Interest Rates Research 14 June 2013

PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 71

Global Rates Weekly

UPDATE: Withdrawal symptoms This report corrects the Euro Inflation Linked article. A version published yesterday inadvertently repeated the previous week’s article.

• At the upcoming press conference, we expect Chairman Bernanke to strike a balanced tone, given the recent sell-off in risky assets, falling inflation expectations, and the continued labor market improvement. In this context, we recommend going long 10y US Treasuries if yields rise to ~2.25% and maintain our 7s30s Treasury curve flattener recommendation.

• We also recommend receiving US 10y10y swap rates and buying 10y10y vol as attractive risk-reward expressions of long duration bias trades.

• We expect the JGB yields to remain volatile, driven by low liquidity and vulnerability to external shocks. We recommend being short 2s5s10s swap fly.

Global

Withdrawal symptoms 2 We expect the Fed to strike a balanced tone at the next FOMC meeting, given the confluence of underperforming financial markets, decreasing inflation expectations and continued labor market improvement. US 10y Treasuries above 2.25% would be a near-term buying opportunity, in our view.

United States

Fear and loathing in rates 6 We recommend going long 10y Treasuries at 2.25%. We continue to favor 7s30s curve flatteners and remain neutral on gamma. Receiving 10y10y swap rates and buying 10y10y vol are attractive risk-reward expressions of a long duration bias. We turn neutral on 7s-30s spread curve flatteners, but stay long front-end spreads.

Euro Area

Lending in the euro area: renewed weakness or a trough in sight? 26 Lending to euro area corporates showed renewed weakness in April. But, if anything, leading indicators suggest lending should not post large declines from here, and could be close to flat. These scenarios should support a recovery, or at least cease to be a large drag on it.

UK

Front-end carnage? 41 The correction on the GBP market has seen the 5y sector suffer. Overall, rate expectations remain relatively subdued and calendar spreads are still compressed, suggesting that further steepening may be necessary.

Japan

Stability is not within reach 52 At first glance, the volatility in JGB yields appears to have calmed. However, developments in risk assets could still prompt wide market swings and liquidity remains depleted. JGB markets remain vulnerable to overreaction in the event of an external shock.

Views on a Page 5

Trade Portfolio Update 55

Global Supply Calendar 69

Global Bond Yield Forecasts 70

United States

TIPS: How low can they go? 13

Agencies: Deconstructing a dislocation 16

Swaps: Repo specialness: A note from 10y ago 20

Money Markets: Is QE dislocating repo? 22

Europe

Sovereign Spreads: Sovereign short- selling restrictions – six months after 30

Swaps: Strategic widening value in EUR and UK ASWs 36

Money Markets: 3m Euribor – still room to move up 39

Covered bond/SSA: Life through a different lens 43

Scandinavia: Norges Bank preview: Unchanged policy rates and slightly more hawkish tone 45

Euro Inflation Linked: Livret A hedging... Finally 47

Volatility: Carry the belly 50

www.barclays.com

Barclays | Global Rates Weekly

14 June 2013 2

GLOBAL THEMES

Withdrawal symptoms We expect the Fed to strike a balanced tone at the next FOMC meeting, given the confluence of underperforming financial markets, decreasing inflation expectations and continued labor market improvement. US 10y Treasuries above 2.25% would be a near-term buying opportunity, in our view.

Global markets continue to adjust to the prospect of eventual policy normalization in the US. Next week, all eyes will be on the FOMC and the ensuing press conference; despite recent tumult in global markets, which are showing signs of withdrawal symptoms, we believe that the Chairman will strike a balanced tone.

On one hand, he can hardly backtrack from the message that Fed officials have been delivering in recent months, that if labor market indicators continue to improve, it would warrant a reduction in the size of asset purchases at one of the next few meetings, especially if the data on economic growth show signs of improvement. On the other hand, he will likely also acknowledge that the FOMC is keeping an eye on market conditions, especially given the speed of the compression in inflation expectations.

From a rates perspective, the hawkish surprise would be if the Chairman does not acknowledge that incoming data have been soft or that there are downside risks to the Fed’s growth forecasts. The dovish surprise would be if he manages to delink the timing of any tapering from eventual rate hikes – this is clearly a difficult proposition without taking a clear stand on how much of the drop in labor participation rate is cyclical versus secular – something on which the Fed has already sent mixed messages.

It is apparent that mere talk of an eventual exit from unconventional monetary policy has sparked tumult across asset classes globally. Stock indices in the US are off 3-4% from their Q2 highs, and IG credit and high yield credit indices have widened 18 and 97bp, respectively, wiping out a little under half the tightening that took place over the past year. 10y real rates are nearly 90bp higher, well above levels where QE3 was initiated, while primary mortgage rates have risen roughly 70bp off their lows. Emerging market equities and debt have been hit harder than most, as concerns about weak Chinese growth, coupled

Rajiv Setia

+1 212 412 5507 rajiv.setia@barclays.com

Amrut Nashikkar +1 212 412 1848 amrut.nashikkar@barclays.com

We believe that Chairman Bernanke will likely strike a balanced tone at the next FOMC press conference

FIGURE 1 Risky assets have underperformed, but many are still up for the year

FIGURE 2 5y5 breakevens have declined but are still above levels where previous accommodative measures were launched

intra-Q2 high chg

QTD chg

YTD chg

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S&P500* -3% 3% 14% 25% CDX IG 18bp -4bp -8bp -37bp CDX HY 97bp 3bp -54bp -220bp 10y breakevens -50bp -49bp -43bp -7bp 10y real yield 88bp 78bp 86bp 65bp MSCI EM Equities ETF* -11% -7% -11% 6% EM Bond ETF* -8% -3% -7% 4% AUD Currency -9% -8% -8% -3% BRL Currency -8% -6% -4% -3% Mortgage REIT ETF* -13% -12% 3% 9% High yield Muni ETF* -6% -4% -3% 2% S&P500 Utilities Index -10% -5% 6% 2% *: on a total return basis

Source: Bloomberg, Barclays Research Source: Bloomberg, Barclays Research

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Barclays | Global Rates Weekly

14 June 2013 3

with a potential reversal of DM flows that have buoyed growth, continue to weigh on sentiment. Higher yielding currencies such as the AUD and BRL have also proven susceptible to normalization fears and are now 8-9% below their Q2 peaks.

The question is, have market conditions worsened sufficiently to give the Fed pause? In our view, the answer is not yet: financial conditions have tightened only modestly when evaluated over a longer horizon. After all, some corrections in asset class performance are always to be expected when a shift in monetary policy regimes becomes apparent. Viewed in that context, while the performance of most risky assets has been rocky, key asset classes are either still substantially up compared with a year ago, or only slightly lower.

Look at inflation expectations and equities for signals Given the volatility across asset classes globally, a hawkish signal by the Fed will not be without risks. We believe that the focus will squarely remain on the performance of US stocks and TIPS breakevens. If stock prices decline another 5-10%, it may be sufficient to

FIGURE 3 Financial conditions still very easy from a long-term perspective

FIGURE 4 Real yields have risen sharply, even as economic data have disappointed

Source: Bloomberg, Barclays Research Source: Federal Reserve, Bloomberg

Financial market conditions have not deteriorated substantially for the Fed to change its policy stance

FIGURE 5 QQE effect on real rates and inflation expectations in Japan has been reversed

FIGURE 6 Given the yen strengthening and the reversal in the Nikkei, financial conditions have tightened since May.

Source: Barclays Research Source: Bloomberg, Barclays Research

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Barclays | Global Rates Weekly

14 June 2013 4

raise questions about the strength of prospective US consumption via wealth effects, denting the Fed’s growth forecasts.

Similarly given the sharp decline in US breakevens, a continued compression of 20-25bp in 5y5y or 10y breakevens may be sufficient for the Fed to signal that inflation expectations have fallen substantially.

If either or both these conditions are met, we believe that the Fed could signal a delayed exit to unconventional monetary policy. After all, it has many reasons to stay put: core PCE at 1.1% y/y is well below its own forecasts and is showing little signs of normalizing. Similarly, while 2014 growth prospects appear brighter, it is largely because of less fiscal drag; activity over the next few quarters is still expected to be sluggish, at about 2%. Also, unemployment remains well above the Fed’s NAIRU estimates, and the faster-than-expected improvement has partly derived from a sharp drop in the labor force participation rate. Declaring victory on the policy front, given all these near-term uncertainties, and especially with global growth also lackluster, may very well ultimately prove premature.

US 10y rates above 2.25% would be a near-term buying opportunity Given the economic outlook and the fact that markets are pricing in the Fed to be much more aggressive than was the case a few months ago, we believe that 10y US rates above 2.25% would be an opportunity to go long tactically with a target of 2% and a stop at 2.4. We also believe that there are several attractive risk-reward implementations of expressing a long duration bias in US rates. In the US Rates Strategy section of this publication, we discuss the following ideas.

1. Receiving 10y10y rates, as we believe that long-dated forwards are better priced for the eventual removal of accommodation, offering lower downside in a continued sell-off.

2. Buying 10y10y vols, where dealer hedging should lead to an increase if rates rally, but the decline in a sell-off should be much lower.

3. Buying broken receiver flys (for those expecting a modest reversal in rates) and selling payer spreads (for those expecting a larger rate rally).

Japan remains a source of global uncertainty Elsewhere, policy uncertainty out of Japan continues to drive volatility in global markets. After the initial euphoria surrounding the BOJ announcement in early April, the yen and the Nikkei have retraced their entire April/May run-ups. 10y JGBs yielded 56bp before the “shock and awe” announcement and are currently 30bp higher, after breaching 1.0% in late May. The rise in rates since early April has almost entirely been driven by higher real rates, as breakevens are roughly unchanged since early April.

While higher real rates could be justified somewhat by expectations of better growth, the point is that QQE was supposed to lower real rates to stimulate the economy, while simultaneously raising inflation expectations. Instead, the market seems somewhat disappointed, with the pace of structural reforms announced by Prime Minister Abe thus far (although we expected little ahead of House elections) and by this week’s BOJ announcement, where the central bank refrained from extending the maturity of its fixed rate fund supplying operations.

The key lesson of the Japanese experience, in our view, is that monetary policy based on balance sheet expansion and communication regarding future policy has its limitations because it can be potentially destabilizing for financial markets if expectations are not managed appropriately. It remains an open question as to how well the Fed will deal with potential market volatility as it tries to extricate itself from unconventional monetary policy.

10y rates at 2.25% in the US would be a buying opportunity, in our view

Meanwhile, Japan remains a source of considerable uncertainty for global financial markets

Barclays | Global Rates Weekly

14 June 2013 5

VIEWS ON A PAGE US EUROPE JAPAN

Direction • Economic data in the US remain modest, with the fiscal deal and the sequester likely to exert significant drags.

• The labor market continues to show only modest improvement, but uncertainty about the Fed’s reaction function has increased.

• We recommend going long 10s at 2.25%.

• In general we recommend being neutral on money markets rates as several factors are at play that could result in a further upward adjustment of rates. After the recent increase in pressure on peripheral bonds, Spanish auctions next week will move into the spotlight.

• UK: The correction on the GBP market has seen the 5y sector suffer. Overall, rate expectations remain relatively subdued and calendar spreads are still compressed, suggesting that further steepening may be necessary.

• We believe that the direction of the markets will remain uncertain prior to the FOMC meeting and that yields will be swayed in the meantime mainly by special supply/demand factors such as auctions and BoJ operations. The markets remain vulnerable to event risk due to the decline in liquidity, but we see 1% as the upside for 10y yields for now.

Curve/ curvature

• We maintain 10s30s flatteners, as the curve looks too steep, given inflation expectations.

• We maintain our long front-end Tsy vs. OIS view, given improving financing conditions. The 2y sector looks cheap.

• We maintain a short view on a weighted 5s10s20s fly to position for a decline in the term premium.

• Shorten on the Cs STRIPS curve into the 10-12y area; switch out of rich 20y Tsy P STRIPS to 20y REFCO P STRIPS.

• Hold on to receive EUR 5y5y/5y10y/5y15y fwds.

• Hold onto pay EUR 5y10y/5y15y/5y20y fwds.

• UK: Longer-dated nominal gilt yields remain rich, underpinned by low real rates, Into Q3’s busy supply calendar, the curve may look to reverse recent front-end induced flattening Into super long supply in June, hold 2052/2060 steepeners. In the short end 6y sector looks rich versus the front end in micro RV after the sell off

• 1s3s5s short vs 3s5s7s long.

Swap spreads

• Maintain 2y spread wideners as an option on a risk flare.

• We turn our 7s30s/10s30s spread curve flatteners view.

• EUR: Keep long 10s/30s ASW box in France

• GBP: While short-dated asset swaps can remain well supported between now and end-June, we see 30y ASW vulnerable both outright and on the ASW curve into May and June’s supply.

• 20s30s box (20y long).

• Short 10y and 5y.

Other spread sectors

• We continue to favor long-end agency-Treasury spread tighteners but find the most upside potential only in the super-long end. 7s have underperformed along the curve and now offer more than 20bp of spread pick-up to Treasuries; shorten duration to 10s with no spread give-up.

• We remain constructive on Canadian covered bonds, given their relative isolation from Europe and continued significant spread pickup to agencies. Pockets of value persist in USD SSA space.

• SEK: Hold SEK/EUR 10y tighteners in swaps and longs in SEK Sep ‘13 3m FRA.

• NOK: Enter Sep ‘13/Sep ’14 3m FRA cross market steepeners versus EUR

• Hold Spain and Italy 2s/5s/10s.

• Hold Spain 5s/10s/30s.

• Hold onto short Spain 10s/15s/30s.

• Long 5-8y Netherlands and Finland versus France.

• Long FRTR Oct ‘19/Oct ‘22/Apr ‘26 fly.

• Pay USD/JPY 1yx1y basis.

• Pay USD/JPY 4y basis.

Inflation • We recommend legging into front-end breakeven longs (1y and under) as they are 80-85 cheap versus CPI forecast, energy hedged. Specifically, we like being long April14s.

• Ahead of the FOMC, neutral on real rates and breakevens beyond the front end.

• For investors expecting an increase in risk aversion, we recommend long Apr17s versus Jan17s for the par-floor outperformance.

• OATi21 attractive on the OATi real yield, breakeven and asset swap curves.

• Short-dated UK linker breakevens fundamentally cheap, but potential selling flows remain of concern.

• Breakevens have started to rise even with negative carry intact, and we expect this trend to continue for now. Over the short term, there is probably an opportunity for capital gains. However, it is difficult to determine where levels will settle over the medium to long term. In establishing long positions over such a horizon, we recommend paying attention to levels.

Volatility • We turn neutral on gamma, as levels should consolidate over the new few weeks.

• Initiate 1m*7y vs. 3m*7y calendar spread, as 7y rates will likely stay rangebound amid Fed policy uncertainty.

• Buy 1y*30y risk reversals, delta hedged (long receivers) to fade the current skew valuations

• Buy EUR1y*30y 100bp wide risk reversal (long receivers) to hedge a risk flare in the eurozone.

• Initiate GBP 3m*(7-30y) bull steepener to position for a reversal of the recent cheapening of GBP belly yields.

• Buy EUR 6y*5y versus 1y*(5y5y) to position for steepening of the vol surface and monetise the range in rates.

Source: Barclays Research

Barclays | Global Rates Weekly

14 June 2013 6

UNITED STATES: RATES STRATEGY

Fear and loathing in rates We recommend going long 10y Treasuries at 2.25. We continue to favor 7s30s curve flatteners and remain neutral on gamma. Receiving 10y10y swap rates and buying 10y10y vol are attractive risk-reward expressions of a long duration bias. We turn neutral on 7s-30s spread curve flatteners, but stay long front-end spreads.

Rates continued to sell off, with 10y rates 8bp higher over the week (after reaching 2.28% intra-week) and the rate and the spread curves continuing their flattening trends. The 7s30s swap curve is now flatter by 14bp from the peak of 186bp it reached in mid-May, while the 7s30s spread curve is flatter by nearly 7bp from its peak (Figure 1). The underperformance in rates, mortgages and TIPS has now spread to a wider range of asset classes, as the markets continue to adjust to the possibility of eventual monetary policy normalization.

We have argued for several weeks that the tapering of asset purchases is more than adequately priced in; rather, it is the uncertainty about the timing of the first hike that is now causing rate volatility. Since late 2011, when forward guidance was introduced, the economy has grown only roughly 2%. Even as growth was bumping along at trend, the unemployment rate during this period fell from 9% to 7.6%. Despite this, fed funds futures pricing shows that the number of months before the first Fed hike remained nearly constant at about 30 (Figure 2). In other words, given slower growth than forecast and tepid inflation, the market was comfortable that the Fed would remain accommodative despite the drop in the unemployment rate.

Given the seemingly higher weight the Fed is now placing on labor market metrics, the market is less sure this time, and we are priced for a hike of 50bp in March 2015, soon after the unemployment rate dips below 6.5%. Despite media reports on Thursday afternoon that suggested that the Fed will continue to keep rates low even after it tapers asset purchases, the key uncertainty in rates will continue to be about the time when the 6.5% threshold will be reached.

Rajiv Setia

+1 212 412 5507 rajiv.setia@barclays.com

Anshul Pradhan +1 212 412 3681 anshul.pradhan@barclays.com

Amrut Nashikkar +1 212 412 1848

amrut.nashikkar@barclays.com Piyush Goyal

+1 212 412 6793 piyush.goyal@barclays.com

Vivek Shukla +1 212 412 2532 vivek.s.shukla@barclays.com

FIGURE 1 Cumulative moves in the rates market over the past month: 10y Treasuries selling off, 7s30s curve flatter, 10s30s spread curve flatter

FIGURE 2 The number of months to the first hike was stable in 2012 and early 2013, despite the fall in the unemployment rate; this time is different

Source: Barclays Research Source: Barclays Research

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Barclays | Global Rates Weekly

14 June 2013 7

The key point is that a large portion of this sell-off has been driven by a change in market expectations for the path of Fed policy rates. It has not come about because of a rise in the term premium, which is corroborated by the relative outperformance of 30y Treasuries. Of course, if risk assets underperform more and inflation expectations continue to decline, the probability of the Fed’s delivering a hawkish surprise will be lower. Given the slowdown in recent data (Figure 3), we believe there is an increasingly favorable risk-reward to going long duration for a tactical trade, if 10y rates back up to 2.25 or thereabouts.

June FOMC: Hawkish/dovish signals to watch

Labor market At the March press conference, Chairman Bernanke noted that there had been an improvement since the launch of QE3 but the Fed wanted to ensure that the improvement was not temporary. He pointed to 200K jobs growth per month over the past 5-6 months, the 0.5pp decline in the unemployment rate and post-crisis lows of initial claims. Since then, information on the labor market has not been unambiguously strong. Over the past three months, payroll growth has slowed to 155K/m, and most expect it to accelerate only modestly, to 175K/m in Q3. On the other hand, the unemployment rate has fallen further, from 7.74% in February to 7.56%. In addition, U6, a broader measure of unemployment, has fallen even faster, driven by a sharp drop in marginally attached workers. Initial claims have remained low. Were the Fed not to acknowledge the recent drop in payroll growth and focus only on the level of unemployment rate, it would be construed as hawkish.

Inflation outlook At the latest hearing, Chairman Bernanke noted the low level of realized inflation but pointed out that “measures of longer-term inflation expectations have remained stable and continue to run in the narrow ranges seen over the past several years.” Since then, 5y5y breakevens have fallen 30bp, to 2.25%, and are now towards the lower end of the range over the past few years (2-3%). Whether this decline is sufficient to change the FOMC’s view should be closely watched. In addition, FOMC participants are likely to revise their near-term inflation forecast lower (from 1.55% for core PCE for 2013 at the March FOMC meeting). But if their medium-term forecasts are unchanged at 1.95% for 2015 or only slightly lower, it would suggest that the FOMC is not yet worried much about recent inflation trends. Characterizing long-run expectations (either market or their own) as “still anchored” would be deemed hawkish; an acknowledgement of the sharp fall in breakevens would be dovish.

Pace of asset purchases At the March press conference, Chairman Bernanke noted that as progress was made towards the ultimate objective of substantial improvement, the Fed may adjust the rate of flow of purchases accordingly. With the Fed unlikely to taper at the June FOMC meeting, discussion of whether it has seen enough progress to dial back the pace of purchases would be closely watched. Were the Chairman to downplay the recent fall in inflation expectations/slowdown in payroll growth and point to the unemployment rate, the market may still pull forward the timing of the first taper, as most still expect it to be a Q4 event.

Labor Force Participation Rate (LFPR) At the March press conference, Chairman Bernanke characterized the drop in LFPR as “mostly because of demographics factors,” but in his latest testimony, he noted that the decline was a sign of a weak labor market. The former points to a hawkish reaction function, as the unemployment rate has fallen even as growth has remained sluggish; the LFPR has declined 2.7pp over the past three years. Given mixed messages, clarification on how the Fed views the decline (how much is cyclical vs. secular?) would help investors gauge the progress towards the employment mandate. If the fall is deemed as mostly

Given the slowdown in recent data, we believe there is an increasingly favorable risk-reward to going long duration for a tactical trade, if 10y rates back up to 2.25 or thereabouts

Barclays | Global Rates Weekly

14 June 2013 8

secular, then the current level of unemployment rate should be seen as the appropriate measure of slack, and a further fall in it due to a continued decline in LFPR should not be discounted. Such an outcome can still be perceived as hawkish, as 150k/m in payroll growth with a 0.3pa drop in LFPR would cause the unemployment rate to get to 6.5% by September 2014 (see Twisting in the wind, June 7, 2013), well before the market’s expectation of the first hike.

Unemployment rate threshold At the March press conference, Chairman Bernanke noted that the Fed could lower the unemployment rate threshold, but at that point, 6.5% was sufficient to approximate “the optimal control path of interest rates, that it seems to give a path of unemployment and inflation that’s about as good as we can get with the monetary policy tools that we have”. Were the Fed to lower its medium-term inflation forecasts and/or emphasize the cyclical portion of the decline in LFPR, Chairman Bernanke could hint at the possibility of lowering the threshold to provide further stimulus. This should help push out the start of the hiking cycle; the market is now pricing in a 40% chance of the first hike by December 2014.

Market implications

Duration: Initiate tactical long if 10s reach 2.25% We continue to believe that 10s are likely to trade in a near-term range of 1.9-2.25%. Given the slowdown in recent economic data and risky asset underperformance, this suggests a favorable risk-reward to going long duration.

In the event of medium-term payroll growth slipping because of the weak economy, 10y yields could rally to below 2%. In our view, 2.4% represents an outer bound for how much spot 10y rates could sell off, even given aggressive assumptions about the normalization of Fed policy.

Rates selling off significantly beyond 2.4% would require a major rise in the term premium. We do not expect term premia to rise, as inflation risk premia should remain low, given lower-than-target inflation, and the Fed has indicated that it would hold on to assets even after it begins hiking rates. Therefore, a significant increase in uncertainty about Fed policy would be required to increase real risk premia. As Thursday afternoon’s media reports

Were the Fed to lower its medium-term inflation forecasts and/or emphasize the cyclical portion of the decline in LFPR, Chairman Bernanke could hint at the possibility of lowering the threshold to provide further stimulus

FIGURE 3 Real yields have risen even as economic data continue to surprise to the downside

FIGURE 4 Long-term forwards have declined, with lower long-term inflation expectations and slower potential growth

Source: Barclays Research Note: Potential growth based on CBO estimates, long-term inflation expectations

from Survey of Professional Forecasters. Source: CBO, Philadelphia Fed, Barclays Research

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Barclays | Global Rates Weekly

14 June 2013 9

regarding the Fed’s discomfort with rising hike expectations suggest, the Fed is unlikely to let uncertainty about its policy linger.

As a result, we would recommend going long 10y Treasuries if yields rise to 2.25% or so, with a stop-out at 2.4% and a target of 2%. Increases beyond 2.4% in the near term would imply that either market conditions or fundamentals have changed substantially more than we expect.

As we highlighted last week, there is some room for forward rates in the 5-10y sector of the curve to increase. The risk is that the core of the FOMC comes to the conclusion that trend payroll growth is substantially lower than the 100-150K that is commonly presumed. If this were to be the case, then continued 165K payroll growth would be consistent with the Fed’s being at the neutral policy rate in 5y, regardless of when the 6.5% unemployment threshold is hit. In this context, 5y1y OIS rates, which have sold off nearly 20bp over the past week, are still somewhat low.

However, if trend payroll growth is declining, then output growth over the long term would also be lower than was the case pre-crisis. Together with falling inflation expectations and increasing fixed income allocations globally as populations age, this means that long-dated forward rates should also be lower than pre-crisis levels (Figure 4). We believe that the long end is better priced for the eventual removal of accommodation, making it relatively more attractive for anyone with a long duration bias. This leads us to recommend receiving 10y10y swap rates. See the Trade Ideas section for details.

Curve: Remain in 7s30s and 10s30s flatteners The 7s30s curve is still too steep relative to inflation expectations, which have continued to decline over the past week (Figure 5). We believe the risk of large long-end receiving flows from insurance companies and pension funds should not be discounted if risky assets decline further.

Curve flattening could also be supported by currency-linked hedging flows in a potential appreciation of $-yen, since we are near the peak of the cross-convexity of $-yen to rates (see Front-end and back-end spreads part ways, published April 11, 2013).

We believe that the long end is better priced for the eventual removal of accommodation, making it relatively more attractive for anyone with a long duration bias

FIGURE 5 The flattening in 7s30s continues to lag the fall in long-term inflation expectations

FIGURE 6 Selling payer spreads is better than buying receiver flys for a higher conviction about a rally in rates

Source: Barclays Research Note: As of June 13, 2013. Long 1x2x1 3m10y 2.35-2.2-2.1 receiver fly costs

about 3.25bp of underlying swap01. Short 3m*10y 1X1 payer spread 2.45-2.7 allows a premium intake of 9bp of underlying swap01. Source: Barclays Research

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Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 Apr-13

%%

7s-30s swap curve, LHS 10y CPI swap, RHS -20

-15

-10

-5

0

5

10

15

1.8

1.9 2

2.1

2.2

2.3

2.4

2.5

2.6

2.7

2.8

2.9 3

3.1

p&l, bp

long 1x2x1 recr fly short 1x1 payr spd

Barclays | Global Rates Weekly

14 June 2013 10

We maintain our 7s30s and 10s30s curve flatteners, (see Trading the Taper, May 17, 2013, for more details). Of the two, we prefer 7s30s at current levels.

Swap spreads: Turn neutral on 7s30s spread curve flatteners, maintain front-end spread wideners The 7s30s spread curve has flattened by since the middle of May, driven by a combination of convexity paying in the belly of the curve due to mortgage underperformance in the sell-off in rates, and the overhang from long-end receiving needs that get triggered when risky assets sell off. 10s30s spread curve flatteners have been additionally supported by 10s trading special in the repo market, which has contributed nearly 2bp to the 10y spread (see the US Swaps section of this publication).

Our fair value model now suggests that the spread curve is fair. Further, the unwind of the 30y auction concession could lead to a widening in 30y swap spreads, and the reversal of the price action in mortgages in case the Fed sounds dovish could tighten belly swap spreads. As a result, we are turning neutral on our 10s30s spread curve flattener and will await better entry levels over the next few weeks.

We believe that spreads in the 2-5y part of the curve may be a better trade for a risk flare. In addition to benefiting from Libor-OIS widening in a sell-off, 3y Treasuries have cheapened to OIS. A reversal of this move against OIS could also support swap spread wideners in this sector.

Vol: Remain neutral on gamma, buy 10y10y vol We turned neutral on gamma last week and see few near-term catalysts for being either long or short. We expect long-dated vols such as 10y*10y to rise in a rate rally, but not decline too much in a sell-off. This makes buying 10y10y vols an attractive risk-reward expression of a long duration view.

Trade ideas • Receive 10y10y rates

• Buy 10y10y vol

• Buy broken receiver flys as a view on a benign rate rally. Alternately, to express a view on a significant reversal, sell payer spreads.

• Buy 1y*30y receiver versus payers, delta hedged to fade skew valuations.

Receive 10y10y rates • The long end offers a better risk-reward profile than the belly to be long duration,

because long-end rates could rally in the event risk assets continue to sell off or because of a dialing back of hawkish Fed rhetoric.

• Further, the long end is unlikely to sell off too much even if the Fed continues to sound hawkish, given weak economic data and falling inflation expectations. Even over the past month, the 10y10y swap rate has sold off only 7bp, while 10y swap rates increased nearly 30bp.

Buy 10y10y vol • The 10y10y sector of the vol surface has cheapened since late April, due to vega supply

from hedging flows driven by the extension of callable zero notes and more than expected issuance of callable zeroes in May.

• Existing zeroes would extend little in a further rate sell-off, resulting in little supply in 10y*10y vol. But if rates reverse, hedgers of callable zero notes would become short

We maintain our curve flattening view, but turn neutral on 10s30s spread curve flatteners; we continue to recommend buying front-end spreads as a cheap option on a risk flare

Barclays | Global Rates Weekly

14 June 2013 11

vol, leading to a rise in 10y10y vol. For details, please refer to Buy 10y10y, sell 3y10y, June 7, 2013.

To express a view on a benign rate rally, buy broken receiver flys; for a larger rate reversal, sell payer spreads • Both trades are limited loss but differ in risk-reward. Selling a payer spread, for example,

a short 3m*10y ATM vs. 25bp high strike payer spread, can take in roughly 80cts and would generate a gain unless the 10y swap rate is higher by 9bp relative to forwards, three months later. The losses are limited to 140cts, implying a risk reward of ~2:1.

• The other strategy involves buying a 1x2x1 broken receiver fly. For example, a 3m10y 10low/25low/35low receiver fly costs about 30cts and can generate a maximum gain of 100cts if 10y swaps rally by 20bp. The losses are limited to the premium outlay of 30cts, implying a risk/reward of 1:3+.

• Even though the second strategy seems to have a better risk-reward, investors with a higher conviction about a rate rally are better off with selling payer spread. Figure 6 plots the P&L of the two strategies: for higher conviction, a payer spread is better.

• We evaluated a variety of tenors for 3m expiry payer spread. The risk-reward is relatively better for 3m*10y; specifically, the 3m*10y payer spread would be struck at roughly 2.45-2.7 and the premium intake would allow the trade to break even at 9bp higher than forwards. In an historical context, since August 8, 2011, a period marked by Fed’s rate guidance, is at the higher end of 1.55-2.55%. Accordingly, for those with high conviction in a rate rally, we recommend selling 3m*10y ATM vs. 25bp high-strike payer spreads.

Buy 1y*30y receivers vs. payers, delta hedged to fade the skew valuations • Separately, we recommend fading the payer skew in longer tails. Given the recent price

action, where vols have risen with the rise in rates, the payer skew across tails has held firm. As shown in Figure 7, even 1y*30y 100bp wide skew (payer versus receivers) has not come off. This, in our view, is not justified.

FIGURE 7 1y*30y payer skew is historically rich

FIGURE 8 In past episodes of eurozone risk flare, 30y tails gained alongside a fall in rates

Note: As of June 12, 2013, Source: Barclays Research Note: As of June 12, 2013, Source: Barclays Research

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1y*30y 100bp wide skew (bp/y)

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90

100

110

120

130

2.0

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1y30y, lhs 1y*30y

Barclays | Global Rates Weekly

14 June 2013 12

• 30y swaps have risen about 45bp since April 30 and are more than 100bp higher than during the previous eurozone risk-flare in May 2012. In our view, 1y*30y vol should remain relatively constant in a further rate rally or sell-off. However, the payer skew being positive highlights that the market expects 1y*30y normal vol to be higher if rates rise. While the recent price action explains such why the market is still pricing such valuations, thinking about the probability of a violent sell-off versus a violent rally does not justify the skew.

• Put simply, with the Fed tapering, and inflation and inflation expectations as low as they are, the risk of a violent-sell off in 30y rates is very small. But another risk-flare in the eurozone or in risk assets could cause 30y rates to fall rapidly. Figure 8 plots the level of 1y30y rate versus vol, highlighting the rise in vol alongside a fall in rates during the last two bouts of the eurozone crisis.

• So we see current skew valuations, with payers more expensive than receivers, as an opportunity: we recommend buying 1y*30y receivers versus payers.

Barclays | Global Rates Weekly

14 June 2013 13

INFLATION-LINKED MARKETS: UNITED STATES

How low can they go? While 5y5y breakevens are cheap, in our view, we think they can decline another 25-30bp before the Fed gets concerned. Despite increased signs of liquidity issues, we find 1y and under breakevens cheap and recommend scaling into energy-hedged longs.

Anchors aweigh, the re-mix? Last week, we wrote that the majority of the move lower in breakevens was justified by fundamentals because realized inflation had been running low and the market believed the Fed’s reaction function had shifted to hawkish despite mixed global economic data. Since then, breakevens have declined further and market participants have been left wondering: how low can they go? In the near term, forward breakevens at least might continue to decline until the Fed begins to show concern about inflation expectations becoming unanchored. Last updated on June 11, 2013, the Fed’s measure of 5y5y breakeven (FED5YEAR <Index> in Bloomberg) is about 246bp, which the Fed will likely consider fair in terms of range of expectations, given its 2% PCE inflation target and the longer-term average spread between CPI and PCE. Since June 11, Barclays’ measure, which correlates well with the Fed’s in terms of changes, has dropped another 3bp. Thus, the Fed’s measure is now likely in the vicinity of 243bp (about 40bp off the 2013 highs). Prior to QE2 and Operation Twist, when the Fed showed concern about declining inflation expectations, its 5y5y BE measure was 210-220bp. As such, if uncertainty continues, we think the general level of breakevens can drop a further 25-30bp before the Fed becomes concerned. Thus, while we believe longer breakevens are structurally cheap, the risk/reward profile remains unattractive on a tactical basis.

FIGURE 1 Prior to QE2 and Operation Twist, the Fed’s 5y5y measure was 210bp-220bp

Source: Barclays Research

If you’re not HOT, you’re cold… Until last week, we held the view that majority of the moves in TIPS market had been more consistent with fundamentals, rather than being liquidity driven. Since then, we have seen some increased signs of liquidity concerns. For example, on-the-run (also known as HOT runs) 5s and 10s have richened sharply versus their surrounding off-the-run counterparts. In Figure 2, we see extensive cheapening in Apr17-Jan18-Apr18 real yield fly. The richening in on-the-run (or near on-the-run) April18s and April17s is not related to the floor. Figure 3

2.0

2.2

2.4

2.6

2.8

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3.4

Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13

5y5y CPI swap rate Fed 5 Year

Michael Pond

+1 212 412 5051 michael.pond@barclays.com

Chirag Mirani +1 212 412 6819 chirag.mirani@barclays.com

Using historical Fed activities, we think 5y5y breakevens can decline another 25-30bp before the Fed becomes concerned.

Barclays | Global Rates Weekly

14 June 2013 14

shows that despite the precipitous drop in short-end breakevens 5y, floor valuations have not actually richened. In early and mid-2012, 5y floor valuations were close to 0.50% of notional (now at 0.25%) at the current cash breakeven levels. In our view, the recent richening reflects the April issues having been trading cheap after a poor 5y TIPS auction in April and the fact that liquidity of the on-the-run is now more important.

A liquidity story is also prevalent in 10s and off-the-run 20s Similarly to 5s, 10s have been richening versus the off-the-run 6-9y sector. One way to see this is via the Apr17-Jul20-Jan23 real yield fly (Figure 4). In the past, the Apr17-Jul20-Jan23 real yield fly had been trading rich because of Jan20s/Jul20s. More recently, it has normalized to fair levels, as a liquidity preference has returned for 10s and 5s (Figure 4). The 20y sector has had even more pronounced cheapening. For example, the Jul20-Jan23-Jan27 real yield fly is now trading at rich levels ( Figure 5). We think this cheapening of off-the-runs can continue ahead of the FOMC statement next week as market participants continue to assess the Fed’s stance. We will be watching these, as well as TIPS ASWs, for signs that the market is moving from just bent to all out broken.

FIGURE 2 Apr17-Jan18-Apr18 real yield fly is cheapening…

FIGURE 3 5y deflation floor premiums (% of notional)

Source: Barclays Research Source: Barclays Research

FIGURE 4 Apr17-Jul20-Jan23 real yield fly is normalizing as cheapened on-the-run 5s and 10s revert to fair value

FIGURE 5 Jul20-Jan23-Jan27 real yield fly richening, as off-the-runs, in particular 15-20y, cheapens

Source: Bloomberg, Barclays Research Source: Bloomberg, Barclays Research

Liquid OTR 5s and 10s are outperforming as liquidity becomes an important factor…

-14-12-10

-8-6-4-20246

Apr-13 May-13 May-13 Jun-13

bp

Apr17-Jan18-Apr18 real yield fly

0.150

0.250

0.350

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0.650

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Jan-12 Jul-12 Jan-135Y breakevens (LHS)5Y Floor Premium - % of notional (RHS)

-20

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2

Jan-13 Mar-13 May-13

Apr17-Jul20-Jan23 real yield fly

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Jul20-Jan23-Jan27 real yield fly

Barclays | Global Rates Weekly

14 June 2013 15

Dipping a toe back in the front end Since mid-March we have had a “cheap but not cheap enough” view on the front end. Due to heightened volatility, we had become cautious on the front end despite its being 60-70bp cheap to Barclays’ energy-adjusted NSA CPI forecasts even recently. Since last week, the front end (1y and under) has cheapened further and is now 80-90bp cheap (Figure 6). We think these levels are attractive enough to start legging into front-end longs. Given the volatility, it would not surprise us if these issues cheapened further, but we think the trade remains attractive on a held-to-maturity basis and energy hedged. We recommend being long $100mn April14s hedged with short 40 XBH4 gasoline futures.

FIGURE 6 Front-end breakeven cheapness versus our CPI forecast, adjusted for energy changes since forecast release

TIPS maturity TIPS real yield BE

BE versus Barclays CPI

forecast BE (bp)

BE versus Barclays CPI forecast BE (bp),

crude adjusted

BE versus Barclays CPI forecast BE (bp),

gasoline adjusted

Jul-13 -0.31 0.38 9 9 9

Jan-14 -0.37 0.47 -82 -79 -76

Apr-14 -0.43 0.57 -92 -90 -88

Jul-14 -1.04 1.22 -91 -89 -87

Jan-15 -0.91 1.18 -77 -76 -74

Note: Forecast date: May 20 2013, energy futures adjustment on the forecast applied as of June 13 2013. Source: Barclays Research

Front-end (1y and under) breakevens are 80-90bp cheap versus our energy adjusted CPI forecast; we recommend being long April14s energy hedged.

Barclays | Global Rates Weekly

14 June 2013 16

UNITED STATES: AGENCIES

Deconstructing a dislocation Agencies’ underperformance of Treasuries and swaps has been atypical, and we believe investors should fade the cheapening of 5-7y sector versus the curve over the medium term. In our view, the Corker bill does not represent a source of GSE credit risk.

Agency spread widening represents a dislocation Agencies have widened to Treasuries along with other spread assets in the recent rate sell-off, with the intermediate sector underperforming the rest of the curve. In particular, spreads in the 5-7y part of the curve are now 6-7bp wider than they were before the most recent set of PSPA changes were announced last August, with 5s reaching T+23bp and 7s reaching T+33bp versus matched-date Treasuries. By contrast, surrounding sectors are 2-3bp wider at most, and the super long end has been relatively stable (Figure 1).

We believe the particular underperformance of intermediate-sector agencies’ represents a dislocation, which investors should expect to reverse over the medium term. Our view is predicated on how agencies’ performance has run counter to typical episodes from the past in several aspects (Figure 2):

• Directionality with rates: Agency-Treasury and swap spreads have widened, even as intermediate Treasuries have sold off ~50bp, whereas typically such a large sell-off would be accompanied by several basis points of spread tightening as risky assets outperform. Alternatively, the recent spread widening would normally correspond with a (risk-aversion) rally in rates of 40-60bp.

• Magnitude versus swaps: Agencies’ spread widening has been 150% of swap spreads’ in this episode, versus the usual 60-80%. In other words, agencies typically outperform swaps when spreads widen overall, but have cheapened to them sharply this time.

• Performance of other risk assets: Agency-Treasury spreads have widened more than their typical sensitivity to other risky assets as well as swaps. Relative to high grade CDS, for example, the recent degree of agency spread widening would typically correspond to a run-up of ~30pts, versus the <10 realized since early May.

James Ma

+1 212 412 2563 james.ma@barclays.com

Intermediate-sector agencies’ outperformance is atypical of past episodes in many respects

FIGURE 1 Agency-Treasury spread curve dislocations

FIGURE 2 Recent underperformance is atypical of past episodes

change, bp

5y Agy-Tsy

5y Swap spd

CDX IG 5y Tsy

Rate selloffs

5/7/13-today 6.3 4.3 7.7 46.1

7/12-8/12 -3.7 -5.8 -9.6 15.8

1/12-3/12 -13.6 -12.7 -31.4 26.0

11/10-12/10 -3.7 -4.8 -7.9 78.8

Rate rallies

4/12-6/12 8.2 10.0 33.6 -39

7/11-10/11 4.7 2.4 50.3 -92.1

4/11-7/11 14.0 16.8 5.6 -90.4

5/10-6/10 8.3 21.5 37 -60.6

Source: Barclays Research Source: Barclays Research

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A-T spd, bp

3y 5y 7y 10y 20y

Barclays | Global Rates Weekly

14 June 2013 17

Motivations and recommendations Just as the backup in rates may have helped exacerbate the push wider in swap spreads due to convexity hedging activity, it may have compounded agencies’ cheapening as well. The rate sell-off has reduced the moneyness of the agency callable universe by tens of basis points, causing the paper to extend as shown by the sharp dropoff of redemptions (Figure 3). In response to this duration extension, some market participants may have sold agency benchmark positions they had been using as hedges.

Up until this point, supply-demand dynamics in agency bellwether space had been healthier for investors, as dealer inventories had dwindled. However, investors’ and Street unease in taking down the additional supply may have stemmed from uncertainty around whether the sell-off would continue, and possibly exacerbated by headline risk from the Corker bill draft.

As we will show later, we believe the Corker bill does not represent a source of GSE credit risk, and furthermore believe that it reinforces the positive supply technical by encouraging the portfolios to shrink even more quickly. Further, recent trading sessions have shown headline risk in both directions, possibly indicating some stabilization of positioning.

Thus, we recommend that investors prepared to fade the rate sell-off should also expect agency spreads to tighten, led by the 5-7y sector:

• As previously mentioned, the 5-7y part of the curve has underperformed surrounding sectors, with 5s reaching T+23bp and 7s T+33bp versus matched-date Treasuries. This has improved spread rolldown from the 5y sector into the 3y sector at T+10bp.

• Furthermore, the 5s-7s part of the agency-Treasury spread curve remains toward the top end of its range in terms of steepness: It has only exceeded 15bp once since 2010 and has generally been in the high single digits versus the present 11bp (Figure 4). Part of this has been the 7y sector’s cheapness to 10s since the beginning of Q2.

• Lastly, GSE funding needs should remain light as the portfolios continue to shrink. Furthermore, we believe the agencies are less likely to fund in the intermediate and long end of the curve in bellwether space, with 5s at L+5bp and 7s at L+15bp, than they would in callables where LOAS levels are solidly negative, even in 10-15y maturities. Investors leery of committing to a spread tightening view versus Treasuries could mitigate their risk exposure by owning agencies on asset swap instead.

As headline risk may stabilize, we recommend reconsidering owning 5-7yrs

FIGURE 3 Callable redemptions drop off as structures extend

FIGURE 4 Intermediate-sector agency-Treasury spread curve

Source: Barclays Research Source: Barclays Research

Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13

05101520253035404550

02468

101214161820

$ bn$ bn/wk

Callable Rdm (LHS) Dealer Invt (RHS)

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5y-7y Agy-Tsy 5y-10y Agy-Tsy

Barclays | Global Rates Weekly

14 June 2013 18

Thus, as we believe the Corker bill does not represent a source of GSE credit risk, we recommend positioning for a reversal of the intermediate-sector spread widening.

The Corker bill: Liquidating the GSEs? A Senate bill to reform the GSEs calls for transferring the guarantee businesses to the Treasury and liquidating the retained portfolios. A draft version of the bill, authored by Senators Corker (R, TN) and Warner (D, VA), and titled the “Secondary Mortgage Market Reform Act of 2013”, had been circulating in recent weeks and was posted to Bloomberg earlier this week.

Broadly, the Corker bill replaces FHFA with the Federal Mortgage Insurance Corporation (FMIC), a new federal agency. FMIC would provide explicit government reinsurance of conforming loans by charging a guarantee fee and placing the proceeds in a Mortgage Insurance Fund (MIF). The agency has also been given other regulatory responsibilities, including setting standards for eligible loans, creating a standard securitization platform for them, and approving PMI providers. In addition, FMIC must investigate and develop credit risk-sharing programs.

While the bill proposes one template for overall GSE reform, we primarily focus on Title 5, “Wind Down of Fannie Mae and Freddie Mac.” As we understand it, Title 5:

• Requires receivership of Fannie Mae (FNM)/Freddie Mac (FRE) on the “FMIC certification date”, which must be within five years of the bill becoming law. On that date, the GSEs’ single-family mortgage guarantee obligations would be explicitly guaranteed and transferred to the Treasury along with all g-fee income.

• Preserves the existing retained portfolio caps, of $553bn as of year-end 2013 and reducing by 15% per year, but requires they be liquidated to $0 balances on December 31 of the year of the FMIC certification date.

Although the Corker bill does not extend its explicit MBS guarantee to holders of GSE debt, the Senior Preferred Stock Purchase Agreements (PSPAs) specifically protect bondholders in this scenario. Even with the prospect of liquidation and receivership, FNM/FRE still have access to the remaining PSPA capacities, of $118bn and $141bn, respectively, per the agreements’ language:

• The PSPAs do not change if the GSEs are moved from conservatorship to receivership: “The Commitment shall not be terminable by Purchaser [Treasury] solely by reason of the conservatorship, receivership or any other insolvency proceeding of Seller [FNM/FRE].”

• If the portfolios are liquidated and there is a net shortfall, FNM/FRE have access to the remaining PSPA capacity: If the liquidation proceeds are not enough to cover liabilities (a GAAP net asset shortfall), FNM/FRE have 15 business days from the “Liquidation End Date” to request a PSPA draw up to the remaining $118bn/$141bn capacity, which Treasury has 60 days to provide.

• The PSPAs protect FNM/FRE debt not assumed by a receiver: “It is the expectation of the parties that, in the event Seller [FNM/FRE] is placed into receivership and an LLRE [limited-life regulated entity] formed to purchase certain of its assets and assume certain of its liabilities, the Commitment would remain with Seller for the benefit of the holders of the debt of Seller not assumed by the LLRE.”

Thus, we believe owners of the senior and subordinated debt are protected and should expect the bonds to continue to be paid on a timely basis. Per the Treasury’s PSPA FAQ,

PSPA capacity remains available even in the Corker bill’s liquidation scenario

Barclays | Global Rates Weekly

14 June 2013 19

“the holders of senior debt, subordinated debt, and [MBS] issued or guaranteed by these GSEs are protected…without regard to when those securities were issued or guaranteed.”

Also, we believe investors can take further comfort from these factors:

• The bill may have a difficult road to passage: Democrats in particular could have concerns with the bill’s affordable housing provisions. At the same time, Republicans on the House Financial Services Committee may feel the bill does not emphasize private capital enough. With housing stabilizing and the GSEs profitable, Congress could also choose to focus on fiscal policy or other topics near term. Lastly, internal conflicts may shift the administration’s focus away from housing reform. These factors could delay the bill from being considered.

• The bill does not specify how liquidation will be accomplished: As the maximum portfolio size shrinks 15% per year, the portfolios would fall below $250bn after five years, or $150bn after seven to eight years. At that smaller size, the Treasury could simply assume the assets at a lower debt/GDP ratio. Alternatively, FNM/FRE could sell illiquid assets before the liquidation, and offset losses with ~$12bn/$6bn in annual g-fee revenues - note that subprime/Alt-A MBS are already impaired to about 60 cents on the dollar. Even if FNM/FRE took a draconian 20% haircut on their $150bn portfolios, leading to a $30bn net asset shortfall, the remaining $120-140bn PSPA capacities would more than offset this.

• In past liquidations/privatizations, the government has protected owners of implicitly guaranteed debt: In the cases of REFCORP and Sallie Mae, the outstanding debt was either bought back or fully defeased. We would expect a similar outcome for owners of FNM/FRE debt maturing after the FMIC certification date, as the costs of disrupting the capital structure far outweigh the potential benefits.

In all, we believe FNM/FRE unsecured debtholders are more than adequately protected by the PSPAs, and the Corker bill should not represent a source of GSE credit risk.

The bill does allow for junior preferred and common stockholders to receive “remaining proceeds from the receivership and liquidation” after the senior preferreds, “after fully satisfying the outstanding obligations of the enterprises.” However, investors concerned with FNM/FRE’s residual value must consider that the portfolios would be liquidated, with the proceeds first satisfying debtholders’ obligations.

Further, the guarantee books and their revenues would be transferred to the Treasury. What remains unclear is whether Treasury will compensate shareholders, including its own $180bn interest in the senior preferreds, in exchange for the guarantee businesses.

Thus, while the Corker bill represents a pathway for FNM/FRE liquidation, it remains unclear what value would be remaining for junior parts of the capital structure. What is clear to us is that, even in this scenario, both senior and subordinated debt are secure, and the recent widening in sympathy to other spread products represents an opportunity to add to positions. In any event, given that many important details need to be fleshed out in terms of prospective mortgage market functioning, the likelihood of passage in current form remains very low; the bill is simply a work in progress, and represents a bipartisan starting point for the discussion of broader housing finance reform.

The bill should not represent a source of GSE credit risk

Barclays | Global Rates Weekly

14 June 2013 20

UNITED STATES: SWAPS

Repo specialness: A note from 10y ago We believe that about 1.5bp of the widening in 10y spreads stems from the extreme levels of specialness in the issue. 10y spreads could tighten if specialness unwinds after the reopening settles, but they have room to widen if the current levels of specialness persist. We turn neutral on the 10y spreads and 10s30s spread curve flattener.

10y swap spreads have widened nearly 8bp since the May 2023 on-the-run note was issued. Most of the move has likely been related to paying flows in 10y swaps caused by mortgage hedging activity, as can be seen by the fact that the widening has come about at the same time as mortgage spreads widened (Figure 1). However, part of this has also likely been driven by repo market specialness in 10y notes that is causing the note to finance at -300bp currently, possibly leading to a pickup in delivery failures (Figure 2).

Many factors that cause extreme levels of repo specialness have come together.

• Before the reopening auction settles on Monday, the existing float is small. It remains an open question whether new supply will be sufficient to eliminate specialness.

• The Fed does not own the on-the-run security, so it is unable to alleviate repo market shortages by lending the security through the SOMA facility.

• A fairly large sell-off in rates occurred since the security was auctioned. OTR 10s are a hedge for dealers for many fixed income instruments, including swaps, inflation-protected securities and other bonds. The selling pressure in these instruments over the past few days likely led to the build-up of large short positions in OTR 10s, which would need to be financed at special rates.

• Market liquidity has deteriorated in the past few weeks, because of which there are few alternatives to OTR10s as a key hedging instrument in Treasury space.

We believe that the scarcity of OTR collateral will be alleviated after the reopening auction settles (see the US money markets section of this publication). The term repo market, on the other hand, still seems to be pricing substantial levels of specialness to persist in the weeks ahead. As a result, the risks to specialness and, hence, to 10y swap spreads are bidirectional.

Amrut Nashikkar

+1 212 412 1848 amrut.nashikkar@barclays.com

Vivek Shukla +1 212 412 2532 vivek.s.shukla@barclays.com

Part of the widening in 10y spreads has arisen because of extreme repo specialness in the 10y note

FIGURE 1 10y swap spreads widened, likely from paying from mortgage hedging…

FIGURE 2 … as well as from extreme levels of specialness in the OTR 10y note.

Source: Barclays Research Source: Barclays Research

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May23-Feb23: OAS diff Repo diff, RHS

Barclays | Global Rates Weekly

14 June 2013 21

Some pointers from the May 2013 note in the July-August 2003 sell-off The situation reminds us of the extreme levels of richness that another 10y note experienced exactly 10y ago (the May 2013 note that was issued in May 2003). Price action in July-August 2003 was somewhat similar to today, with 10y rates selling off 100bp amid mortgage convexity flows (Figure 3). This led to a large short base, which the $18bn amount outstanding in the security was unable to satisfy. The note richened throughout the auction cycle. In August, it reached a peak richness on a spread basis of nearly 10bp over the February note and stayed rich well past the issuance of the August note. Two things were different back then.

• First, there was no fails charge. With GC near 1% and traders having the option to fail once repo rates went negative, the most a security could go special was a little over 1%. This can be seen, for instance, from the time series of the weighted average fee for borrowing the security in the SOMA lending facility (Figure 4). This meant an insufficient incentive for security lenders. As a result, the market could price in continued delivery failures that led to the extreme relative spread widening. In today’s circumstances, the fails charge of 300bp means that even with GC near zero, there is potentially 300bp of upside to a security lender. So while short-term periods of extreme levels of specialness are possible because of the negative fails charge, they are less likely to persist for as long.

• Second, at the time when the May 2013 note was issued, auction re-openings did not occur every month (scheduled 10y reopening began in Sep 2003). As a result, after the $18bn initial issuance in May, there was no additional supply to the market until August. Currently, the auction reopening every month serves to alleviate any shortages that build up during the course of the month, which again means that it is difficult for the market to expect either extreme specialness or delivery failures to persist.

As an extreme case, the economic value in terms of spread widening, if the security were to trade special at -300bp for the two months it will be on-the-run, is about 5bp, of which 2.5bp is already likely priced in. However, this suggests there is risk to 10y spreads in both directions from the repo market, giving us another reason to turn neutral on 10y spreads.

Continued specialness presents widening risks to swap spreads, while specialness unwinding could cause spreads to tighten

FIGURE 3 In May 2003 also, the 10y note richened to extreme levels on a swap spread basis as delivery failures picked up…

FIGURE 4 … while specialness in the note was lower than the current 10y note

Source: Barclays Research Source: New York Fed, Barclays Research

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14 June 2013 22

UNITED STATES: MONEY MARKETS

Is QE dislocating repo? In recent weeks there has been a steady stream of commentary arguing that the Fed’s QE purchases are creating market dislocations. The repo market is cited as evidence that the Fed’s asset purchases are causing an unhealthy scarcity of collateral. We disagree.

• Overnight collateral rates have fallen into the low single digits and a significant volume of Treasury collateral now trades at sub-zero rates.

• Fails or incomplete deliveries have increased since January. However, they are concentrated in one issue and have not led to a seizing-up in the market.

• Borrowings from the Fed’s securities lending program have increased. But the weighted average rate on these transactions is still close to GC.

• We believe the decline in general collateral rates is temporary and related to shrinking seasonal bill supply and, ironically, perceptions about a slowing in the pace of Fed asset purchases.

Low repo rates alone are not evidence of a QE-induced distortion. Similarly fails activity is too narrowly concentrated to indicate much crowding out from the Fed. Economic arguments for slowing the pace of asset purchases stand on firmer intellectual ground than ones based on market distortions.

QE distortions Overnight collateral rates have rarely attracted as much attention as they seem to now.1 In the past month, several market commentators have observed the steep decline in collateral funding rates and concluded that the Fed’s QE asset purchases are absorbing market supply and creating scarcity in the nearly $1.8trn market for Treasury collateral (bilateral and tri-party). Indeed, we estimate that in the past month a daily average of roughly 40% of the trades in the (smaller) inter-dealer GCF market are occurring at sub-zero funding rates. By contrast, pre-QE, this average was less than 5%. Commentators note these low rates are evidence of increasing difficulty in borrowing securities that is reducing overall market liquidity.

The timing of the Fed’s relaunch of QE and the plunge in repo rates is (very) roughly contemporaneous. Importantly, the reasoning appears to make logical sense – as the Fed buys Treasuries it removes them from the market and reduces their availability in the repo market, which in turn pushes financing rates lower. After establishing a link between low repo rates and QE, it is not difficult to argue that the Fed’s asset purchase program is creating distortions and preventing the repo market from operating normally. QE distortion arguments suggest that the Fed’s balance sheet has grown too large and it is time for the Fed to slow (or end) its asset purchases.

Low rates and fails Of course, low repo rates by themselves are not evidence of market dislocation. After all, the market may still clear – just at a new (lower) equilibrium rate. However, low repo rates accompanied by a decline in market trading volumes or liquidity – if attributable to QE – would be grounds for concern.

1 See, for instance “The Fed Squeezes the Shadow Banking System”, Wall Street Journal, May 23, 2013 and “Repo Flip Indicates Collateral Risks”, International Financing Review, June 10, 2013

Joseph Abate

+1 212 412 7459 joseph.abate@barclays.com

QE is seen as causing distortions in the repo market

Barclays | Global Rates Weekly

14 June 2013 23

Along these lines, analysts point out that the volume of fails or incomplete trades in the Treasury market has increased – rising from a daily average of $35bn in the 3m preceding the re-launch of QE to $55bn since January and perhaps as much as $75bn in the past month (Figure 1).2 They observe that with the Fed absorbing a significant portion of available supply, it has become too expensive to source collateral to deliver -- instead, it is cheaper to let the trade fail.3 But is it right to blame QE?

Blame the Fed? Indeed, $75bn per day in failing Treasury trades seems like a lot – certainly it is relative to recent history. But the context in which these fails are occurring is just as important as is whether or not the incomplete deliveries are creating market distortions that reduce liquidity.

Careful inspection reveals that the fails are concentrated in just one issue – the 1.75% May 2023, which has been trading with a very large premium in the repo market (Figure 2). To the extent that fails are not driven by operational difficulties, dealers must make a daily decision to either search and deliver the issue or to fail and pay the 300bp penalty. In this case, fails are driven mainly by the fact that the issue size is small as it hasn’t been reopened yet. Given the non-pecuniary costs of failing (from irritated customers) the decision breakpoint is actually a little higher than the 300bp fee – perhaps as high as 325bp depending on the customer. As the plot reveals, the 1.75% May 2023 has been trading close to this breakpoint for some time. But it is not the first OTR 10y to trade rich by a long stretch. The August 2022 10y briefly traded nearly this special last year before the re-launch of QE.

In deciding which Treasuries to buy, the Fed deliberately avoids purchasing securities trading at a premium in the repo market. As a result, not only is the Fed not buying the 1.75% May 2023, but also it is not holding any of the issue in the “dungeon” of its balance sheet. As a result, the Fed is not able to lend the issue to alleviate the fails. Ironically, by not buying the issue the Fed’s actions may be causing the issue to trade more special thereby keeping fails volumes from falling.

Federal Reserve securities lending More significantly, markets do not appear to be struggling too much to source collateral outside the OTR 10y note. Instead, while borrowings from the Fed’s securities lending program have increased they are not at record levels. And, the collateral is being exchanged

2 Estimate based on the weekly fails figures from the NY Fed and the daily figures from DTCC. 3 Since 2009, there has been a charge of Treasury fails of 300bp.

Fails volumes have increased since May…

FIGURE 1 Treasury fails ($bn)

FIGURE 2 TSY 10y OTR (bp)

Source: Federal Reserve

Source: Barclays Research

But are concentrated in the OTR 10y…

…which, ironically, the Fed, has not purchased

Borrowing from the SOMA has picked up but the spread is low

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at weighted average rates close to the general collateral (less the 5bp transaction fee). Recall that in these daily auctions dealers exchange general collateral for the specific issue collateral they need. For collateral in strong demand, the weighted average auction spread will be significantly wider than the 5bp transactions fee. The current low spread indicates that while the volumes of Treasuries borrowed from the Fed have increased, the market’s overall “specialness” is not especially deep. If the Fed’s QE purchases were creating market distortions we’d expect that the weighted average borrowing rate from the Fed’s lending program (for intermediate and long-term Treasuries) to be significantly lower than fee-adjusted GC rate.

Similarly, if the Fed’s purchases were somehow making it harder to source collateral, then trading volumes in the repo market would be expected to decline. But, the volume of Treasury collateral traded in the GCF market appears to be rebounding from a month-end decline in May. Volumes traded in this inter-dealer, blind, brokered market have averaged about $150bn per day. Although activity can briefly drift, there does not appear to be a significant trend in either direction since the resumption QE last year (Figure 3). Likewise data on the total amount of tri-party repo outstanding against Treasury collateral have averaged just more than $660bn since QE began compared with $600bn in the pre-QE period (January 2012-September 2012). As a result, we think it is a stretch to argue that the Fed’s QE purchases have reduced trading volumes in the market.

If the Fed’s asset purchases are not responsible for the lower level of repo rates or the increase in fails, then what is – and, is it temporary?

So why is repo low? There are several factors behind the recent richening in collateral rates. But the primary factor however, appears to be technical and related to a much larger-than-expected shrinkage in net bill issuance since the end of March – which, is more closely timed to the decline in overnight repo rates than the re-launch of QE (Figure 4). For most investors, bills and repo are close substitutes thus movements in bill supply have a strong influence on overnight repo rates.

In Q2, net bill issuance is projected to decline by just more than $210bn. This includes $105bn worth of inter-quarter CMBs originally issued in February and March that matured shortly after the mid-April tax date. Clearly, bill supply normally shrinks in the second quarter as the Treasury’s coffers become flush with cash from households and businesses

Treasury repo volumes appear to be rising

FIGURE 3 GCF TSY repo volumes ($bn)

FIGURE 4 Overnight TSY GC and weekly net bill supply (bp, $bn)

Source: DTCC Source: DTCC and US Treasury

Net bill supply is set to fall by over $200bn in Q2

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remitting their tax payments. But by comparison to previous years, this year’s reduction in net bill issuance is steeper – in 2012, bill supply fell by $80bn and $170bn in 2011. Moreover, at the start of February, the Treasury Borrowing Advisory Committee was looking for Q2 net bill supply to shrink by $63bn.

The sharp reduction in bill issuance reflects a combination of tax and spending influences including the increase in payroll taxes at the start of the year, as well as the reduction in spending from the sequestration. In addition, non-withheld tax collections were especially strong this year, reflecting the increase in stock prices last year (and the attendant taxable capital gains) as well as the rush by some companies to push 2013 dividends ahead into 2012 in case there was no last minute deal on resolving the fiscal cliff and all taxes went up in 2013.

Taper talk Ironically, it isn’t the Fed’s asset purchases that are crowding out the available supply of Treasuries and causing dislocations in the market, but perceptions that the pace of these purchases will slow. Since mid-May, tapering expectations have been percolating in the market and the inconclusive May employment report did nothing to dispel them. Instead, investors have started to increase short positions in the intermediate and longer-term sectors of the Treasury market – where the Fed is buying securities. As the short-base increases, the demand for repo in these securities also rises as investors typically borrow the security in the repo market to short it or to cover their shorts. This, coupled with the small initial offering of the May 2023 10y note likely explains most of its richening to -300bp. It also suggests that once new supply of the issue settles on June 17, much of the premium in the issue will abate. Past issues that have traded as rich in the repo market have frequently cheapened up by more than 150bp.

Our economists do not expect the Fed to taper its purchases this year – and instead, a series of potentially disappointing growth indicators later this year could nip budding expectations of a slowing in the Fed’s asset purchases before too long. More near term, of course, bill supply reductions will slow (as they normally do in Q3) and we expect the GSEs will pull the additional $60bn they currently have parked in the repo market into bank deposits ahead of making their deferred tax accounting payment to the Treasury. As this cash is withdrawn from repo, we expect overnight collateral rates to drift higher – maybe not all the way back to their late March level of 17bp but probably back toward 10-12bp, especially if the anticipated bill supply reductions in July turn out to be smaller than the $30bn we are anticipating. Together these factors – from the cheapening in GC rates, to an expected reduction in the cost to borrow the OTR 10y, as well as diminishing expectations of Fed tapering – should reduce fails volumes and push of QE-induced distortions to the sidelines.4

4 It might still be argued that policy is creating dislocations in markets – although through a different channel. See, “Long-collateral squeeze”, Global Rates Weekly, May 16, 2013.

Talk of tapering is increasing the Treasury short-base

Repo rates may start backing up in late June

Barclays | Global Rates Weekly

14 June 2013 26

EURO AREA: RATES STRATEGY

Lending in the euro area: renewed weakness or a trough in sight? This is an amended version of a stand-alone report issued on 13 June.

Lending to euro area corporates showed renewed weakness in April. But, if anything, leading indicators suggest lending should not post large declines from here, and could be close to flat. These scenarios should support a recovery, or at least cease to be a large drag on it.

Bank lending data: weak in April, but in a context of broad stabilization Weak bank lending to non financial corporates in the euro area has been a key feature of the past few years. This has often been highlighted by the ECB and market participants, and is hampering the economic recovery. President Draghi highlighted in particular in the latest Introductory statement to the Press Conference that lending had shown weakness in April: “The annual negative growth of loans to non-financial corporations (adjusted for loan sales and securitisation) increased from -1.3% in March to -1.9% in April. This development stemmed, in particular, from net redemptions in short-term loans, which could reflect reduced demand for working capital against the background of weak order books in early spring. More generally, weak loan dynamics continue to reflect primarily the current stage of the business cycle, heightened credit risk and the ongoing adjustment of financial and non-financial sector balance sheets.”

A review of the data in more detail suggests that the particular weakness in April is unlikely to continue– if anything, leading indicators suggest that lending should not post large declines from here, and could be close to flat.

Corporate lending in the euro area: leverage and deleverage There are different ways to look at the corporate lending in the euro area (note that unfortunately, the data are not consistently available). Figure 1 illustrates the overall bank lending to non financial corporates (NFC) by sector of activity in the euro area over the past six years (ie, these data excludes the mortgage and household lending in general). As evidenced by the chart, there was large real estate- and construction-related lending in 2006-2008,

Laurent Fransolet +44 (0)20 7773 8385 laurent.fransolet@barclays.com

Weak bank lending in April highlighted by the ECB

FIGURE 1 Euro area NFC lending by NACE categories (€ bn)

Source: ECB

An overview of NFC lending in the euro area

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14 June 2013 27

which has started to decline recently, as well as (smaller) moves in other categories. Note that these flows by activity category include loans that have been securitized or sold, and are only available on a quarterly basis, with relatively long lags (latest available data relate to Q4 12).

Figure 2 shows more recent monthly developments, up to the end of April, splitting the data between peripherals and core countries, and adjusting these for securitization and sales (the ECB series on this starts only in February 2009). The lending in core countries in maturities above 1y on average has been slightly positive, but hovered close to zero in past years, while net lending in the periphery has been firmly negative. In short maturities (which account for 25% of the total lending – see the Annex), lending is intrinsically more volatile on a month-to-month basis. April 2013 was particularly weak (-€18bn, of which short-term loans accounted for about -€6bn), but in April 2012 lending was high, at more than €8bn (the highest since the crisis intensified in H2 11) and hence, the decline in the annual rate was indeed significant (from -1.3% to -1.9%), meriting particular attention from Draghi.

FIGURE 2 Monthly lending to corporates (€ bn, adjusted for sales and securitizations), 3m avg

Source: ECB, Barclays Research

Going forward: better days ahead? First, we analyse short-term loans. Figure 3 shows that the quarterly total euro area NFC lending in sub 1y maturities is well correlated with the results (advanced by 9 months) of the questionnaire on short-term loan supply to enterprises in the ECB Bank Lending Survey (ECB BLS). Overall, while this sub 1y lending is quite volatile on a month to month basis (April is indicated by the square), the relationship does not suggest that in the coming quarters there will be large negative declines in this kind of lending. Slightly positive levels of lending seem more likely.

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14 June 2013 28

FIGURE 3 Short-term lending likely to be almost flat going forward

Source: ECB, Barclays Research

The relationship between actual lending and the results of the bank lending survey is similar for loans above 1y, especially if we focus on loans to sectors not related to construction and real estate (see Figure 4 - note that we estimated the 2013 data for construction based on 2011/2012 levels, but the overall conclusion does not change if we include the construction/real estate sector). The recent quarterly flows in NFC lending do not seem out of line with what the ECB BLS or other surveys suggest: as shown, here we plotted a normalized version of the AFTE ‘Financing Availability’ indicator, which relates to French corporate treasurers – the fit with the actual lending is better than with the ECB BLS survey.

FIGURE 4 Long-term lending likely to be slightly better in the quarters ahead

Source: ECB, AFTE/Coe-Rexecode, Barclays Research

These surveys (again, advanced by 9 months) suggest that in contrast to the decline posted in April (indicated by a square), lending should recover and be slightly more positive going forward. It also seems to indicate that the big contraction in lending seen in Q3/Q4 12 is less likely. On the construction side, the negative trend is likely to be more modest: a lot of the deleveraging occurred in Spain in 2012, and exposures have almost halved already.

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Surveys lead the lending by about 9 months, and point to some improvement

Barclays | Global Rates Weekly

14 June 2013 29

Conclusion It is difficult to identify the real causes for the weakness in lending: there are both supply and demand factors at play. Currently, a large part of credit weakness is probably due to a weak demand for credit by households and corporations, heightened uncertainty and credit risk on small borrowers.

In our opinion, the leading indicators for actual lending in short- and long-term maturities, do not suggest further large declines. To the contrary, lending could be neutral or even pick up slightly, which would be positive for the euro area’s economic recovery, especially if the recent ‘greenshoots’ in surveys (PMIs) or actual data (IP) continue, as investment bottoms out, as we expect.

Clearly, the ongoing processes of balance sheet adjustments by both corporates and banks, and supply constraints in general, are likely to keep overall lending lower than before. The supply constraints, and risk aversion constraints, are likely to be more limited in ‘core’ countries, and there overall lending will probably pick up first if and when demand picks up. Supply constraints (and risk aversion) are likely to remain higher in peripheral countries (even if only for banks undergoing restructuring), and lending will likely continue to be negative (or at best flat) there for quarters to come. Therefore, we expect the ECB will to work to address these banking systems weaknesses quickly, pushing for an agreement on the resolution directive and on bank recapitalization, and itself undertaking an asset quality review (which, perversely, may have a negative impact on the flow of credit in the near term). Specific plans to address SME lending weakness will likely take some time to develop, and will not be driven by the ECB as such – SME lending, while very important in some countries, is around 25% of the overall euro area lending (see Figure 5).

While a stabilisation or pick-up in lending would be good news for the ECB, and may push back further the prospects for a further rate cut, the bank would unlikely view these developments in a hawkish manner; it would likely remain firmly on hold for a very long time, whether Fed tapering does/does not occur.

While a stabilisation or pick-up in lending would be good news for the ECB, and may push back further the prospects for a further rate cut, the bank would unlikely view these developments in a hawkish manner; it would likely remain firmly on hold for a very long time, whether Fed tapering does/does not occur.

FIGURE 5 Overall stock of NFC lending in the euro area (€ bn)

Country Total Sub 1y % of sub 1y % of SMEs (2011)

Germany 909 144 16% 35%

France 872 171 20% 21%

Italy 862 326 38% 18%

Spain 684 141 21% 15%

Netherlands 389 126 32% Austria 165 37 23% Belgium 116 42 36% Portugal 106 29 27% 77%

Greece 103 39 38% Ireland 94 28 30% Finland 68 9 13% 20%

Cyprus 26 6 24% Total 4,393 1,100 25% 24%

Note: Data is as of end April 2013, except for the share of SME lending which is 2011 data. Source: ECB, OECD, BdE, Barclays Research.

Supply or demand?

Lending could pick up slightly if activity does recovers

But supply constraints and risk aversion will likely continue to diverge across countries

Barclays | Global Rates Weekly

14 June 2013 30

EUROPE: SOVEREIGN SPREADS

Sovereign short-selling restrictions – six months after Whereas there has been no significant impact on government bond markets, there has been a notable uptick in trading of Italian and French bond futures. Of the relative-value themes, Portuguese CDS appears tight relative to other countries and cash markets.

Sovereign CDS Analysing the change in behaviour of sovereign CDS markets is confounded by the fact that the “delegated acts” (details on the regulations) were made available on 5 July 2012, and three weeks after (26 July), Mario Draghi at the ECB gave his “whatever it takes” speech, sparking a broad-based rally, in particular for financials and sovereigns. With that in mind, when analysing changes in market dynamics, we examine dynamics relative to other parts of the market.

iTraxx Main has disconnected from underlying sovereigns (Figure 1) after the go-live date of 1 November 2012. In prior periods, Main and matched sovereigns had a strong relationship, but after the sharp rally going into 1 November, it is evident that the matched basket of sovereign CDS is much less reactive to the market (Main) than previously. We can argue that the reduced volatility of sovereigns generally relative to the broader market is a sign that the ECB statements worked, but the difficulty in trading sovereign CDS post SSR cannot be disregarded.

FIGURE 1 Main vs. basket of matched sovereign CDS: ECB speech in July confounded effect of SSR announcement, but post 1 Nov, sovereign CDS much less reactive to the market

Source: Barclays Research

Sovereign CDS trading volumes are down relative to broader market (Figure 2), reflecting the reduced volatility. Sovereign CDS used to contribute 50% of the total trading volumes in single-name CDS in Europe, whereas currently, the share has fallen to about 35%. Tellingly, in the recent market volatility, CDS volumes are increasing generally but the share of sovereign CDS volumes lingers below 30%.

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European Credit Strategy Søren Willemann +44 (0) 20 7773 9983

soren.willemann@barclays.com Interest Rate Research Huw Worthington +44 (0)20 7773 1307 huw.worthington@barclays.com

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14 June 2013 31

FIGURE 2 CDS trading volumes in sovereign CDS were 40-50% of total trading volumes in European single-name CDS before SSR, constituting now about 35%

Note: Total is single-name CDS volumes (weekly, $) across sovereigns, financials corporates. Source: DTCC, Barclays Research

The announcement of the SSR in July 2012 led to broad-based de-risking on sovereigns (Figure 3), with countries like Belgium and Ireland seeing falls in net notional (open interest) of 35-45%. Of note, Italy had the lowest fall in net notional among the peripherals, supporting the anecdotal evidence that counterparty risk desks are very active in Italian CDS.

After the SSR go-live date of 1 November, Italian CDS has remained one of the most active names in terms of changes in net notional as a percent of net notional in November (Figure 4), whereas Spain has had the lowest volatility in positioning since then, indicating that the activity in the CDS contract is low, as is the case of Austria, Germany and France.

The introduction of the SSR has increased volatility for Italian and Spanish CDS (Figure 5). We analyse the ratio of percentage realised volatility as a ratio of realised volatility of Main and examine the difference from the three months before the SSR-delegated acts were published (5 July 2012) and since the go-live date of 1 November 2012 to now, sorting for each country by the size of the change. Two conclusions stand out: firstly, Scandinavian CDS volatility has dropped markedly on a relative basis, reflecting the difficulty in trading

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FIGURE 3 Change in net notional from SSR announcement to go-live date, in percent of net notional July 2012

FIGURE 4 Weekly (annualised) volatility in net notional changes since SSR go-live date, in percent of net notional November 2012

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them within the SSR framework; secondly, Italy and Spain (among others) feature as having a higher realised volatility now than before the SSR, relative to the developments in the realised volatility generally.

FIGURE 5 Relative change in CDS volatility before/after introduction of SSR: Italy and Spain realised volatility higher, Scandinavian realised volatility lower

Note: We calculate percentage realized volatility for each sovereign entity and iTraxx Main in the 3 months prior to the announcement of the SSR on 5 July 2012 and the period from after the go-live date of 1 Nov 2012 to now. We calculate the ratio of realised volatility of each single name to that of iTraxx Main, and look at the change from pre to post SSR – positive (negative) numbers indicate that realised volatility has gone up (down) relative to the broader market. Source: Barclays Research

Why is Italian CDS more volatile now than previously? A more detailed look at the development in realised volatility for Italy and Main is revealing. Prior to the SSR announcements in July 2012, Italian realised volatility had been quite low – even lower than that of Main for a period. Post the SSR announcements, Italian CDS volumes increased into November 2012, but as volatility in Main subsided post the ECB-induced rally, Italian CDS has remained volatile. Anecdotal evidence suggests that counterparty risk desks remain active in Spain and (especially) Italy but post the SSR, relative-value investors who previously had been involved have partly stepped away, putting more pressure on the dealers to absorb risk. In turn, this creates the potential for more one-sided trading with less-nuanced views being expressed.

FIGURE 6 5yr €CDS-cash basis – 24mth ranges, current levels and levels 7 May 2012 when SSR delegated acts were published – Periphery somewhat corrected from tights – core CDS-cash basis still remains low

Note: We focus on CDS denominated in EUR and constant 5yr maturity ASW spreads interpolated from liquid bonds. Source: Barclays Research

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Barclays | Global Rates Weekly

14 June 2013 33

FIGURE 7 Portugal-Spain in 5yr €CDS and 5yr cash ASW – Portugal outperforming Spain in cash, much less so in CDS…

FIGURE 8 … Leading Portugal CDS to look 50bp tight when compared to Spain CDS and cash markets

Source: Barclays Research Note: We plot the “differential of the differential” shown in Figure 9.

Source: Barclays Research

One exception is Portugal where the CDS-cash basis appears low relative to historical levels and other peripherals. This has been a recent occurrence in the present sell-off, and shows up clearly when comparing the Portugal-Spain differential in 5yr cash ASW to the same differential in CDS (Figure 7). Portuguese cash has been underperforming Spanish, but much less so in CDS, meaning that Portuguese €CDS trades 50bp tight relative to Spanish CDS and cash markets (Figure 8), which is interesting given that in the last two years, Portuguese CDS has tended always to trade wide in this metric.

Government bonds and futures The period since the introduction of the SSR has been characterised, in general, by a sustained re-tightening in bond spreads with France outperforming Germany in the 10y area by 12bp, Belgium by 16bp, with the larger peripheral issuers tightening versus bunds by 70bp in Italy and over 110bp in Spain.

As Figure 9 and Figure 10 illustrate, however, these moves were part of a much longer-term trend established initially post Draghi’s “whatever it takes” comments which had already triggered tightening of 32bp, 55bp, 186bp and 215bp, respectively. Indeed, the initial market move post the imposition saw some slight re-widening in spreads before the longer-term trend re-established itself thereafter into year end.

The potential impact of the SSR on EGB markets, as we highlighted back in October, was effectively limited to the ability (or the opinion of a market maker as to the ability) to borrow, or “locate”, the bond in the repo market. Hypothetically, this could cause some uncertainty as to the ability to locate an individual bond; however, this had already been addressed by the widespread distribution on a regular basis of “locate” lists, which summarise a list of bonds that trade normally in repo, being made available on a regular basis to market participants by dealers. In effect then, the rules have not represented a major departure from pre-existing market practice, and have not represented a major operational concern. As such, the tightening we have seen has been a reaction to the widespread change in sentiment for EGBs, with in particular non-domestic demand returning after a prolonged period of underweight positions have reversed as opposed to short positions being closed out, or becoming absent around the imposition of the SSR.

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Barclays | Global Rates Weekly

14 June 2013 34

FIGURE 9 Selected core 10y yields spreads vs. Germany

FIGURE 10 Selected peripheral 10y yield spreads vs. Germany

Source: Barclays Research Source: Barclays Research

Effect on futures markets While we believe cash EGB markets have been relatively unaffected by the new rules, one area which may have been seen, albeit an unintended benefit, has been the bond futures markets in BTPs and OATs.

Since their relatively recently re-introduction in 2009 and early 2012, respectively, contract volumes and open interest in both BTPs and OAT 10y bond futures, as illustrated in Figure 11, had remained at relatively low and stable levels through until late 2012. The imposition of SSR, however, seems to have been a catalyst for an increase in liquidity in these markets with rolling one month contract volumes more than doubling from before the introductions of the SSR to now. In particular it is worth highlighting that the period directly after the ban came in saw contract volume spike, before returning briefly to previous levels. This could have been, in part, due to “transition trades” from CDS positions, which previously may have either been more speculative in nature or may not have met the guidelines for “proxy hedge” positions on the underlying sovereign. Nevertheless, since then, contract volumes have continued to rise steadily, at the same time as net risk taken in sovereign CDS has

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FIGURE 11 10y Generic OAT and BTP bond futures volumes rising as net risk in sovereign CDS drops

Note: Futures volumes are 1mth rolling averages, CDS notional is in $bn for major sovereigns. Source: DTCC, Bloomberg, Barclays Research.

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Barclays | Global Rates Weekly

14 June 2013 35

declined. This seems possibly to reflect a longer term and more sustained move from previous sovereign CDS market participants who have migrated to using bond futures markets using Italy as a proxy for peripheral bonds and France for core bonds to express RV and outright credit views in EGB markets. In any event, it will be notable to see whether this seemingly unintended consequence of the SSR regulations on CDS markets will open up further opportunities in bond futures for other issuers in time.

Next week’s cash flows On Tuesday Finland will auction 10y 30y bonds for up to €1.5bn across both lines, The following day Germany will tap it’s 10y bund for €5bn. Thursday sees Spain come to the market alongside French bond and linker auctions. Support for the market will be small during the week with €2.76bn of redemptions in Spain and Italy and just short of €3bn of coupons from a variety of issuers.

FIGURE 12 Barclays’ cash flow expectations for week beginning 14 June 13 (€bn)

Source: Barclays Research

Beginning Auction Date Issuance Redemptions Coupons Net Cash Flow03-Jun -0.43 Germany 5.00 0.00 0.23 4.78

Weekly 10-Jun -1.78 France 9.50 0.00 0.00 9.50

Net 17-Jun 14.95 Italy 0.00 1.38 1.00 -2.38

Cash flow 24-Jun 10.05 Spain 4.50 1.38 0.05 3.07

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Austria 0.00 0.00 0.11 -0.11

Total issuance 20.50 Portugal 0.00 0.00 0.98 0.98

Total redemptions 2.76 Total 20.50 2.76 2.792 14.95Total coupons 2.79

Net cash flow 14.95

Net Cash Flow is issuance minus redemptions minus coupons. Negative number implies cash returned to the market.

Barclays | Global Rates Weekly

14 June 2013 36

EUROPE: SWAPS

Strategic widening value in EUR and UK ASWs Overall, we think EUR and UK ASW wideners have started to offer good medium- to long-term value again on better deficit prospects. We acknowledge that recent small widening worsens the entry levels, but any small re-tightening should be seen as a strategic buying opportunity.

Since the beginning of the year, the financial market has gradually become friendlier towards swap spread (ASW) widening. 10y US ASW vs OIS have widened about 12bp pretty much in a linear fashion. While the road has been somewhat bumpier for German and UK ASWs, they started to reverse the past two months’ tightening and are wider on the year as well. In our view, these macro ASW widening themes are likely to remain on a medium-term basis, at least in the German and UK markets, for the reasons we discuss below.

FIGURE 1 Globally, ASWs by and large have been widening since early this year

Source: Barclays Research

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Cagdas Aksu

+44 (0)20 7773 5788 cagdas.aksu@barclays.com

FIGURE 2 Deficits have fallen a lot globally and are likely to continue to do so

FIGURE 3 As growth outlooks improve in developed markets, deficits are likely to enhance further

Note: 1y-ahead deficit expectations – indexed at 100 in January 2003. Source: Consensus Economics, Barclays Research

Source: Consensus Economics, Barclays Research

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Barclays | Global Rates Weekly

14 June 2013 37

1. Forward-looking deficit expectations have been falling since 2010 in Germany, UK and US. Particularly in the US and to certain extent in Germany (Figure 2), these improving deficit profiles have been gaining momentum lately, and we believe they are likely to stay intact. A good portion of the improvement in the deficit outlooks has so far come from fiscal consolidation. Now that the developed market growth outlook is starting look somewhat better (at least expectations are improving), further enhancement in deficit outlooks may well come from a better growth outlook.

With the current 1y-ahead deficit expectations from the consensus economics publication, both German and UK ASWs are on the cheap side in our fundamental models on a medium-term basis (Figures 6 and 7). As we argue above, if the consensus revises down their deficit expectations further on the recent improvement in the developed market growth outlook, this would make these ASWs look even better value from a strategic widening perspective.

2. Over the medium- to long-term, ASWs are fundamentally driven by budget deficit expectations. Indeed, ASWs have a positive correlation with rates in the long term (ie, when rates go up, ASWs widen, and vice versa). Indeed, this intuitively makes sense because typically in an environment in which rates are going up, growth prospects are strong, government revenues are high and, as a result, deficit expectations improve. Furthermore, when rates are going higher structurally (in a rate-hiking environment, etc), there tends to be more strategic paying flows in swaps, particularly from Bank Treasuries and some other institutional investors, which also partly explains why swap spreads widen in a higher rate environment.

However, during risk-on/risk-off periods, this correlation tends to go negative as ASWs widen when outright German/Gilt yields rally due to flight to quality (and tighten when this is reversed). Indeed, from the start of the eurozone debt crisis in early 2010 until summer 2012, this correlation was largely negative, reflecting the risk-on/risk-off mindset in the markets.

While a long-term positive correlation has not been fully established yet, we think this is probably a transitional period at the moment, which is likely to give a widening bias to EUR and UK swap spreads in big outright rate moves from current levels. In other words, if the outright market sell-off continues from here, some market participants might get convinced that this is the beginning of a more structural sell-off that is likely to help

FIGURE 4 Historically, ASWs widen in a rising yield environment and vice versa

FIGURE 5 Indeed, for the first time in a while, Bund ASW widened in the recent sell-off

Source: Barclays Research Source: Barclays Research

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Barclays | Global Rates Weekly

14 June 2013 38

establish the usual long-term positive correlation between outright market and ASW (ie, ASWs would widen in a sell-off). Alternatively, if the outright market sell-off that started in early May is another “false alarm” and rates rally back due to weakening economic outlook or higher risk premium, then the flight-to-quality premium is likely to increase in ASW, and there would be a widening bias as well.

Overall, we think that German and UK ASW wideners have started to offer good medium- to long-term value again. We acknowledge that the c.5bp widening in the past week or so does not make current entry levels very attractive, but any small tightening should be seen as a good opportunity to put wideners back on, in our opinion.

FIGURE 6 Bund ASW still offers long-term widening value even after recent widening

FIGURE 7 UK ASWs look cheap on a medium-term basis versus the deficit projections

Source: Consensus Economics, Barclays Research Source: Consensus Economics, Barclays Research

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Barclays | Global Rates Weekly

14 June 2013 39

EUROPE: MONEY MARKETS

3m Euribor: still room to move up The 3m Euribor is moving up, reflecting a gradual adjustment to the new monetary policy expectations embedded in Eonia rates. Euribor whites have sold off, but with the risk for rates still to the upside, we do not see a case for fading the recent price action yet.

Since the ECB’s June meeting, the 3m Euribor fixing has crept up 0.9bp to the current 20.9bp. The move has followed a long period of broadly stable fixing at about 20bp.

The Euribor’s recent dynamic is related to the repricing of the monetary policy expectations following the stabilization of the economic data in the Eurozone that have reduced the probability of a further policy rate(s) cut by the ECB. In particular, the market is not pricing anymore any cut of the deposit facility rate into negative territory. Moreover, the price of the Eonia forward for the Mar-2015 ECB meeting, at about 43bp, suggests that the market is probably pricing in a situation of low liquidity surplus (due to the maturity of the two 3y LTROs) with a “normalization” of Eonia at around the refi rate level of 50bp (ie, no refi rate cut, no additional liquidity). Interestingly, the same Eonia forward rate one month ago was about 25bp lower, implying that the market was still pricing in the possibility of a refi rate cut to 25bp, and indicating the magnitude of changes in monetary policy expectations over the last month.

A comparison with the latest episode of prolonged sell-off on money markets rates induced by changes in monetary policy expectations (as in January this year) could be useful to understand the possible evolution of the 3m Euribor.

Between the ECB meetings in January and February, the 3m Euribor increased by about 4bp (from 19.2bp to 23.2bp). The upward movement was driven mainly by eurozone endogenous factors related to expectations for aggressive 3y LTROs repayments, less-dovish than-expected comments by President Draghi at the January meeting, coupled with better-than-expected indications from PMIs. Notably, the sell-off on the euro short rates was EU-driven, with US rates remaining unchanged. As shown in Figure 1 the increase in the 3m Euribor rates was driven by the rate component, with the risk premium that

Giuseppe Maraffino

+44 (0)20 3134 9938 giuseppe.maraffino@barclays.com

Laurent Fransolet +44 (0)20 7773 8385 laurent.fransolet@barclays.com

3m Euribor has been moving on an

upward trend since ECB’s June meeting

A comparison with the latest

period of sell-off in January-February this year

FIGURE 1 3m Euribor: decomposition in rate and risk premium parts

FIGURE 2 Euribor panel banks breakdown: average contribution €bn)

Source: Barclays Research Note: we consider the average of the contributions of all banks in the panel by

each banking system, without eliminating the highest and lowest 15% of all the quotes collected. Source: Euribor-Ebf, Barclays Research

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Barclays | Global Rates Weekly

14 June 2013 40

remained broadly unchanged. A reversal of the movement happened after February’s ECB meeting on more dovish comments by the ECB, which remarked on its commitment to keep its monetary policy stance accommodative, based on the slowdown in the 3y LTROs repayments and on the worsening of the economic data.

However, this time might be different. As in January, the movement in Euribor has been driven by the rates component. Survey data point to an economic stabilization in the eurozone with less room for further cuts in policy rates. Importantly, the passive tightening of the liquidity conditions risks is concrete (due to the ongoing, although slow, repayment and the upward trend in autonomous factors) and should limit any rally back of short rates. In addition, global factors related to the upward pressure on US rates owing to expectations for Fed tapering QE, are playing a more active role in affecting euro short rates compared with last January.

The adjustment of money market rates to the new landscape in policy rates/liquidity conditions is usually very gradual. Therefore, we believe that the recent upward trend is likely to continue with the fixing probably approaching the 25bp area (which would correspond to a Euribor/Eonia spread of about 14bp vs 11bp currently). Such a view is also supported by Figure 2, which shows the average contributions by banking system and compares them with the change in the rate contribution during the latest sell-off episode in January-February this year. As the chart shows there is still room for a further increase in contribution from all banking systems, which would lead to a further increase in the fixing.

Barring a scenario of a worsening economic situation that would lead the market to price in again the possibility of further policy rate cuts (including the negative depo rate which would push Eonia rates down), we expect a or slow move up in Euribor towards 25bp.

Euribor futures have already sold-off and are pricing in the 3m fixing at 25bp for September, with more increases in the next few quarters. However, we would not recommend fading the white contracts’ movement yet. In general, we recommend being neutral on money markets rates as several factors are at play that could result in a further upward adjustment of rates.

This time is different… …we expect a stabilization after a

further increase

Still room for increases in contributions from each bank

We recommend being neutral on money markets rates

Barclays | Global Rates Weekly

14 June 2013 41

UNITED KINGDOM: RATES STRATEGY

Front-end carnage? The correction on the GBP market has seen the 5y sector suffer. Overall, rate expectations remain relatively subdued and calendar spreads are still compressed, suggesting that further steepening may be necessary.

It has been a rollercoaster week for the front end of the GBP curve. Yields have been led higher by the sell-off in USD rates and underpinned by a suite of data that hinted at a nascent recovery. The sell-off gathered pace, with the back of the money market curve in particular coming under severe pressure. Figure 1 shows the changes in the Short Sterling curve since the publication of the May MPC Minutes, the last piece of collective MPC communication, versus the close on 12 June.

FIGURE 1 Short sterling: The sell-off has been in the back of the money market curve

Source: Bloomberg, Barclays research

The bulk of the sell-off has been at the back end of the money market surface in the 2015-16 contract space (the “green” short sterling contracts). Figure 2 shows the strip of 1yr fwd rates and how much they have moved since the minutes of the May meeting.

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Moyeen Islam

+44 (0)20 7773 4675 moyeen.islam@barclays.com

The front end has sold off heavily this week with “green” Short Sterling contracts some 50bp higher in yields since the May MPC Minutes were published

The belly of the curve has significantly underperformed

FIGURE 2 The belly has repriced and the curve flatten (bp)

FIGURE 3 Short sterling open interest versus volumes (000s contracts)

Note: 1y gaps to 15y, 5y gaps thereafter. Source: Barclays Research Source: Bloomberg, Barclays Research

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Barclays | Global Rates Weekly

14 June 2013 42

The combination of the compression of term premium and lure of positive carry structures has left valuations most stretched in the belly of the curve; hence its correction in the sell-off. Clearly, there has been an exiting of risk in the front end: Figure 3 shows that aggregate open interest fell even as volumes spiked to over 1.5 million contracts.

The OIS market currently is pricing in the first rate move from the MPC at around Q215, a shift earlier of some 3 months or so in terms of outright expectations. With Governor Carney due to start in July, it seems unlikely that anything on forward guidance will be forthcoming as early as his first meeting. The MPC has said that it will report back on forward guidance in the August Inflation Report, but there clarity is still required on exactly what guidance would be tied to. If the MPC was to choose to follow the Fed, it would probably look at a labour market indicator of the degree of slack within the economy. The interaction between what in effect becomes an intermediate indicator and the long-run target of 2% CPI needs to be better understood by the market. Thus, we would expect any forward guidance indications in the August Inflation Report to be an opening proposition rather than a definitive statement.

Despite the sell-off, the pace of tightening has not materially altered. Figure 4 shows the 3-month calendar spreads between IMM dates in both OIS and Short Sterling space. Notably, there seems to be no real pricing of a full 25bp of tightening in any single quarter. This strikes us as low given that once the MPC considers a tightening cycle, the spreads would have to move wider. Thus, looking for a steepening of the calendar spread term structure seems like an interesting way of aiming for a steady rebuilding of term premium on the surface. Another way of thinking about this is by looking at the spot 1y gap flys, where the 4-6y sector looks too low relative to other parts of the curve. We would look to fade this relative flatness by paying the 6y sector versus the shorter end of the curve.

Figure 5 shows there has been a partial decoupling in the implied/realised vol ratios between GBP1y1y fwd and GBP1y2yfwd, as the realised vol in GBP1y2y fwd rose in the sell-off, outstripping the move higher in implied vol. With both ratios over 1, implied vol is still rich but it could be that 1y1y vol is too rich relative to 1y2y vol (we discuss GBP vol more generally in the Euro Volatility section of this report).

Open interest fell as volumes spiked, suggesting an exiting from risk at the front end

Despite the sell-off, the OIS market still prices very little for the MPC

The MPC will publish its initial thoughts on forward guidance in the August Inflation Report

Calendar spreads still remain too compressed with no single quarter having a full 25bp priced in the next 2-3 years…..

….this has left the 4-6y sector too low versus the front end

FIGURE 4 In rate space, calendar spreads remain too tight (bp)

FIGURE 5 Implied/realised vol ratio - 1y2y ratio has decoupled?

Source: Bloomberg, Barclays Research Source: Barclays Research

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Barclays | Global Rates Weekly

14 June 2013 43

COVERED BONDS AND SUPRANATIONAL, SUB-SOVEREIGN & AGENCIES

Life through a different lens (This is an edited extract from The AAA Investor, published 13 June 2013)

This week, we would like to highlight the publication of the AAA Handbook 2013: Life through a different lens. Understanding the different viewpoints of lawmakers, regulators, rating agencies and other market participants has become an important success factor for AAA investors.

Since the publication of the 2012 edition of the AAA Handbook, the market in supranationals, agencies, sub-sovereigns and covered bonds has experienced substantial spread compression. This was due largely to the enhanced policy commitments of central banks, which led to a change in the perception of market participants regarding the readiness of monetary authorities to implement more aggressive strategies.

Following a long period of spread contraction and falling yields, which lasted until early May, markets are now undergoing a correction phase. The policy-induced synchronisation of strategic positioning and regulatory limitations on the risk-taking capacity of trading desks have exacerbated the move. Thus, we expect that it will take more time before the risk / duration overhang is cleared. Once Q2 is over and we enter July, the capacity to counter the recent move may increase again and markets will likely move back to the 12-month mean during the course of Q3.

Covered bonds have a slower reaction speed compared to SSAs and government bonds and thus generally outperformed the latter in the current move. We expect that this will likely revert in Q3. Also, the widening move in peripheral markets and senior unsecured bank paper could lose momentum, offering an opportunity to position for renewed tightening in Q3. The overall reduction of risk positions only offers limited opportunities to re-engage in some “fallen angel” covered bond instruments. The focus among investors is very much on Multi-Cedulas as well as and some Italian covered bonds.

Nobody said it was easy The AAA landscape is subject to substantial change. This is related less to the products themselves, but rather to the way lawmakers, regulators, market participants and rating agencies are looking at them. These changes are much faster and have a more severe effect on market valuations than alterations to the products themselves.

The global regulatory framework of the banking industry and financial markets has been subject to a fundamental transformation across a broad range of areas, including bank capital, liquidity risk, credit risk management, compliance, bank resolution and trading infrastructure. In Europe, the creation of the European Banking Union has added an additional layer of complexity. In the US, uncertainty over the direction of housing finance reform complicates the assessment of relative value.

The respective changes are all driven by the intent to make financial markets and banking systems more robust. Within this process, authorities in Europe generally assign a positive and stabilizing role to SSA and covered bonds; lawmakers and regulators look at them as part of the solution, not part of the problem. Consequently, the new rules tend to strengthen the favourable treatment of these AAA products. In the US, the debate is focused on reducing the involvement of the public sector in the housing market and proposals for a controlled wind-down of government-sponsored entities (GSEs). At the same time, new forms of government sponsorship through a public guarantor (PG) system, as well as the introduction of covered bonds, are being discussed.

Fritz Engelhard

+49 69 7161 1725 fritz.engelhard@barclays.com

Michaela Seimen +44 (0) 20 3134 0134 michaela.seimen@barclays.com

Jussi Harju +49 69 7161 1781

jussi.harju@barclays.com

Barclays | Global Rates Weekly

14 June 2013 44

Despite the authorities’ generally supportive stance for AAA instruments, market participants face the challenge of gauging the effect of the multiple layers of change across various pieces of legislation. For example, in Europe, capital requirement rules for banks holding these instruments are not aligned with the rules on liquidity buffer investments and these in turn are not in sync with central bank repo rules. In the US, it is unclear how the introduction of newly proposed instruments for housing finance will be aligned with the phase-out of GSEs.

In addition, the application and implementation of the respective rules across various regions and across individual cases is uneven. For example, the implementation of bank resolution rules varies within the EU. Whilst some jurisdictions include language explicitly protecting covered bonds from resolution measures, others leave this point open. Furthermore, actions designed to render credit institutions viable, such as the transfer of assets and liabilities to bridge institutions or the write-down of unsecured debt instruments, may have unintended negative consequences for covered bonds when not fully understood by authorities. Finally, many rules give the authorities the capacity to review and amend detailed requirements or make discretionary decisions. For example, the detailed definition of eligible liquidity buffer investments within the EU is not yet clear and could also be subject to change over time. This exposes the management of such investment portfolios to a high degree of uncertainty.

More than ever, market participants are obliged to follow very closely political discussions on the various regulatory initiatives, as these may have a significant effect on the risks involved in the respective instruments.

The tighter regulatory landscape is resulting in a global trend towards decreasing the leverage of credit institutions and a more conservative approach to risk measurement and provisioning. The flipside is a lower capacity of credit institutions to provide the real economy with credit in a downturn. For example, the political initiatives in Europe to enhance corporate lending have so far focused on facilitating the funding of SME loans. However, the bottleneck seems to be the ability of credit institutions to enhance risk exposure in a market that has been slow in adjusting the pricing to the increased risk in the sector5. From this viewpoint, the economic effect of various initiatives on making use of SME loans in asset pools for covered bonds must be taken with a good pinch of salt, as these address the banks’ funding costs, but not the more dominant factor of risk-adjusted pricing in SME lending.

Deleveraging of bank balance sheets and the wind-down of US agencies is leading to a shortage in the supply of high-quality liquid fixed income instruments. At the same time, the structural demand for such paper is unabated. The regulatory requirement for banks to maintain portfolios of such paper has even led to an increase in demand. This creates a rising global imbalance that is already reflected in the historically tight pricing of these products versus underlying government bonds. In a growing number of markets, covered bonds yield less than underlying government bonds. Given the persistent imbalance in the sector, we expect this situation to prevail, although in Q3 there might be a technical correction back to the mean of the past 12 months.

5 European Banks: Solving the SME lending puzzle, 23 May 2013.

Barclays | Global Rates Weekly

14 June 2013 45

SCANDINAVIA: RATES STRATEGY

Norges Bank preview: Unchanged policy rates and slightly more hawkish tone We expect Norges Bank to leave policy rates unchanged next week and to deliver a slightly more hawkish forward looking policy guidance. Hence, we see value in entering NOK Sep ’13/Sep ’14 3m FRA steepeners versus EUR.

We expect Norges Bank (NB) to leave policy rates unchanged at 1.50%. While NB likely will continue to signal some probability for near-term cuts (20-40%), the forward looking policy guidance will likely become a touch more hawkish. Hence, we see value in entering money market steepeners versus EUR going into the meeting

On Thursday (20 June) next week, NB will announce its latest policy rate decision followed by a brief press conference (13.00 – London time). It will also publish its second Monetary Policy Report, including the financial stability assessment (MPR), which will contain updated economic projections and updated policy rate forecast.

In its March MPR, the NB’s policy rate path signalled close to a 50% probability for a cut either at the May or the forthcoming meeting. However, we believe that recent data have decreased the probability for a cut quite substantially. At the May press-conference Deputy Governor Qvigstad also sounded significantly less dovish than could have been expected, in our view, arguing that it had not been a particularly hard decision to leave policy rates unchanged. (Norges Bank keeps policy rates unchanged (1.50%) and leave no new guidance, 8 May 2013)

While global- and domestic cyclical developments have been broadly in line with NB’s projections, we note that inflation has surprised clearly to the upside in recent months. (Norway: High May Inflation numbers suggest dim prospects for another rate cut, 10 June 2013) Indeed, NB’s preferred core-inflation measure, CPIXE, was 0.4pp above its forecast in April and 0.3pp above its forecast in May. Whereas it is too early to talk about a definitive trend change from the past two and a half year’s low inflation environment, it is also notable that the prices increases during the past two months have been surprisingly broad-based.

Mikael Nilsson Rosell +44 (0)20 7773 6057 mikael.nilsson@barclays.com

FIGURE 1 Core-inflation has surprised clearly to the upside in recent months

FIGURE 2 Weaker NOK (i-44) and tighter cross-market interest rate differentials

Source: Norges Bank, Barclays Research Source: Norges Bank, Barclays Research

Norges Bank signalled almost a 50% probability for a cut, but we believe policy rates will remain unchanged

Cyclical developments broadly in line, but inflation has surprised clearly to the upside

0.60.70.80.91.01.11.21.31.41.51.6

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%

3mth interest differential I-44 (LHS, inverted)

Barclays | Global Rates Weekly

14 June 2013 46

On the other hand, inflation remains well below target (2.5%) and the recently agreed wage agreement suggests downside risks to the NB’s 2014 wage growth forecast (NB: 4.0%; BarCap: 3.5%). However, going into next week’s meeting, any re-assessment of the underlying domestic cost pressure, in our view will largely be offset by the fact that trade weighted NOK (i-44) has remained weaker, c1.5%, than the NB anticipated in its latest forecast. Here, we note that short-end cross-market spreads versus Norway’s main trading partners have remained relatively stable since the previous meeting.

The risk and discussion that a “too low policy rate for too long” might nourish medium-term systemic risks is very much alive in Norway and is also, in our view, an important argument against further rate cuts. Indeed, domestic credit growth to households has accelerated from 7.2% y/y in February to 7.7% in April (4.5-year high). House price inflation also remains elevated (at around 6% y/y), which should continue to sit uncomfortably with NB.

Overall, we believe that NB will leave policy rates unchanged in next week’s meeting. While we expect that NB’s own policy rate forecast will continue to signal a probability (20-40%) of near-term rate cuts, we believe that the longer-term forward looking policy guidance will be slightly more hawkish.

With the short end discounting unchanged rates policy rates until year-end and only a small probability for a hike during next year, we see value entering Sep 13/Sep 14 3m FRA steepeners going into the meeting. However, rather than outright steepeners, we prefer holding NOK money market steepeners versus flatteners in EUR, with the box trading at c-5bp. If central banks tart to normalize policy rates during the coming year we would expect NB to lead, not lag, that process.

Elevated credit growth and house price increases also suggest limited room to cut rates

Trade idea: Hold NOK money mkt. steepeners vs. flatteners in EUR

Barclays | Global Rates Weekly

14 June 2013 47

INFLATION-LINKED MARKETS: EURO AREA

Livret A hedging… finally? The recent rates sell-off, combined with the gradual cheapening of FRCPIx swaps since the start of the year, looks like it may trigger Livret A hedging. We see 5-10y FRCPIx swaps as the most likely to benefit. In cash, we see the OATi21 as particularly attractive.

The French CPI ex-tobacco printed at 0.67% y/y in May but, based on our economist’s forecasts, it should rise to 0.91% in June. The June y/y rate is closely watched as, theoretically, it enters into the calculation of the Livret A rate effective from the start of August. Our economists’ 0.91% y/y forecast would be consistent with a 1.25% remuneration rate, 50bp lower than the current 1.75%. With French y/y inflation generally expected to remain low in June, even if higher than in May, speculation about whether the Government will reduce the Livret A rate is therefore likely to build in the coming month. At the start of the year, the rate was reduced by 50bp (from 2.25%), while a strict application of the formula would have dictated a 75bp drop. Assuming our economists’ forecast proves correct next month, we would be surprised if the Government suddenly decides on a strict alignment of the rate with the formula. The prospect of a 50bp drop will likely generate a heated debate (as is usually the case with everything related to the Livret A rate), and a bonus may be given to savers, as last time.

Nevertheless, it appears likely that the Livret A remuneration will be cut next month and even a 25bp reduction this time would imply a large 75bp drop from the rate that prevailed up to the end of January this year. It is not obvious to gauge whether this will slow down Livret A inflows. In January this year, Livret A + Livret de Developpement Durable (which we would refer to collectively as “Livret A” for the rest of the article) inflows totalled close to €12bn as the account ceiling was raised for a second time. Thereafter, in February and March, inflows dropped to €2.4bn and €2.7bn respectively. However, given that those two months have seen a slowdown of inflows in the past two years even when the rate was increased, we cannot conclude that the lower rate has reduced the appeal of the Livret A. In fact, in April, outstandings increased by a healthy €4.5bn If there are any seasonals in Livret A flows, we note that May and June usually see a drop, but the data for this year are not available yet. Altogether, we believe that even if the rate drops versus the remuneration on life insurance contracts (its closest competitor) next month, the appeal of the Livret A may

Khrishnamoorthy Sooben

+44 (0)20 7773 7514 khrishnamoorthy.sooben @barclays.com

FIGURE 1 Growth in Livret A outstandings remains robust

FIGURE 2 10y FRCPIx swaps historically cheap

Source: Barclays Research Source: Barclays Research

Likely cut in Livret A rate should not prompt significant outflows

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Barclays | Global Rates Weekly

14 June 2013 48

be affected but this is unlikely to generate huge outflows. The remuneration rate is an important factor for savers but when it comes to the Livret A, the easy access to savings and its status as a risk-free account are equally important factors.

In any case, we believe that even if outflows are seen in the coming months, demand for French inflation is unlikely to be materially affected. This is because although inflows from late last year have been significant (as a result of increases in the account ceiling), we do not believe that significant hedging demand has been generated. This suggests there is a non-negligible stock of Livret A outstandings at the moment that have been left unhedged. At the end of 2012, we saw potential for a wave of hedging over 2013 if increased inflows came alongside a potential adoption of the recommendations of the Duquesne report (see “Bracing for the Livret A storm”, Global Inflation-Linked Monthly, December 2012). It appears there has not been any progress on the latter but it may seem surprising that the increased inflows have failed to generate hedging. Two reasons, in our view, explain the lack of hedging. First, it seems there has been a broad consensus that French inflation would trend significantly lower this year. For most of this year, FRCPIx swap levels were probably seen as too high to encourage hedging when realised inflation is expected to be low. Second, and probably more important overall, FRCPIx real rate swaps and bond real yields have been very low for most of the year. We note, as a reminder, that Livret A hedging theoretically needs to be done in real rate. This is because the normal formula that is supposed to determine the remuneration rate references both short-term rates and inflation, with equal weighting. The floor is set at y/y inflation + 25bp and that floor is currently struck at the moment. However, the assessment of Livret A liabilities over a long-term horizon entails the modelling of both future nominal rates and inflation. As a result, hedging is depends on the level of real yields and real rate swaps, rather than only inflation swaps.

Following the recent sharp nominal sell-off and the gradual but notable cheapening of FRCPIx swaps since the start of the year, we therefore see scope for increased demand to hedge Livret A related liabilities. We expect such demand to be particularly supportive for 5-10y FRCPIx swaps, given the nature of Livret A-related demand, although we see potential for demand up to the 15y point. We note also that FRCPIx swaps are at their cheapest levels since August last year. The 10y, for instance, is now just over 2%, close to the low end of its range since Q2 10. While French inflation is widely expected to remain low in the near term, and may put further downside pressure on valuations, the current absolute level of 10y

FIGURE 3 FRCPIx real rate swaps not cheap but sell-off may kick-start hedging demand

FIGURE 4 FRCPIx swaps cheapening vs Euro HICPx but no strong pressure for quick reversal

Source: Barclays Research Source: Barclays Research

Hedging demand seems to have been limited so far this year

Real rate cheapening should encourage hedging

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Barclays | Global Rates Weekly

14 June 2013 49

swaps appears attractive for what is relatively long-term hedging. FRCPIx swaps have also cheapened significantly versus euro HICPx this year as the prospects of lower French versus European inflation have encouraged tactical trades shorting FRCPIx versus Euro HICPx. The wide spread levels at the start of the year, combined with the relative prospects on realised inflation, meant that such trades appeared very attractive from a carry perspective. Although we see prospects for increased Livret A related hedging, we are not highly convinced there will be strong pressures for FRCPIx/Euro HICPx swaps differential to correct wider as some hedging may also be done in Euro HICPx.

OATis are likely to benefit from hedging demand even if indirectly. This is not to say that there is no straight demand for OATis for hedging purposes but we see support as likely to come via asset swaps. OATis typically have a discount in asset swap versus OAT€is because of the relative richness of FRCPIx swaps. We note that following the recent sell-off, OATi asset swaps have cheapened in both absolute terns and relative to nominals. We expect OATi asset swap demand to resurface as a result. We see particularly good value in the OATi21. The bond is cheap on its absolute and relative asset swap curves and stands out as attractive too on the real yield and breakeven curves. The OATi21 has corrected much of its initial cheapness relative to the OATi19 but still remains attractive versus peers. One of the reasons, in our view, is its relatively small size. We expect the Agence France Trésor to build the outstanding of the bond this year and we see this as likely to encourage trading in that particular issue.

OATi21 relatively attractive

Barclays | Global Rates Weekly

14 June 2013 50

EUROPE: VOLATILITY

Carry the belly For investors looking to position for a reversal of the recent sell-off in the belly of the GBP swap curve, we recommend initiating GBP 3m*4y receiver spreads and GBP 3m* (7y-30y) bull steepeners.

The past week has seen a sharp re-pricing in the belly of the GBP swap curve. For example, the GBP 5y rate has sold off c.17bp since June 5, while the 30y rate has increased only 3bp in this period. Adding this to the sell-off that has already occurred in the preceding month, means that the 5y swap rate has risen about c. 45bp since April 30, 2013.

While the sell-off has partly been brought about by some improvement in the UK economic data, the sell-off in the US and positioning by investors has probably exacerbated the move. For investors who, like us, believe the extent of sell-off is not justified and some correction is warranted - particularly if the incoming BOE Governor Mr. Carney adopts a dovish stance - we recommend two trades.

Receiver spreads One way to fade the recent sell-off in the belly of the GBP swap curve is to initiate receiver spreads. In Figure 1, we analyze various such spreads, each of which has been constructed using 3m expiry options struck at the spot rate (as opposed to the forward rate) versus the spot rate – 25bp.

The trades have been compared on their risk-reward ratios - ie, maximum payoff/initial premium outlay - as well as the potential gains in case of a partial reversal (to June 5 levels) and a complete reversal (to April 30 levels) in rates.

Among the structures analysed in Figure 1, we prefer initiating EUR 3m*4y as it not only offers a high risk-reward ratio (c. 1: 4) but also provides good returns in the case of both, partial and complete reversal of rates. From a vol perspective too, we are comfortable with the long vol exposure of the trade. As Figure 2 shows, the implied vol for intermediate tenors in GBP are close to par compared to the 20d realised vol, despite the recent rise in volatility. This suggests that even if rates rally back, implied vol, being sticky, would take time to come off and, therefore, avoid mark-to-market losses.

Piyush Goyal

+1 212 412 6793 piyush.goyal@barclays.com

Hitendra Rohra +44 (0)20 7773 4817 hitendra.rohra@barclays.com

FIGURE 1 EUR 3m*4y receiver spreads offers high risk-reward ratio and gains in rate-reversal

FIGURE 2 Implied vol on long-tails are rich compared to mid-tails

Note: Consider the example of GBP 3m*4y receiver spreads: The trade costs 6.4bp to initiate and has a maximum pay-off of 25bp. Risk reward ratio is therefore 25/6.4 = 3.9. The spot 4y rate was 1.00% on June 5 2013, and a reversal to that level would lead to a gain of 10.1bp. Similarly a rate reversal to April 30 levels would lead to a gain of 18.6bp. Data are as of June 13, 2013.

Source: Barclays Research Note: Data are as of June 12, 2013. Source: Barclays Research

GBP 3m*4y receiver spread is optimal, especially for a full reversal of the recent sell-off in yields

OptionSpot Rate

Premium (in bps)

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ratio

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Spot Rate on April 30

Gain on reversal to

April 30 level (bps)

3m*3y 0.95% 5.7 4.4 0.83% 6.2 0.64% 19.3

3m*4y 1.16% 6.4 3.9 1.00% 10.1 0.75% 18.6

3m*5y 1.37% 6.9 3.6 1.18% 12.1 0.90% 18.1

3m*7y 1.77% 7.5 3.3 1.57% 12.1 1.27% 17.5

1x1 Receiver Spread (Spot rate vs Spot rate -25bp) Imp Vol 2 Yr 3Yr 4Yr 5 Yr 7Yr 10 Yr 30 Yr

1m 35 49 58 65 75 86 813m 41 53 62 68 77 86 816m 48 57 64 69 76 83 781y 51 59 65 69 75 82 772y 65 70 72 75 78 80 74

20d rlzd vol 2 Yr 3Yr 4Yr 5 Yr 7Yr 10 Yr 30 Yr

1m 27 41 52 59 61 56 443m 31 46 56 62 62 57 446m 39 53 62 66 64 58 451y 55 66 72 72 67 60 462y 82 85 82 78 72 61 48

Imp/rlzd 2 Yr 3Yr 4Yr 5 Yr 7Yr 10 Yr 30 Yr

1m 1.32 1.20 1.12 1.10 1.23 1.53 1.853m 1.32 1.15 1.10 1.09 1.25 1.51 1.846m 1.24 1.08 1.03 1.05 1.19 1.43 1.741y 0.92 0.90 0.90 0.96 1.12 1.37 1.672y 0.80 0.82 0.89 0.96 1.09 1.30 1.53

Barclays | Global Rates Weekly

14 June 2013 51

Bull Steepeners In addition to buying receiver spreads on mid-tails, investors can also initiate bull steepener.

Apart from the attractive rate entry levels, due to the recent bear flattening of the curve, bull steepeners, such as 3m*(5y-30y), currently look good from a vol perspective too. Implied vol on mid-tenors are lower than those on longer tenors, Figure 2. For example, EUR 3m*5y is pricing an implied vol of 68bp/y, about 13bp lower than the implied vol of 3m*30y (81bp/y). This means that a premium neutral bull steepener can be struck at a flatter level than the forward curve, thereby providing a greater cushion against losses. Also, unlike the mid-tails, implied vol on longer tails are at a considerable premium to realised vol (Figure 2). This means that in the absence of sharp moves in the underlying, implied vol on long tails could come off and lead to some gains on the trade.

In Figure 3, we evaluate various premium-neutral GBP bull steepeners constructed using the 3y, 5y and 7y tenors for the short tail and 15y and 30y tenors for the long tail. The steepeners have been compared on a number of different metrics: namely, the gain on re-steepening of the curve to the April 30 levels (normalised by the 60d realised vol) and the z-score of the premium-neutral curve compared to its year-to-date and 3y histories. Of the structures that have been analysed in Figure 3, the 3m*(7y-30y) bull steepener offers the highest potential gain/realised vol ratio. A high gain to realised vol ratio is desirable as it implies relatively high gain compared to the volatility accompanying those gains.

Apart from this, the curve level at which the 3m*(7y-30y) bull-steepener is struck is extremely low compared to its recent history (year-to-date z-score of c. -4.7), implying attractive entry levels. We therefore recommend initiating 3m*(7y-30y) bull steepeners to those who are looking to fade the recent sell-off in the GBP mid tails.

Investors who are wary of the possibility of bull flattening can, in our view, make the trade limited loss by employing receiver spreads, at the cost of initiating the trade at slightly worse levels.

FIGURE 3 3m*(7y-30y) bull steepeners offer the highest potential gain (to realised vol ratio) in case of a re-steepening of the curve

Note: Consider the example of 3m*(7y-30y) bull steepener: The spot 7y-30y curve is 138bp, while the 3m forward curve is 132bp. A premium neutral bull steepener can be initiated at a strike of 131bp. The spot rate was 163bp, and a re-steepening of the curve to that level in 3m would lead to a gain of 32bp, or a gain/realised vol of 17.0. The curve strike level of 131bp has a year-to-date z-score of -4.7 and a 3y z-score of 0.3 Data are as of June 13, 2013. Source: Barclays Research

We also like bull steepeners, given the relative vol levels

Short Tail Long Tail Spot Curve (bp)

Fwd Curve Breakeven Curve

Spot Curve on April 30

Gain on reversal to

April 30 level (bp)

60d realised vol

Gain / 60d realised vol

Year-to-date Z-score of breakeven

3y Z-Score of breakeven

3y 15y 179 176 164 173 8 2.2 3.7 -2.4 -0.5

3y 30y 220 214 203 226 22 2.4 9.4 -3.4 -0.1

5y 15y 137 134 129 146 17 1.8 9.8 -4.0 -0.3

5y 30y 178 172 168 199 31 2.2 14.4 -4.2 0.2

7y 15y 98 94 92 110 18 1.3 13.9 -5.0 -0.0

7y 30y 138 132 131 163 32 1.9 17.0 -4.7 0.3

3m expiry Bull-Steepeners

Barclays | Global Rates Weekly

14 June 2013 52

JAPAN: RATES STRATEGY

Stability is not within reach At first glance, the volatility in JGB yields appears to have calmed. However, developments in risk assets could still prompt wide market swings and liquidity remains depleted. JGB markets remain vulnerable to overreaction in the event of an external shock.

The BoJ, belying market hopes, did not opt to extend the maturities of its fund-supplying operations against pooled collateral at its Monetary Policy Meeting this week. While JGB yields rose thereafter, they did not experience the sharp upswing seen in April and May. Volatility in 10y yields appears to have peaked, and the level seems to be settling within a core range of 0.8-1.0% (Figure 1).

The primary reasons behind the big jump in yields in May were the depletion in market liquidity from the BoJ’s huge JGB purchases; the downturn in the yen and equity rally; and the convergence of yields to equilibrium levels following the introduction of the BoJ’s Qualitative and Quantitative Easing (QQE). The BoJ, addressing the first problem, moved to rein in liquidity by increasing the flexibility of its operations and adjusting its annual purchasing allocations. Indeed, volatility peaked as soon as the bank altered its allocations in its purchasing operations on 30 May, a similar phenomenon was observed when it enhanced its operational flexibility on 20 April (Figure 2). However, the situation in April proved fleeting, as volatility shot back up in May when yields surged. We suspect that the basic problem of low liquidity will persist given the BoJ’s ongoing vast purchasing activity.

Regarding the currency and stock markets, the rapid rise in JGB yields in May was sparked by mounting speculation over a Fed exit policy, so USD/JPY remained on a steep uptrend while stocks continued to rally. This activity in risk asset markets may have exacerbated the rise in JGB yields. The 100-day regression residual reveals that the cheapness in JGBs relative to USTs peaked at approximately the same time as Japanese stocks hit their high.

As for yield convergence, the termination of the Asset Purchase Program and introduction of QQE led to a steepening in the short and intermediate sectors of the yield curve and a volatility-related increase in JGB holding risk, causing yields to climb. Still, we can argue that yields over the full length of the curve have settled at levels balanced, to some extent, with

Reiko Tokukatsu, CFA

+81 3 4530 1532 reiko.tokukatsu@barclays.com

Noriatsu Tanji +81 3 4530 1346 noriatsu.tanji@barclays.com

Basic problem of low liquidity will persist

FIGURE 1 10y JGB yield volatility (20-day)

FIGURE 2 Regression residual (100-day) for 10y JGB vs UST yields and share prices

Note: annualized. Source: Barclays Research Source: Barclays Research

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Barclays | Global Rates Weekly

14 June 2013 53

demand. Since their abrupt rise in May, JGB yields have actually reached attractive levels even compared with lending rates and foreign bond yields, as we have noted on repeated occasions. Although it is true that the tail in superlong auctions has widened steadily since May, the fact that yields have not significantly cheapened on either an absolute basis or relative to the curve indicates that supply/demand is roughly in balance in secondary markets, which include the BoJ purchasing.

We believe volatility will continue to be contained, to some degree, by this last factor, at least when yields are rising, as well as by the greater flexibility and new allocations in BoJ purchasing operations. On the other hand, talk of a Fed QE exit could trigger a renewed UST slump, a Japanese equity rally and yen decline. In addition, liquidity is likely to remain deficient as long as the BoJ continues its massive purchasing operations. A dramatic surge in yields, like those seen in April and May, has become less likely, but we should not jump to the conclusion that market volatility is coming to an end. We believe JGB yields will remain at risk of overreaction in the event of an external shock.

Increasing risk premium This week, a number of “carry trades” suffered as the Nikkei and fell sharply and the JPY strengthened. It did not take much for the JPY to strengthen to a 94-handle against the USD after it broke 100. One hardest hit was USD/JPY Xccy basis, which moved sharply in a negative direction, especially in short- to medium-term sectors (Figure 3). It is interesting that despite the large move, the recent disinversion of 5s10s spread remained intact (Figure 4).

A 1y1y USD/JPY paying position is in our recommended portfolio with the thinking that USD funding is unlikely to become tight. Although we believe that it is still the case, the moves over the past few days showed that such trades are possibly crowded by the investors whose risk-taking capacity relies on the performance of risk assets. In this sense, we would consider adding position at some stage, though it is likely to take some time.

As for 4-5y sector, the increase in Samurai issues can explain the sharp moves in the 5y sector. Two weeks ago, we discussed in this report that European credit spread was widening while samurai credit spread was not. Now the gap is even wider (Figure 5). Therefore, there is more incentive to issue in JPY market. Some issuers cancelled samurai issues this week, implying that the 5y basis could have moved even more. Given the consistent demand from domestic banks for long-term USD funding, we would look to a flattener 5s10s if the spread continues to disinvert.

We believe JGB yields will remain at risk of overreaction in the event of an external shock

FIGURE 3 Short-end USD/JPY Xccy basis moved sharply in a negative direction

FIGURE 4 5y USD/JPY Xccy basis also moved, but 5s10s disinversion continued

Source: Barclays Research Source: Barclays Research

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Barclays | Global Rates Weekly

14 June 2013 54

We think that the fact that JPY rates failed to rally amid the JPY strength (Figure 6) means that JPY rates are now not so much a safe-haven asset but rather something that requires a risk premium. In this sense, we think that the belly cheapening in the yield curve is likely to continue, especially around the 5y due to its sensitivity to monetary policy. As recommended in our daily relative value package, we include shorting 2s5s10s in our model portfolio.

FIGURE 7 Trade recommendation updates (bp)

Entry date

Year end/ Entry level

Level at last report

Current (incl

carry) or closed

Weekly P&L

(JPY mn)

Risk (DV01,

JPY mn)

Target (including carry) Stop Horizon Action

Swap

1s3s5s short 25-May -9.0 -9.0 -10.0 -10.0 10.0 -3.0 -12.0 1m Hold 10-15-20 short 17-May 9.8 14.2 14.2 0.0 10.0 16.0 5.0 1m Hold 10x10-20x10 steepener 6-Jun -10.0 -10.5 -15.0 -22.5 5.0 0.0 -15.0 1-3m Hold

2s5s10s short 12-Jun -28.0 n/a -28.0 0.0 5.0 -20.0 -38.0 1-3m New (RV package , 12 June)

Swap spread

Short 10y swap spread (JB327) 19-Apr -15.0 -15.2 -13.8 7.0 5 -10.0 -20.0 1-3m Hold Short 5 y swap spread (JS109) 19-Apr -15.0 -15.5 -17.0 -7.5 5 -10.0 -20.0 1-3m Hold

Swaption 3Yx1Y straddle short 4-Jun 58.0 60.0 59.0 1.0 10bn face 40.0 80.0 1-3m Hold

Xccy basis Pay 1yx1y 10-Nov -44.0 -31.0 -35.0 -40.0 10 -30.0 -80.0 medium-

long Hold

Pay 1yx1y 11-Apr -46.0 -41.0 -44.0 -15.0 5 -30.0 -80.0 long Hold JGB futures sell JBM3JBU3 calendar spread 7-Mar 24.0 28.0 24.0 12 300

contract 18.0 30.0 2wks Expired

Weekly P&L =-75.0; total P&L since 2013: 528.9; balance sheet=15.0. Note: Current levels based on the absolute maturity to capture rolldown correctly; therefore, it is different from the constant-maturity spread. Source: Barclays Research

FIGURE 5 The European credit spread continued to widen, but the samurai credit spread did not

FIGURE 6 JPY rates failed to rally despite the JPY strengthening

Source: Barclays Research Source: Barclays Research

40

45

50

55

60

65

70

75

80

80

85

90

95

100

105

110

115

120

125

130

5-Dec 5-Jan 5-Feb 5-Mar 5-Apr 5-May 5-Jun

Itrx Europe (bp, LHS)

Samurai average swap spread (bp, RHS)

85

87

89

91

93

95

97

99

101

103

105

0.60

0.65

0.70

0.75

0.80

0.85

0.90

0.95

1.00

1.05

1.10

1-Jan 1-Feb 1-Mar 1-Apr 1-May 1-Jun

10Y swap (%, LHS) USD/JPY (RHS)

Barclays | Global Rates Weekly

14 June 2013 55

TRADE PORTFOLIO UPDATE

Trade portfolio update Since the previous publication (June 7, 2013), the portfolio has gained $0.06mn. It has increased $7.7mn year-to-date and $57.2mn since inception.6

FIGURE 1 Mark-to-market performance of the portfolio – cumulative P&L, $mn

Note: As of June 13, 2013. Portfolio stop loss = $10mn. Given this total loss allowed, we allocate $500k as the stop-loss for high-conviction trades and less for low-conviction trades. Source: Barclays Research

Total equity = $100mn, stop-loss = $10mn We estimate an initial and variation margin for each derivative trade and a haircut for cash trades. The total of all such margins and haircuts is less than $100mn. In other words, the portfolio is assumed to have $100mn of equity. Thus, all returns are computed on a base of $100mn. Any unused equity is invested in fed funds and assumed to earn the daily funds rate.

6 Since January 2009.

$57.2

0

10

20

30

40

50

60

70

Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13

mn

Piyush Goyal

+1 212 412 6793 piyush.goyal@barclays.com

Vivek Shukla +1 212 412 2532 vivek.s.shukla@barclays.com

Barclays | Global Rates Weekly

14 June 2013 56

TRADE PORTFOLIO

New Trades

Note: All prices as of June 13, 2013. Source: Barclays Research

Inception Date

Theme Trade Weights/Notional AmountLevels @ Inception

Current Level

Net Change (Gain (+) /Loss (-))

Total Stop Loss (bp)

HorizonInitial

MarginVariation Margin

Total Margin

US TIPS6/12/2013 Long front-end TIPS Long Apr14s, short

XBH4$100mn:40 -44bp,

261.78-48bp, 265.5 ($28,500) ($500,000) 6m $500,000 $28,500 $528,500

US Treasury6/13/2013 Low inflation

worries7s30s flatteners

$50k dv01 176.4 176.6 ($10,000) ($500,000) 1m $500,000 $10,000 $510,000

3/14/2013Improvement in

funding environment

Long OTR2y versus OIS $100k DV01 8.2 8.4 ($20,000) ($500,000) 3m $1,000,000 $20,000 $1,020,000

JPY Swaps

6/13/2013Belly is likely to

cheapen2s5s10s short $50k dv01 ($28.00) ($28.25) ($13,000) ($350,000) 3m $1,200,000 $13,000 $1,213,000

US Options

6/13/2013 Vol Skew1y30y 100bp wide risk

reversals (delta hedged)$100mn ($270,000) ($290,000) ($20,000) ($250,000) Expiry $800,000 $20,000 $820,000

6/13/2013 Lower rates3m*10y 1x2x1 receiver

fly (strikes 2.25%, 2.10%, 2.00%)

$100mn $270,000 $250,000 ($20,000) ($125,000) Expiry $725,000 $20,000 $745,000

Barclays | Global Rates Weekly

14 June 2013 57

Trades Outstanding

Inception Date

Theme TradeWeights/Notional

AmountLevels @ Inception

Current LevelNet Gain (+)

/Loss (-)Stop Loss (bp) Horizon Initial Margin

Variation Margin

Balance Sheet Used

US TIPS $8,079,380

1/12/2012Front-end Asset Swap Tightener

Long Jan '14 TIPS ASW $500mn Libor - 13bp Libor -7bp $1,420,000 ($250,000) 1y $2,500,000 ($1,420,000)

8/3/2012Long Core Inflation

Sell 1% 2y CPI Floors vs. Long CL4 Puts 65

($100mn): +50 ($376,500) ($306,500) $70,000 ($200,000) 1y $800,000 ($70,000)

10/5/2012 Carry Long Jan '15 ASW relative to nominals $100mn 14bp 12bp $45,000 ($300,000) 1y $1,000,000 ($45,000)

10/18/2012 Supply unwind Long Feb 40 Relative ASW $10mn 22bp 33bp ($130,000) ($400,000) 1y $400,000 $130,000

3/8/2013 SupplyApr16-Jan22 rel ASWs flattener (20K

DV01)20k DV01 11bp 14bp ($60,000) ($200,000) 3m $1,250,000 $60,000

3/27/2013Low realized CPI

volSell 3y y/y CPI strangle, energy hedged $100mn 1%-3.5% ($1,400,000) ($1,400,000) $0 ($500,000) 3m $2,000,000 $0

5/9/2013 Cheap front end Long Jul13 breakeven $200mn -60bp +59bp ($14,380) ($500,000) 3m $500,000 $14,380

5/30/201310s30s

breakeven curve flattener

Jan-23-Feb43 $25k dv01 15 12 $40,000 ($200,000) Unwound $1,000,000 ($40,000)

US Treasury $2,521,000

3/14/2013Improvement in

funding environment

Long OTR3y versus OIS $100k DV01 8.9 9.2 $48,000 ($500,000) Unwound $1,000,000 ($48,000)

4/25/2013Decline in term

premiumShort 5s10s20s (0.4:1.4:1)

$50k DV01 -30.4 -33.6 ($99,000) ($500,000) 1m $750,000 $99,000

5/23/2013 Low inflation worries

10s30s flatteners$50k dv01 117.4 116.8 $30,000 ($500,000) Unwound $750,000 ($30,000)

Eurozone Sovereign debt $390,000 10/5/2012 UFR positioning Receive 5y5y/5y10y/5y15y fwd $15k dv01 102bp 88bp $210,000 ($375,000) 3-6m $600,000 ($210,000)

US Swaps / Futures $780,000 5/23/2013 RV 10s30s spread curve flattener $100kDV01 -22 -27.5 $550,000 ($500,000) Unwound $800,000 ($550,000)

5/30/2013For reversal of

sell-offLong front Eds (EDU4) $50k dv01 53.8bp 54.5bp ($35,000) ($250,000) 1m $200,000 $35,000

5/29/2013 RV Sell USU3 invoice spreads $50k dv01 13.2bp 9.10bp $205,000 ($250,000) 1m $500,000 ($205,000)

JPY Swaps $2,915,000

5/30/2013CTD spread is

too wide relative to 7s10s

Sell JBM3JBU3 calendar spread 300 24 24 $0 ($150,000) Expired $600,000 $0

6/4/2013

intermediate sector volatility

too rich vs. forward yield

Short 3yx1y straddle $100mn face -58 -60 ($20,000) ($200,000) 3m $750,000 $20,000 $770,000

6/6/20133y is too rich and 7y is too

cheapSwap 3s7s flattener $50k dv01 38.5 38 $25,000 ($350,000) Unwound $500,000 $20,000 $520,000

6/6/2013

Long end steepeneng trend is not yet taken up in forward

10x10-20x10 steepener $50k dv01 -10 -10.5 ($25,000) ($350,000) 3m $1,000,000 $25,000 $1,025,000

Barclays | Global Rates Weekly

14 June 2013 58

Trades Outstanding (continued)

Inception Date

Theme TradeWeights/Notional

AmountLevels @ Inception

Current LevelNet Gain (+)

/Loss (-)Stop Loss (bp) Horizon Initial Margin

Variation Margin

Balance Sheet Used

US Options $16,375,000 11/15/2012 Short vol Short 1y*10y straddles ($10mn) ($570,000) ($590,000) ($20,000) Expiry $880,000 $20,000

8/9/2012 TacticalLong 3y*1y 25bp low-strike recr vs 45bp

high-strike payer$200mn:($200mn) 0 ($90,000) ($90,000) ($500,000) 1y $800,000 $90,000

8/16/2012 Relative ValueShort belly of 2y5y - 2y10y - 2y30y payer

fly+$94mn : ($100mn):

+$22mn($300,000) ($260,000) $40,000 ($500,000) 1y $2,200,000 ($40,000)

1/4/2013 Short vol sell 2y*10y straddles @ 2.65% ($50mn) ($4,105,000) ($4,155,000) ($50,000) ($500,000) 6m $2,200,000 $50,000

1/17/2013 Sell skew Sell 3y*5y 2.5% payer, delta hedged ($100mn):($40mn) ($2,115,000) ($2,475,000) ($360,000) ($500,000) 1y $1,200,000 $360,000

2/14/2013 Calendar spread long 5y30y p 3.6 vs 1y30y p 3.15 +$50mn: ($50mn) $3,320,000 $3,190,000 ($130,000) ($500,000) 1y $1,000,000 $130,000 4/11/2013 Steeper Vol

SurfaceLong 3x13 cfs vs 3y10y swaption

straddle+$50mn: -$50mn $4,650,000

$4,260,000 ($390,000)($500,000) 1y $1,600,000

$390,000

5/3/2013 Short VolBuy 1x1x1 4EH4 98.125 – 98.375 – 98.5

CALL LADDER3000 contracts 0 $170,000 $170,000 $500,000 Expiry $1,500,000 ($170,000)

5/16/2013 Fed Tapering Long 3en3p 98.625 vs 5en3p 97.25 +2000-2000 ($25,000) $450,000 $475,000 ($500,000) Expiry $1,000,000 ($475,000)

5/30/2013For continuation

of sell-off1m*5y vs. 1m*15y bear flattener

Long $260mn 1m*5y 20bp OTM:Short $100mn 1m*15y 22bp high strike

payer

10000 $110,000 $100,000 ($250,000) 1m $500,000 ($100,000)

5/30/2013For reversal of

sell-offBuy swaptions vs TY options (bull-

spread tightener)

Sell 1000 TYN3 130 call: Long $122mn 6/21 7y reciever @

1.69%

10000 ($165,000) ($175,000) ($250,000) 1m $500,000 $175,000

6/7/2013Fed uncertainty Sell 1m7y (@1.81%), Buy 3m7y

(@1.89%)$100mn:$100mn $820,000

$955,000 $135,000 ($250,000) 1m $1,200,000 ($135,000)

6/7/2013Steeper vol

surfaceSell 3y10y, Buy 10y10y $20mn:$20mn $540,000

$540,000 $0 ($250,000) 1m $1,500,000 $0

EUR Options $2,122,000

9/7/2012 Short vol EUR 1x2 1y5y 1.15 vs 0.9 recr ladderEUR 100mn:

(200mn)0 $360,000 $360,000 ($250,000) 6m $1,692,000 ($360,000)

10/5/2012 Long volLong EUR 1y*10y 1x2 payer spread (2.2

vs 2.6)(EUR 50mn): EUR

100mn0 ($240,000) ($240,000) ($500,000) 6m $550,000 $240,000

JPY Options $0

Cross-currency ($340,000)10/11/2012 Carry Pay 1yx1y Xccy basis $40k dv01 -53.5 -35 $740,000 ($400,000) 1y $400,000 ($740,000)

US BMA $1,790,000

1/12/2012Sell Front-end

Ratios

Long 3m1y BMA ratio vs short 3y1y ratio; 3m1y matured on 4/12 at 1y ratio

= 50, implying p&l -$42k$200mn : ($200mn) 54, 84 50, 69 $340,000 ($250,000) 1y $800,000 ($340,000)

5/10/2012Sell Front-end

RatiosShort 3y ratio $200mn 65.375 60 $185,000 ($250,000) 1y $800,000 ($185,000)

6/7/2012Sell Front-end

RatiosShort 3y ratio $200mn 66.75 62 $85,000 ($250,000) 1y $800,000 ($85,000)

Barclays | Global Rates Weekly

14 June 2013 59

Trades Outstanding (continued)

Note: All prices as of Jun 13, 2013. Source: Barclays Research

Inception Date

Theme TradeWeights/Notional

AmountLevels @ Inception

Current LevelNet Gain (+)

/Loss (-)Stop Loss (bp) Horizon Initial Margin

Variation Margin

Balance Sheet Used

Cash 6/7/2013 6/13/2013Cash Used as Collateral/ Haircut $45,131,400 $41,783,880

Fed Funds (residual cash) $69,912,988 $73,720,360

Return on Fed Funds $118,472 $119,404

Return on trades $15,384,836

Total $115,504,240

Barclays | Global Rates Weekly

14 June 2013 60

Trades Unwound

Inception Date

Unwound Date Theme Trade

Weights/Notional Amount

Levels @ Inception

Levels @ Unwind

Net Change (Gain (+) /Loss (-))

Total Stop Loss (bp) Horizon

US TIPS9/29/2011 1/12/2012 Front-end Asset Swap Tightener Long Jan '12 TIPS ASW $500mn Libor -

15.75bpLibor - 34bp $170,000 ($250,000) Unwound

1/6/2012 1/19/2012 Supply Trade Sell Apr '16 - Jul '21 - Apr '28 $25k dv01 20bp 21bp $25,000 ($500,000) Unwound

10/20/2011 2/23/2012 Relative Value 10y-30y breakeven steepener $20k dv01 21.5bp 5bp ($260,000) ($250,000) Stop-out

3/9/2012 3/28/2012 Relative Value Long Apr '14 - Apr '15 breakeven $30k dv01 165bp 185bp $500,000 $200,000 Unwound

1/27/2012 4/6/2012 Dovish Fed Long 5y5y breakevens $20k dv01 232bp 251bp $250,000 $300,000 Unwound

6/16/2011 4/19/2012 Eurozone contagion Long the belly Jan '16 - Apr '16 - July '16 real yield fly

$20k dv01 5.5bp 7bp ($20,000) ($75,000) Unwound

8/5/2011 5/24/2012 Long TIPS Long July'12 TIPS energy hedged; bought 20 XBM2 on 4/6/12 for 327.66

12k dv01, Short 40 XBH2 (XBM2)

-60.5bp, 267.76

-253bp, 288 $865,000 $0 Unwound

3/29/2012 6/1/2012 Relative Value Long TII Jan 22 Relative Asset Swap 45k dv01 33bp 31bp $10,000 ($500,000) Unwound

4/19/2012 7/6/2012 Eurozone contagion Long Apr '17 vs Jan '17 $50k dv01 6bp -5bp $550,000 ($500,000) Unwound

6/1/2012 7/19/2012 Inflation risk premium Long 10y10y vs 5y5y BE $15k dv01 -19bp -8bp $80,000 ($150,000) Unwound

6/28/2012 7/19/2012 Supply Short belly of Jan '18 - Jan '21 - Jan 26 real yield fly

$20k dv01 -12bp -9bp $90,000 ($250,000) Unwound

7/19/2012 8/30/2012 Flattener Jan '14 - Apr '17 breakeven flattener ; energy hedged

$15k dv01; (30 contracts)

67bp, 94.44 52bp, 96.35 ($100,000) ($250,000) Unwound

8/16/2012 10/18/2012 Supply Trade Apr '17 - Feb '42 breakeven flattener $15k dv01 39bp 35bp $12,000 ($250,000) Unwound

11/2/2011 10/25/2012 Normalization Long Apr' 13 TIPS vs. sell 2% CPI cap and sell XBH3

$30k dv01; 45 contracts

-103bp, -36bp, 249.83

-107bp, 4bp, 275

$1,100,000 $700,000 Unwound

9/20/2012 11/8/2012 Dovish Fed Receive 2y forward 2y break-even (Jan '14 vs Jan '16)

$20k dv01 228bp 215bp ($250,000) ($500,000) Unwound

8/17/2012 11/15/2012 Sell Deflation Floor Long Jan' 17 vs. Apr '17 $50k dv01 0bp -1bp ($50,000) ($100,000) Unwound

9/7/2012 11/29/2012 Carry trade Buying German I/L Apr 2016, asset swapped into USD

$100mn 32.3bp 16bp $690,000 ($500,000) Unwound

11/8/2012 1/4/2013 Fiscal Cliff Short Jul17 Breakeven 25k/$56mn 215bp 228bp ($292,344) ($500,000) Unwound

11/29/2012 1/4/2013 Supply Fly: 5s Sell the belly of Jan15-Jan17-Jan19 RY Fly $15K DV01 -21 -18 $60,000 ($200,000) Unwound

11/29/2012 1/4/2013 Risk Premium 10s30s BE steepener ahead of Dec. FOMC 15K DV01 2bp 6.2bp $70,000 ($250,000) Unwound

1/4/2013 2/7/2013 Concession unwind Long Jan15-Apr17-Jan19 RY Fly $15k dv01 -10 0 ($175,000) ($150,000) Stop-out

2/21/2013 1/10/2013 Front-end Underpriced Long $250mn TIIJan14s hedged with sell 100 CLZ4

$250mn -134bp, 91.74

-226bp, 93.5 $1,003,000 ($600,000) Unwound

1/17/2013 3/14/2013 Long the belly and fade the roll Jan19-Jul22-Jan25 real yield fly $20k dv01 32bp 37bp ($10,000) ($160,000) Unwound

4/18/2013 4/25/2013 Dovish Fed Long 5y5y breakeven (Apr 17-Jul22) fwd BE $25k dv01 266bp 278bp $255,000 ($500,000) Unwound4/25/2013 5/30/2013

Relative Value Sell the belly of Apr17-Jul20-Jan23 real yield fly $50k DV01 -15.5bp -9.4bp $383,000 ($500,000) Unwound

5/8/2013 5/30/2013 Dovish Fed Long 5y5y BE $25k dv01 269bp 260bp ($225,000) ($250,000) Stop out

Barclays | Global Rates Weekly

14 June 2013 61

Trades Unwound (continued)

Inception Date

Unwound Date Theme Trade

Weights/Notional Amount

Levels @ Inception

Levels @ Unwind

Net Change (Gain (+) /Loss (-))

Total Stop Loss (bp) Horizon

UK Inflation6/1/2012 6/14/2012 Macro Long IL20 vs. pay match-maturity swap GBP 7mn 280bp 262bp ($515,000) ($500,000) Stop-out

6/22/2012 7/6/2012 Macro Buy IL29 Breakeven (vs. UKT 4.75%) GBP 13mn: (GBP 13.3mn)/ $35.7k dv01

262bp 263bp $35,700 ($500,000) Unwound

6/29/2012 7/26/2012 Real Yield curve flattener Long IL32 vs IL17 $45k dv01 126bp 145bp ($720,000) ($500,000) Stop-out

7/13/2012 9/28/2012 Relative Value Sell IL17 vs IL16, IL22 real yield fly $37.5k dv01 -24bp -24bp $150,000 ($300,000) Unwound

9/14/2012 10/18/2012 Cheap forward real rates Receive 20y20y forward RPI real rate swap $17.2k dv01 36bp 42bp ($103,000) ($500,000) Unwound

9/28/2012 11/29/2012 Real yield flattener IL22 - IL42 real yield flattener $25k dv01 97bp 100bp ($175,000) ($500,000) Unwound

11/16/2012 1/10/2013 UK Linker RV Sell IL22 vs IL17+32 RY barbell 62.5k DV01 0bp 1bp $125,000 ($500,000) Unwound

12/12/2012 1/10/2013 10y UK breakevens rich Sell IL22 Breakeven $25k DV01 250 293 ($1,075,000) ($1,000,000) Stop-out

1/17/2013 2/7/2013 UK 5y5y fwd real yield rich Sell IL22 into IL17 cash for cash $30k DV01 -20 -15 $150,000 ($500,000) 3m

2/21/2013 2/1/2013 UK Linker RV IL24 vs IL17+IL34 real yield barbell $125k dv01 32 37 ($500,000) ($500,000) Stop-out

2/14/2013 3/8/2013 Real Yield IL32-IL55 real yield flatteners $50k dv01 26bp 33bp ($500,000) ($500,000) Stop-out

EUR Inflation6/1/2012 6/22/2012 Macro Receive 5y Euro HICPx Inflation EUR 25mn 1.35% 1.48% $390,000 $390,000 Stop-out

6/29/2012 7/26/2012 Relative Value Sell Bund i23 vs. OBL i18 breakeven $27.2k dv01 47bp 50bp ($106,000) ($300,000) Unwound

8/10/2012 9/7/2012 Short inflation Sell 10y FRCPIx ZC Inflation $37k dv01 2.32% 2.4% $50,000 $100,000 Stop-out

9/14/2012 9/28/2012 Relative Value Sell 10y FRCPIx vs. Euro HICPx $39.5k dv01 27bp 37bp ($388,000) ($400,000) Unwound

11/29/2012 12/14/2012 Real Yield Short BTPi16/19 fwd real yield $5.4k DV01 346bp 360bp $75,000 ($250,000) Stop-out

1/17/2013 2/28/2013 Curve Buy BTP€i41 versus BTP€i21 EUR 10mn 21s vs EUR 4.5mn 41s ($11k

dv01)

77bp 36bp $411,000 $75,000 Unwound

1/4/2013 3/14/2013Relative value Buy OATi23 versus OATi22

EUR21.3mn 23s vs 25mn 22s ($35k dv01)

3.5bp 1bp $105,000 ($75,000)Unwound

2/14/2013 3/28/2013 Curve trade Long OBL€i18 vs OAT€i40 BE $50k dv01 95bp 81bp ($100,000) ($500,000) Unwound

US Treasury1/12/2012 1/26/2012 Fed-on-hold Long 2y-5y-10y treasury fly $50kdv01 -49.5bp -66.5bp $850,000 ($500,000) Unwound

1/19/2012 1/26/2012 Dovish Fed 10y-30y tsy curve steepener $50k dv01 106.25 bp 117.25 bp $550,000 ($500,000) Unwound

2/9/2012 2/23/2012 Unwind of auction concession 7y-30y tsy curve flattener $50k dv01 177.75bp 174.75bp $150,000 ($500,000) Unwound

3/1/2012 3/9/2012 Bond auction concession 10y-30y tsy curve steepener $50k dv01 111.5bp 116.25bp $237,500 ($500,000) Unwound

3/29/2012 4/6/2012 Bond auction concession 10y-30y tsy curve steepener $50k dv01 111.5bp 117.5bp $305,000 ($500,000) Unwound

3/1/2012 4/19/2012 Increase in odds of QE3 Long 5y-10y-30y fly $50k dv01 1.75bp -1.7bp $172,500 ($500,000) Unwound

3/1/2012 4/19/2012 Fading 7yr Short 5yr - 7yr - 10yr $50k dv01 -4.5bp -11.8bp ($365,000) ($500,000) Unwound

3/16/2012 4/19/2012 Dovish Fed Long ct2 75k dv01 36.9bp 26.7bp $865,000 ($500,000) Unwound

4/20/2012 5/17/2012 Low front-end term premium Vol weighted 2y - 3y steepener $80k dv01: ($50k dv01)

-2bp -7.5bp ($270,000) ($500,000) Unwound

Barclays | Global Rates Weekly

14 June 2013 62

Trades Unwound (continued)

Inception Date

Unwound Date Theme Trade

Weights/Notional Amount

Levels @ Inception

Levels @ Unwind

Net Change (Gain (+) /Loss (-))

Total Stop Loss (bp) Horizon

US Treasury4/26/2012 5/17/2012 Bond auction concession 10y-30y tsy curve steepener $50k dv01 117.2bp 112.2bp ($250,000) ($500,000) Unwound

5/10/2012 6/1/2012 Fading 7yr Short 5yr - 7yr - 10yr $50k dv01 -12.2bp -18.2bp ($325,000) ($300,000) Stop-out

5/10/2012 6/14/2012 Relative Value Short HC Nov '15 Ps vs. HC Feb '15 Ps $50k dv01 6.25bp 8bp $87,500 ($300,000) Unwound

6/7/2012 7/6/2012 Fading Operation Twist Long 3% Sep '16 vs. OIS $50k dv01 16.1bp 13.5bp $130,000 ($250,000) Unwound

6/28/2012 7/19/2012 Dovish Fed/ Relative Value Long 9.25% Feb '16s $40k dv01 0.525% 0.40% $500,000 ($400,000) Unwound

6/14/2012 7/26/2012 Macro Long 10y treasury $25k dv01 1.635% 1.425% $570,000 ($300,000) Unwound

7/12/2012 7/26/2012 Flattener 10y-30y tsy curve flattener $50k dv01 108.4bp 106bp $115,000 ($300,000) Unwound

7/26/2012 8/9/2012 Macro Long 7y tsy $50k dv01 0.94bp 1.045bp ($525,000) ($500,000) Stop-out

9/7/2012 9/13/2012 Steepener 7y-30y steepener $50k dv01 171.5bp 184bp $625,000 ($500,000) Unwound

8/10/2012 9/20/2012 Fed on hold Long 5y $25k dv01 0.694% 0.68% $50,000 ($500,000) Unwound

10/11/2012 11/29/2012 Flattener 7y-30y flattener $50k dv01 177bp 178bp ($45,000) ($500,000) Unwound

9/20/2012 1/10/2013 Low funding rates Long 3y $50k dv01 35.5bp 33.2bp $219,000 ($500,000) Unwound

11/15/2012 1/10/2013 Liquidity Premium Long OTR 10s vs Old 10s $100K DV01 3.8bp 4.7p ($89,000) ($500,000) Unwound

12/13/2012 1/10/2013 Long end Fed purchases 7s30s Tsy curve flattener 25k dv01 175.8 175.7 $5,000 ($500,000) Unwound

2/14/2013 1/24/2013 bond refunding steepener 10s30s $50k dv01 119.7 120.3 $28,000 ($500,000) Unwound

1/10/2013 2/28/2013 Long front end Long 4y $50k DV01 59.4bp 53.3bp $378,000 ($500,000) Unwound

1/17/2013 2/28/2013 Lower growth, higher fiscal risk premium

Long 5s10s30s fly $50k DV01 -9.6bp -12.5bp $194,370 ($500,000) Unwound

2/1/2013 2/28/2013 Easy Fed, Fading richness of 7s Long 2s5s7s gross fly $50k DV01 8.6bp 3.6bp $243,700 ($500,000) Unwound

2/14/2013 3/14/2013 Not enough liq premium in OTR Long Feb23s vs Nov22s $100k dv01 2.95bp 2.76 $53,000 ($500,000) Unwound

9/20/2012 3/27/2013 QE underpriced Long 10y $25k dv01 1.78% 1.76% $260,000 ($500,000) Unwound

2/14/2013 3/27/2013 sequester/post auction dynamics 10s30s curve flattener $50k dv01 116.65 124.2 ($414,000) ($500,000) Unwound

2/28/2013 4/5/2013 Fade the curve steepness 7s10s flattener $100k DV01 62.8 61.39 $175,000 ($500,000) Unwound

3/27/2013 4/5/2013 Risk aversion 7s30s flattener $50k DV01 186 175.9 $530,000 ($500,000) Unwound4/11/2013 4/18/2013 Low front end risk premium 5s10s Flattener (65% dv01 on 10s) $50k dv01 43.5 39.9 $179,000 ($500,000) Unwound

4/18/2013 5/16/2013 Curve too steep given inf exp 7s30s curve flattener $50k DV01 172.2 182.9 ($500,000) ($500,000) Stop out5/3/2013 5/23/2013 Long duration Long 10y $50k DV01 1.79 1.9 ($530,000) $500,000 Stop-out

5/9/2013 5/30/2013 Overweight 3s Long 2s3s5s (2:2:0.5) $50k dv01 -11.6 -10.3 ($65,000) ($500,000) Unwound

JGB6/8/2012 6/21/2012 Fading monetary policy easing 5y-10y flattener $125k dv01 66bp 61.8bp $525,000 ($250,000) Unwound

6/8/2012 6/21/2012 relative value 10y-20y flattener $125k dv01 81bp 84.4bp ($425,000) ($375,000) Stop-out

10/17/2012 10/25/2012 Bear flattener JGB 10y-20y bear flattener $50k dv01 90.5bp 91.5 ($50,000) ($150,000) Unwound

11/8/2012 12/13/2012 Auction Concession Unwind JGB 30s40s flattener 60k DV01 19 16.4 $156,000 ($150,000) Unwound

1/29/2013 Tactical JGB 10s12s flattener $60k dv01 30.2 29.8 $24,000 ($150,000) Unwound

2/21/2013 3/7/2013 JGB 20s30s steepener JGB 20s30s steepener $120K 17.5 14 ($400,000) ($400,000) Stop-out

3/21/20133/28/2013 Still flattening room for JGB

10s20sJGB 10s20s flattener 60 95 91 $240,000 ($150,000) Unwound

4/18/2013 5/3/2013End of extreme low short end

means flatter curveJGB 10s20s flattener $40k dv01 90 90.5 ($20,000) ($300,000) Unwound

Barclays | Global Rates Weekly

14 June 2013 63

Trades Unwound (continued)

Inception Date

Unwound Date Theme Trade

Weights/Notional Amount

Levels @ Inception

Levels @ Unwind

Net Change (Gain (+) /Loss (-))

Total Stop Loss (bp) Horizon

Eurozone Sovereign debt4/19/2012 5/17/2012 Eurozone contagion Short FRTR Apr '20 vs. 50% RFGB Apr '20 and

50% RAGB Jul '20$35k dv01 -42bp -58.5bp $542,500 ($250,000) Unwound

4/27/2012 5/25/2012 Italy vs. Spain Short BTPS 3.75% Mar 21 vs SPGB 5.5% Apr 21

$12.5k dv01 -37bp -70bp ($425,000) ($350,000) Stop-out

9/7/2012 11/21/2012 Front end periphery convergence Long SPGB 4.75% Jul 14 vs BTP 4.25% Jul 14 $10k dv01 60bp 102bp ($420,000) ($350,000) Stop-out

6/15/2012 2/28/2013 Relative Value Short Bobl ASW vs. EONIA long Schatz ASW vs. libor

$15k dv01 -48bp -24bp ($360,000) ($350,000) Stop-out

1/10/2013 3/8/2013 Fundamental cheapness Long 5y5y fwd EUR ASW $30k dv01 -4 15 $570,000 ($450,000) Unwound

US Swaps / Futures1/19/2012 2/23/2012 Calendar roll USH2 invoice spread widener $100k dv01 0.45bp -2.4bp ($285,000) ($500,000) Unwound

1/6/2012 3/15/2012 Eurozone Contagion Short EDU2 Long EDU4 2000 contracts 47.75bp 54.75bp ($525,000) ($500,000) Stop-out

3/16/2012 4/6/2012 Spread widener FV invoice spread widener $50k dv01 17.75bp 28.25bp $525,000 ($500,000) Unwound

4/19/2012 5/24/2012 Relative Value Sell TYM2 Invoice spread vs. 1/3rd dv01 1y1y libor-OIS

$50k DV01 12.15bp 19.7bp ($377,500) ($500,000) Unwound

5/18/2012 5/30/2012 Calendar Roll Long TUU2 Short TUM2 2000:(2000) 2.875 (ticks) 1.75 (ticks) $70,313 ($250,000) Unwound

5/18/2012 5/30/2012 Calendar Roll Long TYU2 Short TYM2 2000:(2000) 31.75 (ticks) 30 (ticks) $109,375 ($250,000) Unwound

1/6/2012 6/21/2012 Issuance Sell 30y spreads $50k dv01 -31bp -24bp ($350,000) ($250,000) Stop-out

4/6/2012 7/12/2012 Front-end spd widener March '14 FRA-ois (USFOSC8) widener $50k dv01 38.5bp 33.5bp ($250,000) ($250,000) Stop-out

7/19/2012 8/3/2012 Flattener 4y1y vs 1y1y flattener $50k dv01 109.5bp 120bp ($525,000) ($500,000) Stop-out

6/7/2012 8/30/2012 Relative Value Short 5y - US - 30y spread $50k dv01 13.15bp 8.4bp $237,500 ($250,000) Unwound

10/11/2012 10/18/2012 Long duration Receive 3y1y $50k dv01 103.25bp 116.9bp ($500,000) ($500,000) Stop-out

9/13/2012 11/23/2012 Relative Value Long 11/23/12 -> Aug '19 vs short TYZ2 C 133

"$130mn: (1000) 0 $684,000 $684,000 ($500,000) Expired

9/7/2012 1/4/2013 Spread Curve Flattener 5y - 10y spread curve flattener $100k dv01 -7.2bp 263bp ($130,000) ($500,000) Unwound

9/13/2012 1/4/2013 Macro 30y Spread widener $50k dv01 -22.5bp -20.5bp $100,000 ($500,000) Unwound

10/11/2012 1/4/2013 Flattener Pay 3y1y Rec 5y9y $50k dv01 237bp 263bp ($500,000) ($500,000) Stop-out

2/14/2013 2/1/2013 7y auction concession unwind Long dv01 weighted OTR7y TYH3 basis $100mn/820 TYH3 cts -260.1 -260.5 ($9,000) ($500,000) Unwound

2/14/2013 4/5/2013 UK v US steepener UK 10s-30s steepener against US flattener 100K DV01 6bp 16bp $1,000,000 ($500,000) Unwound

4/18/2013 5/3/2013 Cross mkt relative value Sell 10y France vs eq wgt US and Japan $50k dv01 64.8 54.8 ($300,000) ($300,000) Stop out

3/8/20136/7/2013

RV1y1y Libor-OIS tightener against 1y1y 3s1s

widener$100k DV01 13.6 14 ($40,000) ($500,000) Unwound

JPY Swaps2/14/2013 1/24/2013 Pause in one-way steepening in

long endLong 1yx10y straddle vs. 1yx20y straddle $120mn -60 -43 $204,000 ($250,000) Unwound

2/5/2013 Volatility and rates are both high Short 1yx8y ATM+10bp payers USD60mn -92 -90 $12,000 ($150,000) Unwound

5/18/2012 5/25/2012 Fade excessive bull-flattening 6x2-8x2 steepener $120k dv01 48.75bp 50.5bp $210,000 ($450,000) Unwound

5/24/2012 6/7/2012 Calendar Roll Short calendar spread (JBM2-JBU2) 100 contracts 20 ticks 18 ticks $26,000 ($12,500) Unwound

5/18/2012 6/21/2012 Good carry trade with stable front end.

6mx1y pay $60k dv01 -53bp -44bp $540,000 ($420,000) Unwound

6/14/2012 6/21/2012 Tactical 5y5y-10y10y flattener $60k dv01 99.5bp 104bp ($270,000) ($120,000) Stop-out

6/7/2012 7/6/2012 Long spreads Long 30y swap spread $30k dv01 19bp 18.8bp ($6,000) ($120,000) Unwound

Barclays | Global Rates Weekly

14 June 2013 64

Trades Unwound (continued)

Inception Date

Unwound Date Theme Trade

Weights/Notional Amount

Levels @ Inception

Levels @ Unwind

Net Change (Gain (+) /Loss (-))

Total Stop Loss (bp) Horizon

JPY Swaps5/22/2012 7/20/2012 Long spreads Long 20Y swap spread $60kdv01 11.4 12.3 ($54,000) ($400,000) Unwound

7/13/2012 7/20/2012 Long spreads Reestablish 30Y swap spread $30k dv01 21.2bp 20bp $36,000 ($54,000) Unwound

7/19/2012 7/25/2012 Long spreads Short 20y swap spread vs 10y10y (1:3 ) $60kdv01 84.4bp 86.9bp $150,000 ($200,000) Unwound

6/14/2012 7/26/2012 Tactical Short 7Y (future) swap spread $60k dv01 -9.1bp -8.5bp $36,000 ($144,000) Unwound

7/6/2012 7/26/2012 Carry Long 6Y swap spread $120kdv01 -16.1bp -12.7bp ($408,000) ($300,000) Stop-out

8/3/2012 8/16/2012 Tactical pay 1y1y swap $75k dv01 -26.1bp -29bp $218,000 ($300,000) Unwound

8/9/2012 8/16/2012 Relative Value long 30y swap spread and receive 20yx10y at 2:1

$100k dv01 123.13 123 $13,000 ($300,000) Unwound

7/20/2012 9/14/2012 Carry Receive USD/JPY Xccy basis 6yx2y vs. 4yx1y $60kdv01 7 -11.7 $1,120,000 ($360,000) Unwound

8/3/2012 9/28/2012 Tactical long 8y swap spread $120k dv01 -5.75bp -5.2bp ($62,000) ($300,000) Unwound

8/31/2012 10/5/2012 Relative Value short swap 7s10s20s $100k dv01 -42.125 -44.5 ($238,000) ($300,000) Unwound

9/14/2012 10/5/2012 Tactical pay 3yx5y Xccy basis $40k dv01 -83 -57 $1,040,000 ($400,000) Unwound

9/21/2012 10/11/2012 Limited rally in 10s Sell 1mx10y receiver spread $40mn -28cts -32cts ($16,000) ($100,000) Unwound

10/5/2012 11/8/2012 Tactical 10y10y - 20y10y steepener $60k dv01 -26bp -18bp $48,000 ($50,000) Unwound

11/7/2012 11/15/2012 Relative Value Swaps 5s10s flattener 120k DV01 44.75 42 $33,000 ($250,000) Unwound

8/31/2012 11/29/2012 Macro long 30y swap spread $60k dv01 21 15.3 $342,000 ($200,000) Unwound

11/7/2012 12/21/2012 Rate Directionality Pay 5y vs 3m Libor 60k DV01 21.5 21 ($3,000) ($150,000) Unwound

9/28/2012 12/28/2012 hedge to overall portfolio Long receiver fly 3mx10y (0.72-0.77-0.82%) $40mn 8cts 17cts $36,000 ($50,000) Expired

11/1/2012 1/7/2013 Carry Trade Sell 1y1y ATM receiver USD40mn -6 -8 ($8,000) ($100,000) Unwound

12/7/2012 1/7/2013 Hedge to short 1y1y long 30y swap spread $60k dv01 14.3 -1 $918,000 ($200,000) Unwound

1/7/2013 1/17/2013 5s swap spread too rich 5s7s box spread $120k dv01 7.5 6.9 ($60,000) ($400,000) Unwound

1/23/2013 2/28/2013 Pause in easing speculaion Swap 20s30s box (20y long) $80k dv01 -7 -4.6 $232,000 ($500,000) Unwound

1/17/2013 3/8/2013 Carry short 5x5, long 10x10, short 20x10 $60k dv01 -149 -140 $360,000 ($250,000) Unwound

2/5/2013 3/8/2013 Volatility Short 1yx8y ATM+10bp payers $60mn -92 -62 $180,000 ($150,000) Unwound

10/18/2012 3/21/2013 Widener 2y Tibor 6v1 widener $120k dv01 19 19.2 $24,000 ($400,000) Unwound

2/7/2013 3/28/2013 Volatility and Rates Short 1yx8y ATM straddle with 5x2 long $30mn -235 -202 $99,000 ($150,000) Unwound

3/28/2013 4/25/2013Volatility is high for 20y tail vs.

10y tailShort 1mx20y (ATM+20bp) payers vs. long

1mx10y (ATM+15bp) payers100mn -5 0 $50,000 ($200,000) Expired

4/11/2013 4/25/2013 Swap 5s10s steepner Swap 5s10s steepner $60k dv01 35 37 $120,000 ($450,000) Unwound

4/24/2013 5/16/2013 Dip buying under slowed economic fundamentals

2s5s flattener $60k dv01 11.5 25 ($450,000) ($450,000) Stop out

7/13/2012 5/30/2013 Short front-end Pay 1y OIS $160k dv01 6bp 6.55bp $88,000 ($350,000) Unwound

3/13/2013 5/30/2013Swap spread term structure is

distortedSwap spread 10s20s30s long usd 60 k dv01 23 12 $540,000 ($450,000) Unwound

5/16/2013 5/30/2013 5y belly too cheap 1s3s5s short vs. 3s5s7s long $30k DV01 -8 -5 $15,000 ($250,000) Unwound

Barclays | Global Rates Weekly

14 June 2013 65

Trades Unwound (continued)

Inception Date

Unwound Date Theme Trade

Weights/Notional Amount

Levels @ Inception

Levels @ Unwind

Net Change (Gain (+) /Loss (-))

Total Stop Loss (bp) Horizon

US Options10/7/2011 1/9/2012 Sell GBP Gamma Sell 3m5y straddles GBP 25mn ($650,000) ($491,000) $159,000 ($500,000) Expired

10/7/2011 1/9/2012 Sell EUR Gamma Sell EUR 3m2y straddles EUR 25mn ($225,000) ($175,000) $50,000 ($100,000) Expired

10/20/2011 1/20/2012 Sell US Gamma Sell 3m*10y straddles $10mn ($420,000) ($285,000) $135,000 ($125,000) Expired

1/19/2012 1/26/2012 Steepener Long 4m30y payer spread (1.8 vs 2.1) and short TYM2 puts @ 128.5

$100mn: (2400) ($100,000) $700,000 $800,000 ($500,000) Unwound

11/18/2010 2/3/2012 Fed on hold long 1y1y collar $300mm:($300mm) $1,546,000 $2,069,000 $523,000 ($500,000) Unwound

3/10/2011 2/3/2012 Fed on hold 1y5y covered call $10mn ($150,000) $108,000 $258,000 ($250,000) Unwound

5/19/2011 2/3/2012 Hedge to Fed on hold Long 1y*2y payer spread (atm vs 100bp high-strike) and sell high-strike 1y*5y payer;

unwound the long 1y2y payer on 9/2/11

$240mn: ($100mn) 0 $100,000 $100,000 ($250,000) Unwound

7/8/2011 2/3/2012 GBP options 1y1y vs 1y5y bear flat; unwound the long 1y1y payer on Sep 22 '11

470mn: (100mn) ($125,000) $517,000 $642,000 ($250,000) Unwound

11/4/2011 2/6/2012 Sell US Gamma Sell 3m*10y straddles $10mn ($431,000) ($233,000) $198,000 ($250,000) Expired

2/4/2011 2/9/2012 Fed on hold Rec 1y1y and sell 25bp low 1y*1y recr $100mn ($225,000) $249,000 $474,000 ($250,000) Expired

11/17/2011 2/17/2012 Sell US Gamma Sell 3m*10y straddles $10mn ($440,000) ($134,000) $306,000 ($250,000) Expired

12/15/2011 2/24/2012 Sell US Gamma Sell TYH2 straddles 100 ($284,375) ($64,375) $220,000 ($100,000) Expired

12/2/2011 3/2/2012 Sell US Gamma Sell 3m*10y straddles $10mn ($393,000) ($259,000) $134,000 ($250,000) Expired

11/10/2011 3/9/2012 Eurozone contagion 6m 10y-30y CMS Bull Flattener $50k dv01 $225,000 ($350,000) ($575,000) ($500,000) Stop-out

2/3/2012 3/22/2012 Steepener 5y*2y vs 5y*30y bear steepener ($200mn):$20mn ($90,000) ($630,000) ($540,000) ($500,000) Stop-out

2/16/2012 3/22/2012 Steepener 2y*10y vs 2y*30y bear steepener ($112.5.mn): $50mn ($20,000) ($560,000) ($540,000) ($500,000) Stop-out

2/9/2012 3/23/2012 Sell US Gamma Sell TYJ2 straddles 100 ($201,000) ($150,000) $51,000 ($100,000) Expired

2/23/2012 4/20/2012 Sell US Gamma Sell TYK2 straddles 100 ($232,813) ($67,813) $165,000 ($100,000) Expired

3/1/2012 4/20/2012 Sell US Gamma Sell TYK2 straddles 100 ($212,500) ($117,500) $95,000 ($100,000) Expired

11/4/2011 5/4/2012 Eurozone contagion Long 6m1y payer spread vs. short 6m5y payer spread

$485mn: ($100mn) 0 0 $0 ($250,000) Expired

2/9/2012 5/9/2012 Eurozone contagion Long 3m1y payer spread vs. short 3m7y payer spread

$490mn: ($100mn) ($110,000) $270,000 $380,000 ($500,000) Expired

11/17/2011 5/11/2012 Eurozone Contagion Buy 6m2y payr spd vs 6m10y payr spd EUR 225mn: (EUR50mn)

0 0 $0 ($500,000) Unwound

2/23/2012 5/11/2012 Higher rates Buy 3m*10y payer 2.25% KO 2.75% $100mn $570,000 $40,000 ($530,000) ($500,000) Unwound

3/9/2012 5/17/2012 Sell US Gamma Sell TYM2 straddles 100 ($245,313) ($320,313) ($75,000) ($100,000) Unwound

3/22/2012 5/17/2012 Rangebound rates Long 1y30y @ 3.1% vs short 3m30y @ 3.1% $20mn:($20mn) $1,540,000 $1,035,000 ($505,000) ($500,000) Stop-out

3/29/2012 5/17/2012 Sell US Gamma Sell TYM2 straddles 200 ($440,625) ($750,625) ($310,000) ($100,000) Unwound

4/6/2012 5/17/2012 Sell US Gamma Sell TYM2 straddles 100 ($190,625) ($280,625) ($90,000) ($100,000) Unwound

4/12/2012 5/17/2012 Sell US Gamma Sell TYM2 straddles 100 ($193,750) ($273,750) ($80,000) ($100,000) Unwound

4/19/2012 5/17/2012 Sell US Gamma Sell TYN2 straddles 100 ($221,875) ($266,875) ($45,000) ($100,000) Unwound

4/26/2012 5/17/2012 Sell US Gamma Sell TYN2 straddles 100 ($192,188) ($192,188) ($30,000) ($100,000) Unwound

1/26/2012 5/25/2012 Cross -currency Long EUR 4m*7y vs TYM2 straddles EUR 10mn: (100) ($20,000) $160,000 $180,000 ($500,000) Expired

4/13/2012 6/1/2012 Higher rates Buy EUR 3m*5y payer 1.55% KO 2.05% EUR 100mn $560,000 $50,000 ($510,000) ($500,000) Stop-out

1/6/2012 6/21/2012 Eurozone Contagion Long 6m1y payer spread vs. short 6m7y payer spread

$490mn: ($100mn) ($340,000) 0 $340,000 ($500,000) Unwound

Barclays | Global Rates Weekly

14 June 2013 66

Trades Unwound (continued)

Inception Date

Unwound Date Theme Trade

Weights/Notional Amount

Levels @ Inception

Levels @ Unwind

Net Change (Gain (+) /Loss (-))

Total Stop Loss (bp) Horizon

US Options2/17/2011 7/12/2012 Relative Value Buy 3y*10y payer @ 5% Sell 3y SL 10y CMS

Cap @ 5%$50mn: ($350mn) ($100,000) 0 $100,000 ($500,000) Unwound

8/18/2011 7/12/2012 Eurozone contagion Long 1y2y payer spread vs 1y10y payer spread $90mn: $20mn ($130,000) $10,000 $140,000 ($500,000) Unwound

2/3/2012 7/12/2012 Eurozone contagion Long 1y1y payer spread (0.55% vs 1.05%) $100mn $105,000 $55,000 ($50,000) ($50,000) Unwound

6/15/2012 7/12/2012 Eurozone contagion 1m*10y vs 1m*30y bull flattener ($116.5mn):$50mn 0 ($510,000) ($510,000) ($500,000) Stop-out

4/20/2012 7/26/2012 Long EUR vs. US gamma Long EUR 4m*7y std vs. TYU2 std EUR 50mn: (750) ($945,000) ($1,495,000) ($550,000) ($500,000) Stop-out

4/26/2012 7/26/2012 Relative Value Long 1y5y straddles vs 3EM2 straddles; sold 3EU2 straddles for $1.75mn

$100mn:(2000) ($250,000) ($10,000) $240,000 ($500,000) Unwound

6/28/2012 7/26/2012 Short vol Short 1y*10y straddles ($20mn) ($1,260,000) ($1,560,000) ($300,000) ($250,000) Stop-out

5/18/2012 8/3/2012 Eurozone contagion Buy 1y*30y flr 2.25% vs 3m*30y flr 2.25% $200mn: ($200mn) $350,000 $1,090,000 $740,000 ($250,000) Unwound

7/12/2012 8/3/2012 Eurozone contagion Long USU2 156-157 Call spread (digital floor) 3000 contracts $515,625 $195,625 ($320,000) ($250,000) Stop-out

8/9/2012 9/13/2012 Tactical 3m*10y vs 3m*30y bull steepener $117mn: ($50mn) 0 $725,000 $725,000 ($500,000) Unwound

9/7/2012 9/20/2012 Steepener 1y*7y vs 1y*30y bull steepener $63mn: ($20mn) 0 $90,000 $90,000 ($500,000) Unwound

9/20/2012 11/23/2012 Relative Value Short TYZ2 straddles vs 11/23-12 -> 7y swaption straddles

+$100mn: (820 contracts)

($250,000) ($70,000) $180,000 ($500,000) Expired

10/23/2012 11/23/2012 Election Long FVZ2 straddles: strike 124 1000 contracts 671,875 781,875 $110,000 ($200,000) Expired

5/24/2012 11/29/2012 Short vol Short 1y*10y straddles vs. long 1y1y payer spread 1- 1.25

($20mn): $200mn ($1,160,000) ($1,015,000) $145,000 Unwound

6/7/2012 11/29/2012 Short vol Short 1y*10y straddles ($50mn) ($3,250,000) ($2,350,000) $900,000 Unwound

11/15/2012 12/11/2012 unwind fvz2 std Short FVZ2 to hedge the long FVZ2 124 straddles

1000 124-25 124-25+ $0 Unwound

1/15/2009 12/13/2012 Longer Rates could Rise Buy 5y*10yr Payr Spd (ATM vs 100 bp high), added the short CMS cap @ 5% on 7/2/10 ;

sell 6w*10y payer @ 2.75% on Nov 10 '11

$100mm: - $100mm ($1,924,000) ($1,910,000) $14,000 ($250,000) Unwound

2/9/2012 12/13/2012 Hike expectations Long 1y*1y - 1y*3y - 1y*5y payer fly ($300mn): $200mn: ($60mn)

($30,000) ($3,000) $27,000 ($500,000) Unwound

5/25/2012 12/13/2012 Short vol Short 2y*10y straddles ($20mn) ($1,830,000) ($1,465,000) $365,000 Unwound

6/21/2012 12/13/2012 Short vol Short 2y*10y straddles ($20mn) ($1,800,000) ($1,445,000) $355,000 ($1,000,000) Unwound

8/16/2012 12/13/2012 Short vol Short 2y*10y straddles ($10mn) ($935,000) ($805,000) $130,000 Unwound

10/23/2012 1/4/2013 Election volatility Long 220mn 2m*5y ATM payer vs. 50mn 2m*30y ATM payer

220mn:(50mn) ($580,000) ($725,000) ($145,000) ($200,000) Expired

1/4/2013 4/5/2013 Tactical 3m*7y vs 3m*30y bear flattener +$75mn:($25mn) ($110,000) $0 $110,000 ($500,000) Expired

3/27/2013 4/11/2013 Front end looks cheap Long Jul13s energy hedged $200mn:65 XBM3-491bp: 308.12

-330bp: 284.39

$300,000 ($500,000) Unwound

2/1/2013 5/30/2013 put-payer short TYM3P 128 vs matched expiry payer (1000): $129mn ($200,000) $0 $200,000 ($250,000) Expired

7/19/2012 6/7/2013 Short vol Short 1y*10y straddles ($20mn) ($1,220,000) ($880,000) $340,000 Unwound

9/7/2012 6/7/2013 Short vol Short 1y*10y straddles ($20mn) ($1,242,000) ($907,000) $335,000 Unwound

9/27/2012 6/7/2013 Short vol Short 1y*10y straddles ($10mn) ($596,000) ($596,000) $0 ($1,000,000) Unwound

Barclays | Global Rates Weekly

14 June 2013 67

Trades Unwound (continued)

Inception Date

Unwound Date Theme Trade

Weights/Notional Amount

Levels @ Inception

Levels @ Unwind

Net Change (Gain (+) /Loss (-))

Total Stop Loss (bp) Horizon

US Options

10/5/2012 6/7/2013 Short vol Short 1y*10y straddles ($10mn) ($597,000) ($427,000) $170,000 Unwound

6/14/2012 6/7/2013 Relative ValueLong 1x11 cap -flr straddles 2% vs 1y*10y

straddles 2%$20mn: ($20mn) $1,964,000 $2,999,000 $1,035,000 ($500,000) Unwound

8/3/2012 6/7/2013 Long risk-reversalLong 1y*30y 100bp wide risk-reversal (long

recr), delta hedged$100mn ($450,000) $440,000 $890,000 ($500,000) Unwound

1/24/2013 6/7/2013 cheap flattener long 2ez3 p 99 vs short 4ez3 p 97.75 +2000: (2000) ($650,000) ($1,175,000) ($525,000) ($500,000) Stop-out

2/28/2013 6/7/2013 Fade skewLong 1y30y recr, Short 1y30y payer, Pay fix

1y30y$100mn: $100mn:

$50mn($430,000) ($60,000) $370,000 ($500,000) Unwound

4/18/2013 6/7/2013 Bull-flattenerLong 6/14/13-30y receiver 2.725% vs short

3EM3C 99 and 34EMC 98.375+20mn: (500 each) 0 $0 $0 ($500,000) Unwound

5/23/2013 6/7/2013 Long Gamma Logn 1m*7y straddles $100mn $995,000 $1,270,000 $275,000 ($250,000) Unwound

EUR Options3/9/2012 12/13/2012 Capped steepener 2y5y vs 2y30y bear steepener, short 2y SL 5y-

30y curve cap @ 75bp(EUR 90mn): EUR

20mn: (EUR 400mn)($1,597,000) ($2,127,000) ($530,000) ($500,000) Stop-out

6/1/2012 5/3/2013 Short vol EUR 1x2 1y5y 1.25 vs 1 recr ladder EUR 20mn: (40mn) 0 $0 $0 ($250,000) Unwound

2/1/2013 5/3/2013 Low for long 6m5y 1x2x1 1.3 - 0.95 - 0.7 recr flyEUR 100mn: (200mn):

100mn$650,000 $1,090,000 $440,000 ($250,000) Unwound

3/8/2013 5/30/2013 RVShort 3m*4y GBP straddles vs 30bp high-

strike 3m*4y payer +GBP 100mn: gbp

100mn ($1,040,000) ($340,000) $700,000 ($500,000) Unwound

4/25/2013 6/7/2013 Rangebound GBP ratesLong gbp 50mn 1x11 cfs vs gbp 50mn 1y10y

straddles 50mn:50mn $5,420,000 $4,895,000 ($525,000) ($500,000) Stop-out

JPY Options5/30/2012 6/29/2012 Higher rates Sell 1m*20y receiver spread $27mn 41cts 20cts $110,700 ($225,000) Unwound

6/28/2012 7/20/2012 Tactical 1m*10y risk reversal (long payers) $80mn notional 0 cts -38 cts ($304,000) ($160,000) Stop-out

7/6/2012 10/5/2012 Relative Value Long 6mx10y 1x2 payers $80mn notional -26cts 1.8cts $222,000 ($200,000) Unwound

10/25/2012 11/15/2012 Tactical Conditional 10s20s flattener 80mn -8 0 $64,000 ($200,000) Unwound

7/13/2012 12/7/2012 Long vol Long JPY 5y5y OTM recr , delta hedged with 10y swap

$80mn notional 80cts 121cts $328,000 ($160,000) Unwound

11/29/2012 1/17/2013 Bear flattener ATM+10bp 6mx5y payer long vs. 6mx10y payer short

$100mn -10 -7 $30,000 ($200,000) Unwound

1/10/2013 1/24/2013 Low vol sell 1mx10y receiver (0.8% at 20 sen) $80mn -20 -43 ($24,000) ($200,000) Stop-out

1/10/2013 1/24/2013 Low vol sell 3mx20y receiver (1.65% at 74 sen) $50mn -74 120 ($15,000) ($200,000) Stop-out

11/28/2012 3/28/2013 Volsurface is too flat Long 10yx10y straddle vs. 5yx5y straddle $120mm 88 96 $96,000 ($250,000) Unwound

Barclays | Global Rates Weekly

14 June 2013 68

Trades Unwound (continued)

Source: Barclays Research

Inception Date

Unwound Date Theme Trade

Weights/Notional Amount

Levels @ Inception

Levels @ Unwind

Net Change (Gain (+) /Loss (-))

Total Stop Loss (bp) Horizon

Cross-currency5/4/2012 6/28/2012 Tactical Long EUR 6m*2y payer vs GBP 6m*2y payer EUR 100mn

:(GBP82mn)0 $135,000 $135,000 ($250,000) Unwound

8/17/2012 10/25/2012 Tactical Receive USD/JPY Xccy basis 20yx10y $30k dv01 53bp 29bp $720,000 ($200,000) Unwound

9/21/2012 11/23/2012 US vs EUR gamma Long RXZ2 std vs. TYZ2 std +500: (860) $300,000 $663,000 $363,000 ($500,000) Expired

10/15/2009 12/13/2012 Cross -currency Short 5x10 US caps @ 8% vs Long 5x10 EUR caps @ 5%

($75mm): EUR 50mm ($200,000) $65,000 $265,000 ($500,000) Unwound

2/3/2012 12/13/2012 Cross -currency Long EUR 3y10y P @ 4% vs USD 3y10y P @ 4%

EUR 10mn: (13mn) ($90,000) ($80,000) $10,000 ($500,000) Unwound

11/29/2012 2/28/2013 EUR vs US Long RXH3 std 144.5 vs short TYH3 std 133.5 +400: (740) $100,000 ($720,000) ($820,000) ($1,000,000) Stop-out

12/21/2012 3/7/2012 USD funding supplied via MoF program

Pay 8y Xccy basis $40k dv01 -66.5 -55 $460,000 ($400,000) Unwound

2/28/2013 3/7/2013 JPY long end is too rich vs. USD short 10yx10y JPY swap vs. USD (beta = 0.4) usd 40 k dv01 107 97 ($400,000) ($400,000) Stop-out

3/8/2013 6/7/2013Paying demand is larger in 4-5y

basispay 4y Xccy basis usd 40 k dv01 -51 -51 $0 ($400,000) 3m-6m

Barclays | Global Rates Weekly

14 June 2013 69

GLOBAL SUPPLY CALENDAR

Source: Barclays Research

Country Bond Coupon Maturity Size - bn

Euro AreaJun-13 Belgium New 30y 4.00

14-Jun-13 Spain Bond Annoucement17-Jun-13 Spain Size Annoucement17-Jun-13 Belgium Bond Annoucement18-Jun-13 Finland 10y RFGB Auction 1.50% 15-Apr-23 1.0018-Jun-13 Finland 30y RFGB Auction 2.625% 04-Jul-42 0.5019-Jun-13 Germany 10y Bund Auction 15-May-23 5.0020-Jun-13 Spain New 5y SPGB 3.0020-Jun-13 Spain 10y SPGB 5.40% 31-Oct-23 1.5020-Jun-13 France 5yr BTAN 1.00% 25-May-18 3.5020-Jun-13 France 2yr BTAN 0.25% 01-Nov-15 3.0020-Jun-13 France 2yr BTAN 1.00% 25-Oct-16 1.5020-Jun-13 France OATi/ei auctions 0.25% 25-Jul-27 1.5021-Jun-13 Belgium Size Annoucement24-Jun-13 Belgium BGB Auctions?25-Jun-13 Holland New 5y DDA 5.0027-Jun-13 Italy BTPei Linker Auction 1.0027-Jun-13 Italy 5yr BTP Auction 3.50% 01-Jun-18 3.0027-Jun-13 Italy 10yr BTP Auction 4.50% 01-May-23 3.0028-Jun-13 Spain Bond Annoucement01-Jul-13 Spain Size Annoucement

Jul-13 Spain New 15y 4.00Jul-13 Spain New 15y SPGB 4.00

02-Jul-13 Austria 5y RAGB 1.95% 18-Jun-19 0.7502-Jul-13 Austria 10y RAGB 3.40% 22-Oct-23 0.7503-Jul-13 Germany 2y Schatz Auction 0.00% 12-Jun-15 5.0004-Jul-13 Spain 2y SPGB 2.75% 31-Mar-15 1.5004-Jul-13 Spain 3y SPGB 3.30% 30-Jul-16 1.5004-Jul-13 Spain 12y SPGB 4.65% 30-Jul-25 1.0004-Jul-13 France 10y OAT 1.75% 25-May-23 4.0004-Jul-13 France 15y OAT 2.75% 25-Oct-27 2.0004-Jul-13 France 30y OAT 3.25% 25-May-45 1.50

Japan17-Jun-13 Japan 5y JGB Auction 270018-Jun-13 Japan 20y JGB Auction 120025-Jun-13 Japan Liquidity Enhancement Auction 30027-Jun-13 Japan 2y JGB Auction 290002-Jul-13 Japan 10y JGB Auction 240004-Jul-13 Japan 30y JGB Auction 500

UKJun-13 UK New 50-60y Syndicated Gilt 4.00

20-Jun-13 UK 2018 Gilt Auction 4.75Jul-13 UK 25-40y Linker Syndicated Tap 3.00

02-Jul-13 UK 2023 Gilt Auction 4.25% 07-Sep-23 3.50US

20-Jun-13 US 30y TIPs Auction 725-Jun-13 US 2y Note Auction 3526-Jun-13 US 5y Note Auction 3527-Jun-13 US 7y Note Auction 29

Unconfirmed Barclays Capital EstimateRichCheap

Barclays | Global Rates Weekly

14 June 2013 70

GLOBAL BOND YIELD FORECASTS

US Treasuries US swap spreads

Fed funds 3m Libor 2y 5y 10y 30y 10y RY 2y 5y 10y 30y

Q2 13 0.00-0.25 0.25 0.20 0.75 1.80 3.00 -0.75 Q2 13 15 15 10 -15

Q3 13 0.00-0.25 0.25 0.20 0.75 1.80 3.00 -0.80 Q3 13 15 15 10 -10

Q4 13 0.00-0.25 0.20 0.25 0.80 2.00 3.15 -0.65 Q4 13 15 15 10 -5

Q1 14 0.00-0.25 0.20 0.30 0.90 2.00 3.15 -0.75 Q1 14 15 15 10 -5

Euro government (Germany)

Euro area swap spreads

Refi rate 3m 2y 5y 10y 30y 10y RY 2y 5y 10y 30y

Q2 13 0.50 0.20 0.10 0.55 1.60 2.35 -0.15 Q2 13 40 40 30 5

Q3 13 0.50 0.20 0.15 0.65 1.75 2.45 -0.10 Q3 13 40 40 30 5

Q4 13 0.50 0.20 0.20 0.70 1.80 2.50 -0.10 Q4 13 40 40 30 5

Q1 14 0.50 0.25 0.30 0.85 1.95 2.60 0 Q1 14 40 40 30 5

UK government

UK swap spreads

Bank rate 3m 2y 5y 10y 30y 10y RY 2y 5y 10y 30y

Q2 13 0.50 0.50 0.30 1.00 2.00 3.15 -1.35 Q2 13 40 15 10 -15

Q3 13 0.50 0.50 0.35 1.10 2.10 3.20 -1.30 Q3 13 40 15 10 -15

Q4 13 0.50 0.50 0.40 1.20 2.20 3.30 -1.25 Q4 13 35 10 5 -10

Q1 14 0.50 0.50 0.45 1.30 2.30 3.35 -1.15 Q4 14 35 10 0 -10

Japan government

Japan swap spreads

Official rate 3m 2y 5y 10y 30y 10y RY 2y 5y 10y 30y

Q2 13 0.10 0. 23 0.11 0.22 0.55 1.60 0.00 Q2 13 15 12 1 -4

Q3 13 0.10 0. 23 0.11 0.22 0.55 1.60 0.00 Q3 13 15 13 2 -10

Q4 13 0.10 0.23 0.10 0.20 0.45 1.45 0.10 Q4 13 15 13 3 -10

Q1 14 0.10 0.23 0.10 0.20 0.45 1.45 0.10 Q1 14 15 13 3 -10 Source: Barclays Research

Barclays | Global Rates Weekly

14 June 2013 71

GLOBAL RATES RESEARCH

Global

Ajay Rajadhyaksha Co-Head of FICC Research +1 212 412 7669 ajay.rajadhyaksha@barclays.com

US

Joseph Abate Fixed Income Strategy +1 212 412 6810 joseph.abate@barclays.com

Piyush Goyal Fixed Income Strategy +1 212 412 6793 piyush.goyal@barclays.com

James Ma Fixed Income Strategy +1 212 412 2563 james.ma@barclays.com

Chirag Mirani Fixed Income Strategy +1 212 412 6819 chirag.mirani@barclays.com

Amrut Nashikkar Fixed Income Strategy +1 212 412 1848 amrut.nashikkar@barclays.com

Michael Pond Head of Global Inflation-Linked Research +1 212 412 5051 michael.pond@barclays.com

Anshul Pradhan Treasury Strategy +1 212 412 3681 anshul.pradhan@barclays.com

Rajiv Setia Head of US Rates Research +1 212 412 5507 rajiv.setia@barclays.com

Vivek Shukla Fixed Income Strategy +1 212 412 2532 vivek.s.shukla@barclays.com

Europe

Laurent Fransolet Head of European FICC Research and European Rates Strategy +44 (0)20 7773 8385 laurent.fransolet@barclays.com

Cagdas Aksu European Strategy +44 (0)20 7773 5788 cagdas.aksu@barclays.com

Fritz Engelhard German Head of Strategy +49 69-7161 1725 fritz.engelhard@barclays.com

Jussi Harju European Strategy +49 69 7161 1781 jussi.harju@barclays.com

Moyeen Islam Fixed Income Strategy +44 (0)20 777 34675 moyeen.islam@barclays.com

Sreekala Kochugovindan Asset Allocation Strategy +44 (0)20 7773 2234 sreekala.kochugovindan@ barclays.com

Giuseppe Maraffino Fixed Income Strategy +44 (0)20 313 49938 giuseppe.maraffino@barclays.com

Mikael Nilsson Fixed Income Strategy +44 (0)20 7773 6057 mikael.nilsson@barclays.com

Hitendra Rohra Fixed Income Strategy +44 (0)20 7773 4817 hitendra.rohra@barclays.com

Michaela Seimen SSA & Covered Bond Strategy +44 (0) 20 3134 0134 michaela.seimen@barclays.com

Henry Skeoch Inflation-Linked Strategy +44 (0)20 777 37917 henry.skeoch@barclays.com

Khrishnamoorthy Sooben Inflation-Linked Strategy +44 (0)20 7773 7514 khrishnamoorthy.sooben@ barclays.com

Huw Worthington European Strategy +44 (0)20 7773 1307 huw.worthington@barclays.com

Asia Pacific

Igor Arsenin Head of Fixed Income Strategy Research, Emerging Asia +65 6308 2801 igor.arsenin@barclays.com

Reiko Tokukatsu Senior Fixed Income Strategist, Japan +81 3 4530 1532 reiko.tokukatsu@barclays.com

For any questions about Barclays Live for Rates, please contact:

Jason Howell +1 212 412 6706 jason.howell@barclays.com

Amy Mignosi +44 (0)20 3134 9774 amy.mignosi@barclays.com

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