
-14
1000 contracts
30-Oct-15
11-Jan-16
60bp
45bp
90bp
-400
$50mn
8-Jan-16
11-Jan-16
-8.25bp
-15.25bp
-14bp
320
Sell $208mn 5s, buy $50mn 30s
25-Sep-15
2-Dec-15
146bp
129.5bp
105bp
624
$100mn
15-Oct-15
17-Nov-15
99-26+
100-00+
n/a
221
26
Global Rates Weekly
2 December 2016 | TD Securities | New York
Model Portfolio—Closed Trades: Canada
Notional
Entry
Date
Close
Date
Entry
Exit
Target
P&L ($k)
Long N18s
$130mn CAD
15-Nov-16
1-Dec-16
66bp
73bp
50bp
-170
BAZ6/H7 Flattener
500 contracts
13-Jul-16
1-Dec-16
-1bp
2bp
-6bp
-38
BAM7/U7 Steepener
500 contracts
8-Jul-16
1-Dec-16
-1bp
5bp
4bp
72
$25k DV01
16-Mar-16
1-Dec-16
5bp
11.7bp
15bp
167
$117m
2-Sep-16
28-Sep-16
59.5bp
50.5bp
51bp
225
2s5s Sw aps Steepener
$51m 5s
25-Aug-16
13-Sep-16
4bp
12.4bp
10.5bp
210
RRB 10s30s Steepener
$5.6m D26s
29-Jul-16
26-Aug-16
39bp
33.5bp
54bp
-45
5s10s Steepener (buy 0.75% S21s vs
1.5% J26s)
$48m S21s
29-Apr-16
17-Jun-16
56.5bp
40bp
75bp
-412.5
Sell S21/J23/J25 Butterfly
$35m J23s
13-May-16
30-May-16
-1.25bp
-4.5bp
6bp
-81
Long 6-year Breakeven
$10m D21s
21-Apr-16
19-May-16
124bp
127.5bp
149bp
99
1000 contracts
3-Mar-16
18-Apr-16
99.165
99.065
99.365
-250
$61m M20s
12-Feb-16
6-Apr-16
-7.3bp
1.0bp
20bp
78
2s5s Steepener (S20/N17s)
$44mn
2-Feb-16
11-Feb-16
10.5bp
3.5bp
28.5bp
-143
Long December 2015 T-bills
$107mn
6-Jan-16
20-Jan-16
46bp
39bp
27bp
70
2s7s Steepener (J22/A17s
$60m A17s, $15m J22s
11-Dec-15
15-Jan-16
56.5bp
50bp
73bp
-65
5s9s Steepener (J24/M21s)
$10k DV01
16-Oct-15
18-Dec-15
38bp
44bp
52bp
60
9s30s Flattener (D48/J24s)
$10k DV01
9-Oct-15
1-Dec-15
93bp
86bp
80bp
70
Long BAM6
$10k DV01
23-Oct-15
29-Oct-15
99.25bp
99.23
99.37
-20
2s10s Flattener (J26/A17s)
$10k DV01
10-Sep-15
28-Sep-15
118.5bp
109bp
109bp
95
Closed Trades
Canada
1y1y/1y2y Sw aps Steepener
Long N18s
Long BAM6
Sell 2s4s5s Butterfly
27
Global Rates Weekly
2 December 2016 | TD Securities | New York
Model Portfolio—Closed Trades: Europe & UK
Notional
Entry
Date
Close
Date
Entry
Exit
Target
P&L ($k)
GE 5s30s steepener
$25K DV01
22-Sep-16
30-Nov-16
104.5bp
135bp
135bp
762.5
Dec 18/Dec 19 Short Sterling
Steepeners
$25K DV01
29-Jul-16
22-Nov-16
13bp
25bp
25bp
300
Rec 2y GBPUSD basis
$25K DV01
1-Jul-16
3-Nov-16
-16bp
-16.5bp
-35bp
12.5
Closed Trades
Europe/UK
Dec 16/Dec 17 flattener
$25k DV01
20-Oct-16
26-Oct-16
4.5bp
8bp
-8bp
-87.2
Pay 3m EURUSD basis
$20K DV01
30-Sep-16
12-Oct-16
-59bp
-38.5bp
-35bp
410
Rec 3m EURUSD basis
$25K DV01
9-Sep-16
27-Sep-16
-28bp
-45bp
-45bp
425
Short Sept 16 Short Sterling
12.5K DV01
29-Jul-16
4-Aug-16
99.67
99.68
99.63
-12.5
25K DV01
1-Jul-16
22-Jul-16
99.57
99.65
99.82
200
12.5K DV01
1-Jul-16
22-Jul-16
19.25bp
17.25bp
27bp
-25
Dec 16/Dec 17 Short Sterling Steepener
25K DV01
6-Jun-16
24-Jun-16
35bps
-1bps
6bps
-175
10y Tsy-Gilt
$50k DV01
19-May-16
17-Jun-16
40.5bp
45.5bp
25bp
-250
Receive 2y GBPUSD basis vs. pay 2y
EURUSD basis
$25K DV01
29-Apr-16
17-Jun-16
25.4bp
24.5bp
15bp
25
5y 5s10s steepeners
$25K DV01
29-Apr-16
17-Ju-n16
10bp
14bp
20bp
100
Short Sterling Dec 16/Dec 17 Flattener
$25K DV01
26-May-16
3-Jun-16
27bp
14bp
13bp
325
Short Sterling Dec 16/Dec 17 Steepener
$25K DV01
6-Apr-16
27-Apr-16
11bp
26bp
48bp
375
Short UKT 1% 2017
$25k DV01
29-Jan-16
27-Apr-16
34bp
48bp
59bp
350
Bund 10s30s flattener
$25k DV01
18-Mar-16
22-Apr-16
71bp
69bp
54bp
25
10y Bono-Bund Tightener
$50k DV01 w eighted
4-Mar-16
14-Apr-16
136bp
126bp
100bp
500
Bund 2s10s flattener
$50k DV01 w eighted
4-Mar-16
5-Apr-16
76bp
58bp
55bp
625
ERZ6/ERZ7 flatteners
1000 contracts
15-Jan-16
29-Feb-16
11.5bp
4.5bp
4.5bp
175
Long Sept 16 Short Sterling Futures
Long Sept 16 FRA-OIS w ideners
L Z6/ L Z7 short sterling steepener
10y Bund –UST tightener
5y EUR-USD basis
n/a
29-Jan-16
5-Feb-16
33bp
26bp
44bp
-6bp
$100mn
3-Dec-15
21-Jan-16
166bp
156bp
145bp
100
n/a
10-Nov-15
17-Dec-15
-43bp
-37bp
-60bp
-6bp
28
Global Rates Weekly
2 December 2016 | TD Securities | New York
Model Portfolio—Closed Trades: Australia & New Zealand
Notional
Entry
Date
Close
Date
Entry
Exit
Target
P&L ($k)
Short Aug IB
10 contracts
1-Aug-16
2-Aug-16
98.405
98.485
98.25
-200
Long Aug IB
10 contracts
13-May-16
1-Jul-16
98.445
98.395
98.485
-123
Short Jul IB
10 contracts
20-May-16
1-Jul-16
98.315
98.27
98.225
112
Closed Trades
Australia/New Zealand
Long ACGB 10/18, sell 07/17,04/20
AU$105m, A$110m, A$30m
16-Jun-16
30-Jun-16
3.3bp
1.3bp
-5bp
50
Long ACGB 04/24/short 04/20
AU$67m / AU$125m
20-May-16
22-Jun-16
52bp
42.5bp
46bp
460
Long ACGB 03/19/ short 04/26
AU$33m / AU$10m
13-May-16
22-Jun-16
70.5bp
54bp
60bp
-160
Long ACGB 04/26 / short T 11/25
AU$15m / US$12m
5-Feb-16
6-May-16
71bps
55bps
55bps
225
AU$30m
1-Feb-16
4-May-16
-8 ticks
-15 ticks
-14 ticks
175
n/a
6-Apr-15
7-Apr-15
-22
-20
-27
5
AU$40m, AU$100m
10-Feb-16
23-Mar-16
38bp
34bp
25bp
118
NZ$25m, US$19m
12-Nov-15
10-Mar-16
125bp
106bp
85bp
331
A$20m ACGB, NZ$22m
27-Jan-16
3-Mar-16
48bp
32bp
60bp
-260
NZ$80m,
22-Jan-16
3-Mar-16
-201bp
-177bp
-225bp
-580
Short Dec IB
n/a
31-Aug-15
1-Dec-15
98.215
98.25
98
21.5
QTC 19/21/22 butterfly
n/a
22-Oct-15
11-Nov-15
12.5bp
14bp
9bp
3.5bp
ACGB 3s10s curve flattener
n/a
25-Sep-15
3-Nov-15
78bp
84
65bp
-6bp
Short May / long Aug’16 IB
Short April / long June IB
Long ACGB 07/22 / short 10/18
Long NZGB/ short US 10yr
Long ACGB / short NZGB 04/23
Long 3yr CAN / short NZGB
29
Global Rates Weekly
2 December 2016 | TD Securities | New York
Government Bond Yield Forecasts
2017
2018
United States
Spot
Q1F
Q2F
Q3F
Q4F
Q1F
Q2F
Q3F
Q4F
Fed Funds Upper Bound
0.50
0.75
0.75
1.00
1.00
1.00
1.25
1.25
1.25
Fed Funds Lower Bound
0.25
0.50
0.50
0.75
0.75
0.75
1.00
1.00
1.00
3m Bill Yield
0.46
0.60
0.65
0.85
0.85
0.90
1.10
1.10
1.15
2yr Yield
1.10
1.25
1.45
1.60
1.60
1.85
2.05
2.25
2.40
5yr Yield
1.83
1.90
2.05
2.15
2.15
2.35
2.50
2.65
2.75
10yr Yield
2.39
2.50
2.65
2.75
2.75
2.90
3.05
3.15
3.25
30yr Yield
3.07
3.40
3.45
3.50
3.50
3.65
3.75
3.80
3.85
Canada
Spot
Q1F
Q2F
Q3F
Q4F
Q1F
Q2F
Q3F
Q4F
Overnight Rate
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
3m Yield
0.51
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.65
2yr Yield
0.73
0.65
0.70
0.75
0.80
0.85
0.90
0.95
1.00
5yr Yield
1.03
1.10
1.20
1.25
1.30
1.45
1.55
1.70
1.80
10yr Yield
1.62
1.75
1.85
1.95
2.00
2.10
2.20
2.25
2.35
30yr Yield
2.23
2.45
2.50
2.55
2.60
2.65
2.75
2.80
2.85
10yr CA-US Spread
-77
-75
-80
-80
-75
-80
-85
-90
-90
United Kingdom
Spot
Q1F
Q2F
Q3F
Q4F
Q1F
Q2F
Q3F
Q4F
Bank Rate
0.25
0.25
0.25
0.25
0.05
0.05
0.05
0.05
0.05
3m Yield
0.31
0.25
0.25
0.25
0.10
0.10
0.10
0.10
0.10
2yr Yield
0.11
0.35
0.30
0.25
0.20
0.20
0.20
0.20
0.20
5yr Yield
0.58
0.75
0.65
0.60
0.60
0.65
0.70
0.80
0.90
10yr Yield
1.38
1.50
1.40
1.30
1.30
1.35
1.40
1.45
1.55
30yr Yield
2.02
2.15
2.10
2.00
2.00
2.05
2.10
2.15
2.25
10yr UK-US Spread
-101
-100
-125
-145
-145
-155
-165
-170
-170
Germany
Spot
Q1F
Q2F
Q3F
Q4F
Q1F
Q2F
Q3F
Q4F
ECB Deposit Rate
-0.40
-0.50
-0.50
-0.50
-0.50
-0.50
-0.50
-0.50
-0.50
3m Yield
-0.88
-0.70
-0.70
-0.60
-0.60
-0.50
-0.50
-0.40
-0.40
2yr Yield
-0.74
-0.45
-0.45
-0.35
-0.25
-0.15
0.00
0.05
0.15
5yr Yield
-0.42
-0.20
-0.10
0.00
0.05
0.10
0.15
0.20
0.25
10yr Yield
0.28
0.50
0.65
0.85
0.95
1.05
1.20
1.30
1.40
30yr Yield
0.95
1.25
1.45
1.60
1.70
1.75
1.80
1.85
1.90
10yr GE-US Spread
-211
-200
-200
-190
-180
-185
-185
-185
-185
Australia
Spot
Q1F
Q2F
Q3F
Q4F
Q1F
Q2F
Q3F
Q4F
Cash Target Rate
1.50
1.50
1.50
1.50
1.75
1.75
2.00
2.00
2.25
3m Yield
1.60
1.75
1.75
1.75
1.95
1.95
2.20
2.20
2.45
3yr Yield
1.96
1.95
2.00
2.10
2.30
2.35
2.50
2.60
2.75
5yr Yield
2.35
2.30
2.35
2.40
2.55
2.60
2.65
2.70
2.85
10yr Yield
2.86
2.75
2.90
3.00
3.15
3.20
3.25
3.30
3.45
47
25
25
25
40
30
20
15
20
New Zealand
Spot
Q1F
Q2F
Q3F
Q4F
Q1F
Q2F
Q3F
Q4F
Cash Target Rate
1.75
1.75
1.75
1.75
1.75
1.75
1.75
2.00
2.25
3m Yield
2.04
2.00
2.00
2.00
2.00
2.00
2.00
2.25
2.50
1yr Yield
1.94
2.20
2.25
2.35
2.45
2.55
2.65
2.75
2.80
2yr Yield
2.20
2.70
2.75
2.85
2.95
3.05
3.15
3.25
3.35
10yr Yield
3.27
3.20
3.40
3.50
3.60
3.65
3.75
3.85
3.95
88
70
75
75
85
75
70
70
70
10yr AU-US Spread
10yr NZ-US Spread
Note: Yield spreads versus Treasuries quoted in basis points. All others in %.
30
Global Rates Weekly
2 December 2016 | TD Securities | New York
Key Research
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22-Nov-16 - 2017 Global Rates Outlook – A Paradigm Shift
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9-Nov-16: US Election: President Trump, Republican Senate and Republican House
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4-Nov-16: Global Rates Weekly – A Night to Remember
28-Oct-16: Global Rates Weekly – That Eerie Tantrum Feeling
21-Oct-16: Global Rates Weekly – Serenity Now
14-Oct-16: Global Rates Weekly – Breaking Out
7-Oct-16: Global Rates Weekly – The Correlation Risk
30-Sep-16: Global Rates Weekly – A Sigh of Life
23-Sep-16: Global Rates Weekly – A Sigh of Relief
16-Sep-16: Global Rates Weekly – Threading a Fine Needle
9-Sep-16: Global Rates Weekly – Opportunity or New Trend?
2-Sep-16: Global Rates Weekly – Stuck in a Moment
US Rates
30-Nov-16: MBS Convexity Risk Resurfaces
30-Nov-16: GSEs: Politics Come to the Forefront Again
7-Oct-16: What Does the Slowdown in Tax Collections Mean?
23-Sep-16: US Elections – Known Unknowns
13-Sep-16: US 10y: Fade Recent Sell-off into Fed/BOJ Next Week
7-Sep-16: Libor: Are We There Yet?
1-Sep-16: Swap Spreads: The Curve Should Get Flatter
Canada Rates
1-Dec-16: Tidying up in the Front-end
2-Sep-16: CAD Front-End: Looking for a Home atop of the Range
Europe & UK Rates
26-Oct-16: UK Rates - What's Priced In and Medium Term Trades Ahead of the Nov BoE
7-Oct-16: EUR Rates - Taper Expectations Grow
15-Sep-16: EUR Rates - BoJ Fuelled Steepening in the Bund Curve
9-Sep-16: EUR Rates: Draghi as Serene as Carney - Opportunities on Front End Basis
2-Sep-16: EUR Rates: Refocusing on ECB Buying Constraints
Australia & New Zealand Rates
1-Dec-16: Why Aussie 10yr bond futures are heavy
14-Oct-16: Stick with Steepeners
22-Sep-16: Is the New 30yr ACGB Issuance Related Steepening Over?
31
Global Rates Weekly
2 December 2016 | TD Securities | New York
Global Strategy Team
Global Strategy
Richard Kelly
Head of Global Strategy
44 20 7786 8448
Global Rates Strategy
Priya Misra
Head of Global Rates Strategy
1 212 827 7156
Gennadiy Goldberg
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Cheng Chen
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Andrew Kelvin
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Prashant Newnaha
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Renuka Fernandez
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44 20 7786 8408
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Jacqui Douglas
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James Rossiter
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Robert Both
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Brittany Baumann
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Ned Rumpeltin
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Mark McCormick
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Mazen Issa
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Global Strategy
Paul Fage
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United States
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Sacha Tihanyi
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Mike Dragosits
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Ryan McKay
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Research Home Page: https://www.tdsresearch.com/currency-rates
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32
Global Rates Weekly
2 December 2016 | TD Securities | New York
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