Wednesday, January 28, 2015

Trade Idea: Long End ASW Widener vs. Long Vol

The  ECB QE in Europe can play out through either expectation channel (inflation expectation leading to long-end sell off) or portfolio re-balancing channel (leading to a general rally). Based on the numbers from my last blog on this, at least for Germany I expect the portfolio re-balancing to be stronger. So we can expect a rally or status quo in near future.

Given  the short end Germany already near zero there is little room left to push it down further compared to swap. In pricing in any uncertainties, there is bigger room on the long end. The negative carry rolling to the 2 year point (which is even more negative on yields) clearly indicates that. This is the same reason that we will have less of a steepening pressure on euro curves from QE (as opposed to what happened in the US). 

Add to this, the interesting relationship of the long end ASW to vols, in rates and across asset classes.Since turn of the last year, the Euro ASW spreads (spread to Germany vs. interest rates swaps) has shown remarkable correlation to volatility in levels. If the correlation is maintained this implies a possible way of trading convexity through this spread going forward. On the long end, 10y shows similar characteristics, but less pronounced.

30 year ASW already widened quite a bit, but given the uncertainties around Greece, there is good chance for further move. This is a fantastic opportunity to proxy a long vol trade, with positive carry!!

The 30 year ASW actually narrowed in 2008 blow-out, but that was presumably driven mostly by receiving pressure from exotics and ALM desks. This time that pressure should be absent, at least given the level of rates.

[UPDATE] The updated numbers and charts on ECB QE

Till Sep 16 (19 months from Mar 15)
Total purchase @60 B/ month) : EUR 1140 B
Total ABS (@~12 B/ month): EUR 230 B
Total EU Inst. (@12% of Addl Purchase): EUR 110 B
Implied Sov Purchase (remaining): EUR 800 B

Total Risk Sharing @12% (EU Inst, purchase by NCBs) + 8% (Sovs, purchase by ECB) = 20%. Rest sov to be purchased by NCBs
Sov Risk Sharing EUR 72 B out of 800 B

Tenor: Min 2 year, Max 30 year

Updated chart above(based on approximate current O/S and assumption of no net new issuance). In the US, QEs had generally had selling off pressure for yields. However, MBS yield generally lowered, and according to Fed research, the Fed QE resulted in holding substantial market share in MBS that explains the impact beyond expectation channel (through portfolio re-balancing effect). Given the high share of core for proposed ECB purchase, this might generate net rallying pressure for rates.

1. QE2 size of 600 B, calculated on current O/S debt
2. QE3 size of 45 B/per month assuming 19 months of purchase on current O/S debt

No comments:

Post a Comment