1、Global Rates Strategy17 May 2019Corrected Note(first published 16 May 2019)(See page 34 for details)Cross currency basis 2H19 OutlookExpected repricing of Feds cuts,cross border issuance and evolution of net T-bill supply warrant tactical positioningRates StrategyFabio Bassi AC(44-20)7134-J.P.Morgan
2、 Securities plcFrancis Diamond(44-20)7134-J.P.Morgan Securities plcKhagendra Gupta(44-20)7134-J.P.Morgan Securities plcTakafumi Yamawaki(81-3)6736-JPMorgan Securities Japan Co.,Ltd.Antoine Gaveau,CFA(44-20)7134-J.P.Morgan Securities plcShumpei Kobayashi(81-3)6736-JPMorgan Securities Japan Co.,Ltd.He
3、nry St John(1-212)834-J.P.Morgan Securities LLCSampath Vijay(44-20)7134-J.P.Morgan Securities plcSally M Auld(61-2)9003-J.P.Morgan Securities Australia LimitedSee page 34 for analyst certification and important Global cross currency bases moved wider mostly on the relative move of FRA/OIS in USD vs.
4、other currencies,while quarter end dynamic suggested very muted funding pressure We believe that the dovish turn of the Fed and the inversion of the USD money market curve have been the main drivers of the narrowing in FX OIS,with partly the evolution of T-bill issuance as additional factor In FX OI
5、S,we have a bias for wider basis at the front end of the curve over the medium term as T-bill issuance is expected to pick up in 4Q19 and Fed not to deliver insurance cuts.However,we see risk of interim narrowing in the short term with declines in T-bill issuance The volatility in global Libor bases
6、 is more likely to be driven by relative widening of USD FRA/OIS that fundamentally reflects relative USD scarcity In EUR/USD OIS cross currency basis we see room for further widening in the intermediate sector on EUR issuance before the summer months,with a bias to enter into front end wideners as
7、we approach the crowding out effect from the expected increase in T-bill issuance(wider USD FRA/OIS and wider FX OIS basis)and repricing of Fed cuts Expressing a view on front end GBP/USD OIS basis based on relative monetary policy expectations is not attractive given the shift in the relationship.W
8、e have a modest widening bias on 10Y GBP/USD basis given still attractive levels for cross-border issuance in GBP We expect USD/JPY cross currency basis to be range bound,but hold a mild widening bias on short(3-6M)and narrowing bias on intermediate(2-5Y)sector for the next few months.Against this b
9、ackdrop,we continue to hold our basis curve steepeners Stay in tactical carry trades on the SEK/USD curve;switch received exposure from 1Yx1Y into 3Mx1Y.We have a medium term mild narrowing bias on the SEK/EUR basis curve In light of slower domestic credit growth weighing on bank term funding needs,
10、as well as an improved carry profile and softer domestic funding,we prefer flatteners in the likes of 5s/10s and 5s/20s AUD/USD cross currency basis.We have a widening bias on 5Y CHF/USD FX OIS basisAll Exhibits are sourced from J.P.Morgan unless otherwise stated.2Global Rates StrategyCross currency
11、 basis 2H19 Outlook17 May 2019Fabio Bassi(44-20)7134- Cross currency basis 2H19 OutlookSince our last update in mid-January,global Libor cross currency bases have drifted broadly lower at the front end of the curve,with the exception of JPY and mostly lower in the intermediate sector,in a move more
12、driven by the relative FRA/OIS dynamics than by USD supply/demand imbalances(Exhibit 1).USD funding conditions remainedwithout any pressure over the period,the muted year-end dynamic persisted in the first few months of the year with limited quarter end pressure.Exhibit 1:Global Libor cross currency
13、 bases have drifted broadly wider at the front end of the curve(with the exception of JPY)and less so in the intermediate sector,in a move more driven by relative FRA/OIS dynamic than by USD supply/demand imbalances1Y(top table)and 5Y(bottom table)EUR/USD,JPY/USD,GBP/USD,AUD/USD,CHF/USD and SEK/USD
14、cross currency basis and statistics since 15 January 2019;bpThe volatility of cross currency basis was particularly low at the front end of the curve,especially in EUR and GBP,where volatility of the basis is now hovering close to the lows since early 2015(Exhibit 2).We attribute some of these modes
15、t volatility to a steady repricing of monetary policy from the Fed,with the removal of the additional rate hikes priced in and eventually with market pricing policy rate cuts by the end of 2019,and limited bouts of risk aversion.This low volatility was very subdued also in the intermediate sector,wi
16、th historical volatility of 5Y cross currency basis at the lows of the last few years(Exhibit 3).We believe that a large driver of the decline in cross currency basis volatility has been the overall benign environment for risky assets since the beginning of the year,with the rebound in equity market
17、s after the dismal performance of late 2018.Leaving aside recent resurfacing concerns on trade deal between US and China and more recently BTP/Bund spread,most of the quarter traded with a risk-on profile,with muted impact on cross currency basis.In terms of issuance there was a decent pick up in cr
18、oss border issuance activity.We typically see an increase in domestic and cross border issuance in the first quarter and this year proved no exception,with the additional component that the relative attractiveness increased some issuance hedging flows in EUR and to a certain extent also in GBP.1YCur
19、rent 15 Jan 19ChangeMinMaxAverageStd DevZ-ScoreEUR-17-11-7-17-9-142-2.3JPY-29-28-1-30-22-262-1.4GBP-23-5-3402-1.8AUD1925-61929252-2.3CHF-14-9-5-14-7-111-2.6SEK-15-6-9-16-6-102-2.65YCurrent 15 Jan 19ChangeMinMaxAverageStd DevZ-ScoreEUR-19-13-6-19-12-151-3.1JPY-44-473-49-40-4530.4GBP310-731072-2.1AUD2
20、730-42732302-2.6CHF-15-15-1-16-11-131-1.6SEK-50-6-51-11-3.43Global Rates StrategyCross currency basis 2H19 Outlook17 May 2019Fabio Bassi(44-20)7134- Exhibit 2:The volatility of cross currency basis was particularly low at the front end of the curve especially in EUR and GBP1M historical volatility o
21、f 1Y EUR/USD,USD/JPY and GBP/USD cross currency basis;since Jan15;bp/dayExhibit 3:and very subdued also in the intermediate sector1M historical volatility of 5Y EUR/USD,USD/JPY and GBP/USD cross currency basis;since Jan15;bp/dayThe 2018 year end turn,looking at EUR/USD for example,appeared earlier t
22、han usual in 4Q18,with a decent widening in mid to late October,but dissipated pretty quickly.In the quarter end at the end of March the turn dynamic was more muted.After adjusting for the number of days in the period we note that the end-of-March quarter turn was particularly subdued for the entire
23、 quarter suggesting as discussed above virtually no funding stress over the period(Exhibit 4).Exhibit 4:After a year-end turn which appeared early in 4Q18 but dissipated quickly,the quarter end turn(adjusted for number of days)was subdued with virtually no USD funding stressMarch quarter-end turn in
24、 FX OIS EUR/USD basis adjusted for the number of days in the turn in the firstquarter of year in 2017,2018 and 2019;bpAs our frequent readers may recall,we typically run a Principal Component Analysis(PCA)across major currencies to assess the drivers of global cross currency bases.The objective is t
25、o find market variables that are locally empirically correlated with the dynamic of the first factor and could be used to make a call on the evolution of the bases.At different point in time we find that fundamental macro drivers such as the relative monetary policy difference are statistically sign
26、ificant in explaining the variability of the cross currency bases,whereas in other episodes risk aversion 0.01.02.03.04.05.06.0Jan 15 Jul 15 Jan 16 Jul 16 Jan 17 Jul 17 Jan 18 Jul 18 Jan 19EUR/USDGBP/USDUSD/JPY0.00.51.01.52.02.53.03.5Jan 15 Jul 15 Jan 16 Jul 16 Jan 17 Jul 17 Jan 18 Jul 18 Jan 19EUR/
27、USDGBP/USDUSD/JPY-2500-2000-1500-1000-500002 Jan16 Jan30 Jan13 Feb27 Feb13 Mar27 Mar2019201820174Global Rates StrategyCross currency basis 2H19 Outlook17 May 2019Fabio Bassi(44-20)7134- variables such as implied rates volatility or intra-EMU spreads become locally more relevant.To separate the dynam
28、ic between Libor and FX OIS bases we now run two sets of PCA analysis,one on the global Libor and the other on the global FX OIS bases.By doing so we are able to separate the component of the basis coming from pure USD scarcity considerations(FX OIS)or from the combined effect including the relative
29、 FRA/OIS dynamic(Libor bases),which given the higher relative volatility is often a call on USD FRA/OIS.If we simply regress the first factor of the PCA for the Libor basis against the first factor of the PCA for the FX OIS basis we find that we cannot explain the volatility of the Libor bases unles
30、s we add the level of USD Libor fixings(Exhibit 5),which is statistically significant.This confirms the evidence of cross currency Libor bases narrowing more or widening less than OIS bases when USD FRA/OIS is outperforming FRA/OIS in other currencies and vice versa.Exhibit 5:The evolution of USD Li
31、bor fixings explains most of the difference between the first PCA factor of 5Y cross currency basis in Libor and OIS spaceFirst factor of PCA*analysis of Libor bases run since January 2013 regressed against first factor of PCA analysis of OIS bases and 3M USD Libor fixings;since Jan15;%*PCA runs sin
32、ce January 2013 on 5Y G3 Libor and FX/OIS bases separatelyThe continue relative narrowing of USD FRA/OIS vs.other currencies since the beginning of the year has resulted in a mechanical widening of the Libor cross currency bases,while FX OIS bases were broadly stable to a touch tighter among various
33、 currencies(Exhibit 6).At the front end of the curve,over a short term regression,we note that USD FRA/OIS explains most of the difference between the first PCA factor for the Libor and OIS basis(Exhibit 7).Looking ahead,we expect this dynamic to continue and we believe that potentially larger volat
34、ility in USD FRA/OIS are making it difficult to use Libor basis to express views on the relative scarcity of USD.y=0.12*(3M USD Libor)+0.58*(first factor of PCA analysis of OIS bases)-0.16R=92%-0.3-0.2-0.10.00.10.20.30.000.501.001.502.002.503.003M USD Libor fixings;%5Global Rates StrategyCross curre
35、ncy basis 2H19 Outlook17 May 2019Fabio Bassi(44-20)7134- Exhibit 6:The relative narrowing of USD FRA/OIS has mostly contributed to the widening of the global Libor basis1Y FRA/OIS in USD,EUR,GBP and JPY;since Jan15;bpExhibit 7:At the front end of the curve USD FRA/OIS explains most of the difference
36、 between the Libor and OIS basis;we expect this dynamic to continueFirst PCA factor for 1Y Libor cross currency basis in EUR,GBP and JPY(since early 2013)regressed against 1)first PCA factor of 1Y FX OIS basisand 2)spot FRA/OIS in USD(3M USD Libor fixing 3M USD OIS rate);past 1Y;Looking ahead,we pre
37、fer to run our analysis on the fundamental drivers of the FX/OIS basis,to separate the valuation from the relative FRA/OIS dynamic.Analysis of the first PCA factor of the 1Y FX OIS basis suggests that monetary policy continue to remain the main driver of the recent narrowing.Exhibit 8 shows the 1Y r
38、egression of the first PCA factor of the FX OIS basis against two proxies of relative monetary policy,the slope of USD money market curve(measured as the difference between 1M OIS rate 3Y forward and spot 1M OIS)and the average of 2Y government yield in Germany,Japan and UK.Exhibit 8:The main driver
39、 of OIS cross currency basis remains the monetary policy difference with the repricing of Fed rate hike expectations explaining the recent move in FX OIS cross currency basisRegression between the first PCA factor of 1Y FX OIS basis and the slope of USD money market curve(measured as the difference
40、between 1M OIS rate 3Y forward and spot 1M)and the average of 2Y government yield in Germany,Japan and UK;past 1Y;-100102030405020152016201720182019USDEURGBPJPYy=0.59*(first factor of PCA analysis of OIS bases)+0.42*(spot 3M USD FRA/OIS)+0.04R=85%-0.25-0.20-0.15-0.10-0.050.000.050.100.15-0.35-0.30-0
41、.25-0.20-0.15-0.10-0.05 0.000.050.100.15First PCA factor for 1Y OIS basis y=-0.16*(slope of USD mmkt curve)+133*(avg of 2Y govt yield in Germany,Japan and UK)+1.80R=75%-30-20-1001020-60-40-20020406080100120Slope of USD money market curve;bp6Global Rates StrategyCross currency basis 2H19 Outlook17 Ma
42、y 2019Fabio Bassi(44-20)7134- The signs of the betas are correct and the larger t-stat confirms that most of the contribution to the narrowing came from the market removing about 75bp of tightening priced in the USD OIS curve and pricing now about 50-60bp of easing by the end of next year.In terms o
43、f other drivers in addition to monetary policy we believe bouts of risk aversion and evolution of T-bill issuance are likely to be the more relevant.In the past we have looked at the empirical correlation between the first factor of our PCA analysis and the evolution of proxy of risk aversion such a
44、s implied rates volatility or intra-EMU spreads.In a quarter which broadly delivered little volatility,with the exception of some recent noise on the BTP/Bund spread we find that the contribution of risk aversion as possible driver of cross currency basis has been quite muted.Additionally,despite th
45、e recent volatility,any BTP/Bund widening dynamic is likely to be seen more as an idiosyncratic fiscal story rather than a systemic drivers,thereby reducing the beta of cross currency basis.On the other side,as discussed in the past we believe that there is a sensitivity of global cross currency bas
46、is to the amount of US T-bill issuance.The increase in T-bill issuance tends to put widening pressure in the FX OIS basis,mostly via the crowding out effect of USD investment,which could be seen,other things being equal,as a decline in the supply of available USD to the market.The dynamic in the Lib
47、or bases could be different for the reason that typically an increase in T-bill issuance tends to be associated with higher USD Libor fixings and wider USD FRA/OIS,counterbalancing the effect on the FX OIS bases.Exhibit 9:The evolution of T-bill issuance will become an important driver especially in
48、 4Q18 when we expect a temporary pick upRegression between the first PCA factor of 1Y FX OIS basis and a)6M rolling change in US T-bill outstanding supply b)the slope of USD money market curve(measured as the difference between 1M OIS rate 3Y forward,quadratic fit)and c)spot 1M)and the average of 2Y
49、 government yield inGermany,Japan and UK;past 2Y;Exhibit 10:Projected negative net T-bill issuance over the short term could lead to some interim narrowing in FX OIS however we are biased for wider front end basis over the medium term on Fed not delivering the insurance cuts priced inProjected net i
50、ssuance of T-bills and Treasury operating cash balance;$bn bothIn Exhibit 9 we add the rolling 6M change in US-T-bill issuance as a regressor and we find that the sign of the regression is negative and statistically significant.The projection for the evolution of T-bill issuance is shown in Exhibit
