Interest Rates Research 10 January 2013

PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 72

Global Rates Weekly

March madness? • We feel the US bond market is underestimating the downside risks associated

with the impending deadline related to the debt ceiling, automatic spending cuts and the expiration of the continuing resolution.

• The recent change in liquidity rules is not a game-changer for rates markets, although a further loosening of bank regulation is a risk to our low-for-long rate view.

• We remain long duration in the belly of the US curve, but not in core European markets, given the ECB decision and the strong performance of peripheral debt.

Global

March madness? 2 Political negotiations in the US should be the focus for rates markets over the next several weeks. We remain long duration in the belly of the US curve. But given the recent ECB decision and the tightening of peripheral spreads, we remain neutral on core European markets, despite the recent sell-off.

United States

Treasuries: Maintain long duration 8 We maintain our long duration view, as current yields levels are too high, given modest growth with downside risk. We also expect the front end to continue to richen versus OIS. Investors should consider terming out to the 4y sector, as the forward Tsy-OIS basis is too wide, given expectations of only a marginal spread between the GC and FF rates.

Euro Area

2013 off to a roaring start 23 2013 has started with moves pushing the level of rates higher in swaps and core markets, and lower in peripheral markets. With some levels now approaching our end-Q1 13 targets, it is time to take stock and re-assess.

UK

The year of living dangerously? 36 Despite the recent rally, there is a growing perception of negative risks to current gilt valuations. We express the need for higher risk premium via Gilt 5/30s steepeners.

Japan

Clearing hurdles for the next BoJ easing 56 The BoJ may consider changes in its JGB purchases, including its rinban operations, for its next monetary easing. One idea is to fuse its JGB purchasing under its rinban and Asset Purchase Program. However, an optimal solution is likely to prove elusive.

Views on a Page 7

Trade Portfolio Update 59

Global Supply Calendar 70

Global Bond Yield Forecasts 71

United States

TIPS: Bottom up still looking good for now 11

Agencies: Longer-dated opportunities 13

Swaps: Spread trading opportunities near the debt ceiling 16

Volatility: A trade for higher rates 18

Money Markets: Lightening the LCR burden 20

Europe

Swaps: Buy 5y5y fwd EUR ASWs 29

Money Markets: Countdown to payback 29

Sovereign Spreads: Euro area 2013 supply 33

Covered Bonds/SSAs: In the sweet spot - SSA bonds 38

Scandinavia: Economy approaching the trough? 42

Euro Inflation-Linked: The supply spectre 44

UK Inflation-Linked: Better the devil you know 46

Volatility: Buy GBP 1y*5y payer ladder 48

Special Topic: LCR – Easing in the rules and liquidity pressure on banks 51

www.barclays.com

Barclays | Global Rates Weekly

10 January 2013 2

Rates and Securitized Products Outlook Conference Monday, February 4, 2012 Barclays, 745 Seventh Avenue, ASK Auditorium, New York City

Preliminary Agenda 12:30pm Registration, Lobby

1:00pm–1:15pm Welcome Remarks, ASK Auditorium, Concourse Level John Stathis, Managing Director, Head of Distribution, Americas, Barclays

1:15pm–2:00pm Global Macro Overview Ajay Rajadhyaksha, Managing Director, Rates and Securitized Products Research, Barclays

2:00pm–3:00pm Research Panel: Searching for Yield in Securitized Markets Moderator: Ajay Rajadhyaksha, Managing Director, Rates and Securitized Products Research, Barclays

Sandeep Bordia, Managing Director, Non-agency MBS Research, Barclays Nicholas Strand, Director, Agency Mortgage Strategy, Barclays Keerthi Raghavan, Vice President, CMBS Research, Barclays

3:00pm–3:15pm Break, Auditorium Foyer

3:15pm–4:15pm When Will Rates Finally Sell Off? Rajiv Setia, Managing Director, US Rates Research, Barclays

Who’s on First: Deflation or High Inflation? Michael Pond, Managing Director, Global Inflation Research, Barclays

4:15pm–5:30pm Client Panel: Vantage Point - A Look at the Rates and MBS Markets by Different Investor Bases Moderators: Chris Leslie, Managing Director, Global Head of Securitized Products Distribution, Barclays

Ajay Rajadhyaksha, Managing Director, Rates and Securitized Products Research, Barclays

Deepak Narula, Managing Partner, Metacapital Management Bob Miller, Managing Director, Portfolio Manager, Blackrock Michael Verdeschi, Managing Director, Head of Portfolio Management & Funding, Citigroup Scott Wede, Managing Director, Head of Securitized Products Trading, Barclays

5:30pm–6:00pm Cocktail Reception, Auditorium Foyer, Concourse Level

Barclays | Global Rates Weekly

10 January 2013 3

GLOBAL THEMES

March madness? Political negotiations in the US should be the focus for rates markets over the next several weeks. We remain long duration in the belly of the US curve. But given the recent ECB decision and the tightening of peripheral spreads, we remain neutral on core European markets, despite the recent sell-off.

There have been few economic releases over the past week – and for those few, data have been mixed. Predictably, price action in the US has been muted, with rates in the belly trading in a tight 5-6bp range. This environment is unlikely to change in the near future. Meanwhile, the ECB closed the door on a near-term rate cut, and this, combined with a large tightening of peripheral spreads despite heavy supply, have pushed “core” euro rates higher in the past weeks.

Over the next several weeks, political negotiations in the US are likely to be the focus for rates markets, as the March deadlines approach on the debt ceiling and spending cuts. We remain long duration in the belly of the US curve, given downside risks posed by upcoming negotiations, but are neutral on core European fixed income.

Early March: Downside risks loom Over the next several weeks, the US Congress needs to agree on three things: the debt ceiling, the continuing resolution, and a way to avoid sequestration cuts. But bond markets were sanguine as the 2012 fiscal cliff deadline approached. Are investors likely to get nervous as March approaches? We think the answer is yes, for a couple of reasons. First, Democrats had more leverage in the tax negotiations1 than Republicans, which raised the odds of an agreement. Second, most economic forecasts already expect the sequester to be fully unwound, the debt ceiling to not raise economic uncertainty, and do not factor in the possibility (however remote) of a government shut-down. In other words, if Congress manages to avoid every pitfall in Q1, it does not improve the economic picture. But if, say, Congress cannot agree on how to postpone sequestration cuts, downside risks to the economy will materialize.

So far, the political indicators, as measured by political statements from both sides, have not been encouraging. The confirmation process for Jack Lew as Treasury Secretary could provide another sign. If the confirmation does not go smoothly, it could suggest that negotiations in February/March will be more fractious. The recent statement by Republican Senator Jeff Sessions stating that “Jack Lew must never be Secretary of Treasury” indicates the difficulty that Congress will have in reaching agreement on one issue, let alone three.

The debt ceiling deadline – and choices Treasury can make A few months ago, the US Treasury sent a letter to the Senate Finance Committee2 outlining various options it considered if the debt ceiling was not raised in 2011. Treasury rejected the idea of asset sales, such as selling the nation’s gold or its MBS portfolio, as too destabilizing. Across-the-board payment reduction (for example, cutting all payments by 40% to remain within the debt limit) was also not a viable option; the Treasury’s payment systems are not designed for across-the-board cuts. Finally, Treasury has also ruled out prioritizing

1 If all taxes went up on January 1, the Democrats could have made a compelling public case that the Republicans were holding back tax cuts for the vast majority, for the sake of a small percentage of upper income taxpayers. 2 http://www.treasury.gov/about/organizational-structure/ig/Audit%20Reports%20and%20Testimonies/Debt%20Limit%20Response%20(Final%20with%20Signature).pdf

Ajay Rajadhyaksha +1 212 412 7669 ajay.rajadhyaksha@barclays.com

Laurent Fransolet +44 (0)20 7773 8385

laurent.fransolet@barclays.com

Markets will focus on approaching debt ceiling and continuing resolution deadlines over the next several weeks…

…and given the downside risks, we remain long duration in the belly of the curve

Barclays | Global Rates Weekly

10 January 2013 4

payments for the same reason – its systems are designed to make payments in the order in which they come due.

Treasury officials concluded that the least harmful option was to implement a delayed payment regime, where no payments could be made until they could all be made on a day-to-day basis. Our interpretation of this statement is that Treasury would amass enough cash that it could make upcoming interest payments, and then start day-to-day financing for the rest of the government’s operations. For example, if outlays on Day 1 were $20bn, Treasury would wait until it had collected $20bn in revenues (say by day 3) and then make the outlays scheduled for day 1 and so on. Luckily, interest payments in the month of March are low ($750mn on March 15 and $5.9bn on March 31) and the extraordinary measures currently being used should likely carry Treasury through the end of February. The chance of a delayed coupon payment is virtually non-existent, but sudden and sharp fiscal tightening would result. In other words, if the debt ceiling is hit, the net effect would be a significant rate rally as growth expectations collapse.

LCR changes: Not a game changer for rates markets We have made the case in the past (see The effect of bank liquidity regulations on the Fixed Income landscape, October 2009, and, more recently, Basel III: A shadow tightening of policy, May 2012) that a significant loosening of bank regulation would be a risk to our low-rate view, since it would allow banks to use the excess cash from central bank actions for lending to the real economy. In this light, the recent changes made by the Basel Committee to the proposed liquidity standards are noteworthy, but not sufficient to change our outlook. The main thrust of these changes was to make the the Liquidity Coverage Ratio (LCR) guidelines less onerous for banks. There were three main components to the change in rules:

• An extension of the timeline over which the LCR will be implemented, with full phase-in by 2019 as opposed to 2015.

• An expansion in the definition of high quality liquid assets (HQLA), with certain corporate and asset-backed securities now newly eligible to be counted, subject to both caps and large hair cuts.

• A relaxation in the factors used to compute the inflow and outflows from various categories of deposits and credit lines.

While the increased phase-in period is likely to give some breathing room to banks, we do not feel it is the most significant change. For example, on the capital front, while banks have a phase-in period until 2019, they have been under pressure to comply earlier. We suspect that something similar may apply to a phase-in of the LCR.

Implementation by national regulators remains key For US banks, a big change would have been expanding Level 1 assets to include agency MBS (which are currently level 2 assets) but that has not happened. In its proposed implementation, the Fed had announced that agency MBS would be treated as level 2 assets. Further, the Basel rules on mortgages appear only to apply to MBS backed by full recourse loans, leaving out most agency MBS pools. The relaxation in the cash outflow factors as well, with reduced run-off factors for deposits, may reduce the size of the liquid buffer required at the margin, thereby helping US banks become more compliant with their LCR.

A big unknown is how the Fed will apply these rules here. In Basel III: A shadow tightening of policy, we had made the case that the LCR constraint would matter more for small banks (who are generally already largely compliant with the require CET1 ratios). However, the increase in loan books of small banks relative to large banks (Figure 1) suggests that many

If the debt ceiling is not raised in time, the chance of a delayed coupon payment in March is virtually non-existent…

…but growth expectations could collapse, resulting in a significant rate rally

Recent changes to the LCR guidelines are not sufficient to change our low for long rate view

Barclays | Global Rates Weekly

10 January 2013 5

small to mid-size banks were operating with the assumption that the LCR standard would not be binding. Therefore, any relaxation of rules is less significant – ultimately, no exemption is being made on the liquidity front based purely on size.

Large US banks already have enough liquidity but are constrained on capital (Figure 2), since their capital ratios are below the 9.5% level that they would likely need to comply with eventually. The changes in liquidity rules are unlikely to lead to a change in their behaviour. Their loan books have grown at only 1.7% over the past year and the growth rate should remain sluggish because of capital constraints. Rather than these direct channels, the changes are likely to be significant through indirect channels, such as their effect on non-financial CP. By reducing the drawdown rate on committed liquidity facilities, the BCBS has effectively reduced the cost to banks of providing liquidity backstops to non-financial borrowers, thus potentially boosting the market (see this week’s “United States Money Markets: Lightening the LCR burden” ).

There could have potential unintended consequences in Europe. By reducing the volume of overnight interbank transactions, the LCR standard could make the EONIA fixing volatile, possibly leading to a greater risk premium along the forward curve. This change also creates an incentive for banks – especially small banks with limited access to the market – to prefer central banks’ refinancing operations to the market liquidity (for calculating the LCR, central bank funding receives a run-off of 100, i.e., it is assumed to be fully stable). This could create challenges for central banks (and the ECB in particular) when they attempt to exit their current accommodative stances (See the European money markets weekly, January 8, 2013).

It is not easy to assess the effect of the expansion of HQLAs on SSA and covered bonds, as the final treatment will also depend on the ability to use national discretions. The Basel Committee did not recognize that some covered bond jurisdictions, such as France and Germany for example, already have rules for liquidity risk. This week’s “In the sweet spot-SSA bonds” looks at the possible effects on covered bonds and SSA in various interpretations. In sum, the proposed changes do not materially change our macro-economic views or our rates forecasts. However, further loosening of bank regulations (such as the changes we mentioned above) does pose risks to our low for long views.

FIGURE 1 Small US bank loans have been growing at a faster pace than large banks, although well below the pre-crisis pace

FIGURE 2 Large US banks further need to improve capital ratios to meet their final targets under the Fed’s proposed rules

-20

-15

-10

-5

0

5

10

15

Nov-07 Nov-08 Nov-09 Nov-10 Nov-11 Nov-12

Small banks (6m chg) Large banks (6m chg)

7.0%

7.5%

8.0%

8.5%

9.0%

9.5%

JPM BAC C WFC US Bancorp

BNY Mellon

Q3 12 Source: Federal Reserve, Haver Analytics, Barclays Research Source: SEC filings, Barclays Research

Large US banks already have enough liquidity but are constrained on capital

Barclays | Global Rates Weekly

10 January 2013 6

Other issues In the UK, the National Statistician proposed no change to RPI aggregation, contrary to our and market expectations. Despite a sharp breakeven rally, we see further upside for shorter-dated breakevens, while the IL29 auction in the coming week should be easily absorbed (for details, see this week’s “Inflation-lined markets: United Kingdom: Better the devil you know”). As for core Europe, we believe the recent rise in rates is justified given absolute yield levels, the ECB decision, and also the large moves in Spain and Italy (see “Euro Area: Rates Strategy: 2013 off to a roaring start”). While core Euro rates are close to our Q1 13 targets, and peripheral spreads are close to the bottom end of the range we expected (without an OMT programme), we do not expect a large reversal from here.

In Spain, we continue to recommend a tactical “risk-on” and steepeners. In core Europe, we focus on bund swap spreads (see this week’s “Europe: Swaps: Buy 5y5y fwd EUR ASWs”). The US is the only place where rates are currently above our Q1 2013 targets and the only major country where we currently recommend a long in the belly of the curve (see “United States: Treasuries: Maintain our long duration view”).

We see further upside for shorter dated breakevens in the UK

We maintain our long belly recommendation in the US

Barclays | Global Rates Weekly

10 January 2013 7

VIEWS ON A PAGE US EUROPE JAPAN

Direction • Economic data in the US remain modest, and implementation risk in Europe is still high.

• While the worst-case outcome was avoided, the fiscal deal will exert significant drag next year, with downside risks.

• We recommend fading the sell-off.

• The risk-on sentiment in the market continues with peripheral markets performing very strongly and outright market selling off further on the back of a relatively bearish ECB. While the outright market can sell-off a bit more in our view, we like fading the cheapening of EUR ASWs gradually by going long 5y5y fwd EUR ASWs.

• If the LDP and New Komeito win overwhelmingly, we would expect a continued decline in the yen and an uptrend in equities. Any unwinding would not exert sufficient pressure to alter the JGB yield range. The main risk is the supplementary budget talks in January. A short position may offer an opportunity for profit-taking, but we do not believe the time will be right for a long position through late January.

Curve/ curvature

• We maintain our long 3-4y Treasuries view to position for a QE3-led improvement in the funding environment.

• Remain neutral on the curve, given significant scope for a decline in the level of intermediate yields.

• We maintain our view of underweighting rich HC securities in the 5-10y sector to position for a rise in the liquidity premium.

• Term out 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 fwd • UK: Gilts are vulnerable to increasing negative

sentiment over 2013. We recommend Gilt 5/30s steepeners .

Swap spreads

• Neutral on long-end spreads, considering debt ceiling debate. • Front-end spread wideners against OIS. • Receive 3y1y to benefit from repricing in rates.

• EUR: Enter into longs in EUR 5y5y fwd ASWs • GBP: APF transfer may improve the fiscal position, but

fundamentals remain poor. We remain negative on 10y gilt ASW. Long 5y ASW vs OIS or vs 10y (both vs 6mL)

• 5s7s box (7s long) • Long futures

Other spread sectors

• We continue to favor long-end agency-Treasury spread tighteners, particularly at the 10y point, which we also find attractive on an absolute yield basis. Investors could also shorten duration by switching to 5s from 7s for next to no spread give-up.

• We remain constructive on Canadian covered bonds, given their relative isolation from Europe and continued significant spread pickup to agencies.

• SEK: Hold 5y SGB ASW tighteners versus Bobl ASW and SEK/EUR 1y6m fwd tighteners. Enter SGB 2s5s10s (short belly)

• Long Spain versus Italy 3s/10s steepener • Long Spain and Italy 2s/5s/10s • Long Spain 5s/10s/30s • Long 5y Belgium and 6y Austria in ASW

• Pay USD/JPY 1yx1y basis • Pay USD/JPY 8y basis • Tibor 1v6 widener, Tibor 3v6 widener

Inflation • Dovish monetary policy, higher realized versus expected inflation and improved market liquidity remain in favor of TIPS in 2013; we maintain a long breakeven and real yield bias.

• Long Jan14s energy hedged; we expect the to-maturity inflation trend to run higher than expectations by 65bp.

• Long the belly of Jan15-Apr17-Jan19 RY fly as a supply concession unwind trade. Neutral on April17 floor (unwind long Apr17s vs Jan17s).

• 10y €i breakevens vulnerable as supply resumes in January.

• Clarity on RPI suggests IL29 auction should be easily absorbed. Decision not to eliminate formula effect leaves further value in 5y breakevens.

• Recent JGBi levels are rich even if we assume the consumption will be hiked in 2014 and 2015, especially in the longer sectors. We recommend keeping a neutral position and waiting for an opportunity to take long positions at cheaper levels.

Volatility • Sell 1y*10y straddles to benefit from range-bound rates and supply from callables.

• Sell 1y*(10y10y) or 3y*10y straddles vs. 10y*10y straddles as a limited loss way to benefit from the range in rates.

• Buy 5y*10y 1x1x1 payer ladder to benefit from temporary increase in callable zero supply.

• Buy 30y tails vs. 5y tails to benefit from ECB-on-hold, CVA hedging.

• Sell EUR 1y*10y 1x2 payer spread to position for a large rise in EUR rates.

• Sell 5y*5y straddles vs. 200bp wide 5y*5y strangles to position for near-term rise in structured note issuance.

• Short 1mx10y, 3mx20y receiver • Long 10x10 straddle versus 5x5 straddle

Source: Barclays Research

Barclays | Global Rates Weekly

10 January 2013 8

UNITED STATES: TREASURIES

Maintain long duration We maintain our long duration view, as current yields levels are too high, given modest growth with downside risk. We also expect the front end to continue to richen versus OIS. Investors should consider terming out to the 4y sector, as the forward Tsy-OIS basis is too wide, given expectations of only a marginal spread between the GC and FF rates.

The Treasury market was largely unchanged amid $66bn in new supply across 3y, 10y and 30y. Economic data were slightly weak, with factory orders surprising to the downside and initial claims rising more than expected. Wholesale inventories rose more than the consensus in November but were revised down for October. Overall, our economist’s Q4 12 real GDP tracking estimate fell modestly, to 2% from 2.2% last week. The long end outperformed on the curve as the auction concession was unwound.

We maintain our long duration view: while there may be little new information in the very near term on the resolution of the upcoming fiscal deadlines (sequester, debt limit and continuing resolution), we believe the current yield level is too high, given modest growth, the risks to which are skewed to the downside. Fiscal tightening in 2013 amounts to almost 1.5% of GDP and could rise to ~2.0% if the sequester is not postponed further. At the same time, given the limited scope of the fiscal cliff deal, further deficit reduction measures are likely to be agreed to over the next few months. While they may not have an effect on growth in 2013, medium-term growth expectations should be scaled down. At 1.9% 10y, the market in our view is not taking these dynamics into account.

While the risk of a downgrade is significant, if the overall package fails to stabilize the fiscal profile, the negative effect on growth of whatever measures are agreed to is likely to outweigh any credit concerns. Similarly, even if the debt limit is not raised in time, it is extremely unlikely that the Treasury would miss an interest payment; it would rather delay other payments, which further increases downside risks to growth. We expect the extraordinary measures to allow the Treasury to remain under the limit till the end of February and interest payments in March are quite low anyways.

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

Vivek Shukla +1 212 412 2532

vivek.s.shukla@barclays.com

We maintain our long duration view, as the market is not yet pricing the dynamics resulting from the fiscal cliff deal

Negative growth concerns should outweigh any credit concerns

FIGURE 1 2y-3y Treasuries have richened vs. OIS (bp)

FIGURE 2 4y Treasuries now look more attractive versus OIS (bp)

0

5

10

15

20

25

Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12

2y Tsy-OIS basis 3y Tsy-OIS basis

3y basis 1y fwd

2.0

4.5

7.0

9.5

12.0

14.5

1.1 1.4 1.8 2.2 2.7 3.2 3.7 4.2 4.7

2y series 3y 5y 7y

Spd vs OIS

years to maturity

Source: Barclays Research Source: Barclays Research

Barclays | Global Rates Weekly

10 January 2013 9

In addition, the latest initiative by the Basel committee to relax the liquidity guidelines (in terms of the computation of the ratio and the phase-in) should only marginally reduce the regulatory drag, in our view. Large banks in the US are still short of the final capital requirements and should continue to prefer low risk weight securities. Given the level of excess reserves in the system, they are probably already compliant with the liquidity guidelines. While significant uncertainty remains about how the Fed will adopt these rules in the US, the phase-in actually increases the chance that smaller banks, which are likely not compliant with the final LCR requirement and operating under the assumption that the rule may not apply to them, may not be exempt. Hence, in our view, the change is not unambiguously negative for safe assets (please see “Global Themes” for details).

Front end should continue to richen Meanwhile, the front end of the Treasury curve has benefited from expectations of easier financing conditions. Figure 1 shows that the 2y and 3y Treasury-OIS bases have tightened steadily over the past month. We had argued earlier that end of Operation Twist sales/ expiration of FDIC guarantee and the rise in excess reserves given ongoing Fed purchases should improve financing conditions and richen Treasuries.3 We believe the sector still looks cheap and maintain our long recommendation; we find securities slightly further out the curve (in the 4y sector) to be more attractive (Figure 2).

Figure 3 shows that money market assets have increased quite substantially over the past two months, with taxable government funds rising $65bn and all money market assets rising $160bn. We believe that there is scope for further inflows due to the expiration of the FDIC guarantee on transaction accounts (TAG). Further, while current primary dealer inventories are still high, particularly in the <3y sector, we expect the normalization process to begin soon. Figure 4 shows that the GC-FF spread has been driven by dealer inventories, as dealers, in contrast with the Fed, need to finance their holdings in the repo market.

Currently, primary dealers hold ~$75bn in <3y Treasuries, compared with an average of close to 0 before the Fed started Operation Twist. We believe overall inventories can decline even more. Figure 4 shows that during QE2 overall inventories fell to below 0. With the Fed now conducting QE3 in Treasuries as well, a repeat should not be ruled out. Hence, even though the latest decline in overnight GC to below FF may reverse, it may not to the extent

3 Treasury and Money markets 2013 annual outlooks “A balancing act” and “Forecast uncertain”

The Basel committee’s decision to relax liquidity guidelines is only a marginal negative for demand for safe assets

Treasuries have richened in the front end. 4y sector still looks attractive

FIGURE 3 Government money market funds have seen large inflows

FIGURE 4 Primary dealer balance sheets should begin normalizing soon

2450

2500

2550

2600

2650

2700

2750

800

820

840

860

880

900

920

940

Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13Taxable govt. MMF assets, $bn, lhs

All MMF assets, $bn, rhs

-10

-5

0

5

10

15

(75)

(25)

25

75

125

175

Jan-10 Jun-10 Nov-10 Apr-11 Sep-11 Feb-12 Jul-12 Dec-12

Primary Dealer Inventory of US Tsys, $bn, LHS

GC-FF Spread, 5d MA, bp, RHS

Source: ICI, Haver Analytics

Source: New York Fed, Barclays Research

A rise in money market fund balances has helped lower short rates

Primary dealer inventory of Treasuries should decline, reducing financing pressure

Barclays | Global Rates Weekly

10 January 2013 10

priced in (Figure 5). Figure 6 shows that the market is pricing in GC to average 3-4bp above the effective funds rate in 2013; in our view, the risk is towards a tighter spread.

Even if GC were to stabilize at a 3bp spread to FF, as priced in, then also it seems that the 3-4y sector is too cheap. Figure 7 shows that 4y Treasuries are trading at ~15bp spread over OIS on a 1y forward basis. In other words, the market is implying that a year from now, even if the GC-FF spread averages just 3-4bp, 3y Treasuries would still be trading at a 15bp spread to OIS. Figure 8 shows that in 2010, with the GC-FF spread trading at a similar level, 3y Treasuries traded only 5bp above OIS, roughly 10bp tighter than currently implied. There was much less risk premium priced into longer tenor spreads back then.

Hence, in our opinion, the richening of the front end is likely to continue. Given current levels, we believe investors should consider terming out in the front end to the 4y part of the curve.

1y3y Tsy-OIS basis looks too wide, given 1y expectations of GC-FF basis

FIGURE 7 Forward Tsy-OIS basis looks high given expectations of a marginal spread between GC and FF rates

FIGURE 8 Historical experience suggests that the term premium in the Tsy-OIS basis should be much lower

5

7

9

11

13

15

17

1.5 1.8 2.0 2.3 2.6 3.0 3.3 3.6 4.0 4.3 4.6

Spot - 3y series 1y fwd - 3y series

Spot - 5y series 1y fwd - 5y series

Tsy-OIS basis, bp

years to mat.

-10

-5

0

5

10

15

20

Apr-10 Jul-10 Oct-10 Jan-11 Apr-11

3y Tsy-OIS basis, bp

GC-FF Spread, 3M moving average, bp Source: Barclays Research Source: Barclays Research

FIGURE 5 Overnight GC rate has declined to below effective fed funds rate…

FIGURE 6 …and is expected to stay only marginally above the effective FF rate

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

1-Nov 16-Nov 1-Dec 16-Dec 31-DecEffective Fed Funds Rate, % GCF Rate, %

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

GC - FF Futures implied spread, bp Source: Bloomberg, Barclays Research Source: Bloomberg, Barclays Research

Barclays | Global Rates Weekly

10 January 2013 11

INFLATION-LINKED MARKETS: UNITED STATES

Bottom up still looking good for now REIS rent data indicate that the upward trend in shelter CPI inflation should continue in the coming quarters. This is positive for short-end breakevens, and we recommend energy-hedged longs, but beyond the next year the drivers of inflation may switch from bottom up to top down.

We believe that front-end breakevens are under-pricing the likely rise in core inflation over the coming quarters and recommend energy-hedged longs. Specifically, we recommend being long Jan14s energy hedged. Many have expressed a view over the past several years that inflation simply can not rise given how much slack there is in the economy. That is a macro/top-down approach to inflation that caused many to erroneously forecast de/disinflation as long as slack in the labor market has remained. However, over the past several years, inflation trends have been led by micro/bottom-up stories, chiefly the homeownership to rentership story in shelter CPI. Bottom up will likely remain the best approach to forecasting inflation over the coming quarters, but at some point the macro picture may matter more.

At the beginning of every quarter we anxiously await the release of the REIS apartment rent data because it has been a good leading indicator of CPI rents specifically and CPI shelter in general. This series showed a y/y rise of 3.8% in 2012 as well as a continued decline in the apartment vacancy rate to 4.5% from a peak in 2009 of about 8%. This leading indicator can be important in forecasting inflation over the next few quarters because shelter makes up close to 40% of core CPI. If the past relationship holds, these data indicate CPI rents will increase to 3% y/y in the coming quarters, up from the latest reading of 2.4%. Along with an expectation that the recent drag from used vehicle CPI is behind us (based on an upturn in the Manheim Used Vehicle index), the expected rise in shelter inflation is a main factor in our economists’ call for y/y core CPI to rise to 2.6%.

We believe the market is under-priced, not just for the likely move up in the trend in core CPI, but even for the recent trend, around 2%, continuing. At -40bp, TIIApr13 breakevens are about 100bp cheap to Barclays CPI forecasts and the TIIJan14s breakeven near 1.45%

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

Chirag Mirani +1 212 412 6819

chirag.mirani@barclays.com

Over the past several years, inflation trends have been led by micro/bottom-up stories, chiefly the homeownership to rentership story in shelter CPI

Reis, Inc rents data indicate CPI rents will increase to 3% y/y in the coming quarters

FIGURE 1 REIS data points to CPI rent inflation heading to 3%

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Source: REIS Inc, BLS

We recommend energy hedged front-end breakeven longs in TIIApr13s and TIIJan14s

Barclays | Global Rates Weekly

10 January 2013 12

are close to 70bp cheap. Historically, average “alpha” of short breakevens (breakevens versus subsequently realized inflation) has been about 70bp. Thus, when breakevens are 70bp or higher, we typically view them as cheap on both a structural and tactical basis. Thus, despite negative carry to the end of this month, we recommend energy hedged front-end breakeven longs in both TIIApr13s and TIIJan14s.

While the REIS data indicated rising CPI rent inflation in the coming quarters, the Q4 data provided a hint of caution. After rising at a 5% annualized pace in Q2, REIS apartment rent inflation was 3.2% annualized in Q3 and 2.4% in Q4. While 2.4% is still a healthy trend, the downward trend begs the question of whether rents are reaching levels that stretch incomes or make buying a better option. Figure 2 shows that, since 2000, rents have risen nearly 60% relative to after-tax mortgage payments and Figure 3 shows that rents are now greater than 20% of household income.

The drop in rental vacancy rates indicates that near-term tightness in the market is likely to continue to put upward pressure on rents. At some point, though, the relative cost of owning versus renting or the rising cost of shelter relative to incomes may slow the increase in rent demand. The first could happen if access to cheap mortgage credit improves and the latter could occur if, as happened in 2009, rent affordability led potential renters to move back with parents or find other accommodations.

Once this bottom-up story plays out, inflation may be driven by macro rather than micro dynamics. Inflation may thereafter remain comfortably above what the market is pricing in, but it might only do so if wages start to rise. If slack in the labor force is reduced, as we expect, that may well happen. The employment report showed that y/y average hourly earning rose 2.1% in December. The rose-colored view is that this was the highest in a year and the recent trend has been quite positive. However, the level itself indicates near-zero real hourly wage growth is far from those that would likely lead to “good” sustainable inflation resulting from an improvement in the economy. That would likely be bad for TIPS’ outright performance but positive relative to nominals. For now though it is a continuation of stagflation light, which thus far has been a boon for real rate and breakeven investors alike.

FIGURE 2 Rents have risen significantly versus home buying costs (mortgage payment + property taxes.)

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Rent/(MtgePayment+PropertyTax)

FIGURE 3 Rents are now greater than 20% of household income

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Rent/Median Family Income Source: National Association of Realtors, Reis, Inc, The Tax Foundation, Haver Source: National Association of Realtors, Reis, Inc, Haver

Barclays | Global Rates Weekly

10 January 2013 13

UNITED STATES: AGENCIES

Longer-dated opportunities Spread pickup remains more abundant in long-end agencies and zeros, while TVA remains a popular alternative. USD SSA paper has outperformed despite considerable new supply volumes, possibly spurred on by the LCR rule changes.

Long-end value remains in agencies New bellwether issuance has taken a breather, but we expect more activity in the remainder of the month, as the two remaining issuance windows are FRE’s and FHLB’s only ones this month, and both were active in January 2012 as well. With the 5y sector now barely Libor-positive, economics continue to argue for new front-end paper; however, we would not be surprised to see longer maturities to match likely investor demand.

The agency-Treasury spread curve remains oddly stepped, with the 2-3y sectors at or below T+5bp, the 5-7y sector at 13-15bp above matched-date Treasuries, and 10s at T+24bp (Figure 1). We maintain our view that investors should switch out of the 7y sector, which appears rich on the agency-Treasury spread curve, and either reduce duration while giving up minimal spread by owning 5s, or improve roll-down and lower the chances of supply-related cheapening by extending into the 10y sector.

Further out the curve, healthy spread pickup opportunities remain only in the 20y sector, with spreads to Treasuries staying in the low 30s. While we believe there may be 5-10bp of further tightening upside as a long-term convergence trade, long-end swap spreads are likely to leak wider over the next few months, as long as fiscal cliff and/or debt ceiling negotiations remain efficient and benign. In this case, we reiterate our recommendation that the trade is better located versus swaps over this period.

We also maintain our view that long-dated agency zeros represent an opportunity, as they pick up more than 40bp to agency bellwethers, while Treasury STRIPS pick up closer to 20bp over coupons on an asset swap basis (Figure 2). Of course, investors should be reminded of zero coupons’ increased duration risk versus similar-maturity bullets.

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

Continue to recommend moving out of the 7y point into either 5s or 10s

FIGURE 1 Agency-Treasury spread curve remains stepped

FIGURE 2 Agency zeros represent pickup over bellwethers, STRIPS

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Source: Barclays Research Source: Barclays Research

Agency zeros pick considerably more to bellwethers than Treasury STRIPS do to coupons

Barclays | Global Rates Weekly

10 January 2013 14

TVA a long-end alternative Even after some recent outperformance, we believe TVA represents another alternative for investors seeking to pick up spread in agency space. Pre-crisis, TVA names traded practically on top of similar-maturity housing GSE paper (Figure 3). But throughout most of 2009, a roughly 50bp basis formed between TVA and the housing GSEs as only FNM, FRE, and FHLB names were eligible for QE1. With the end of Fed purchases of agency debt, the basis narrowed to about 15bp in 2011-12, but widened after the latest round of PSPA changes were announced in August 2012 back to its current ~25bp. Note that there was no similar repricing when the previous set of PSPA changes were announced at YE09, and TVA actually outperformed during that period.

In our view, the reach for yield and hunt for Libor-positive assets should help TVA converge back to the area of 15bp cheap to agencies, if not tighter. We have maintained that liquidity premia in the super-long end are worth 10-15bp in a low-vol environment, and the Fed is certainly unlikely to conduct new purchases of long-end agency debt to widen the basis.

Further, from a fundamental standpoint, while TVA paper also does not bear an explicit guarantee, the agency is fully government owned and has statutory pricing controls and protected status as a supplier over its power generating area. Thus, for investors unsatisfied with the level of spread pickup offered by 20y agency bellwethers, we recommend switching into TVA names and expect some compression in the medium term. The explicitly guaranteed AID bonds also represent a viable, less-liquid alternative (Figure 4).

SSAs outperform amid supply USD SSA paper has paradoxically outperformed agencies and swaps in the past week, despite a rapid acceleration of issuance activity after a slow start to the year. Deals totalling $11bn and counting have been announced this week, and while it is still early in the month, the present run rate would total $44bn by month-end, outstripping the $30-35bn issued in 2010 and 2011 and representing almost one-third of our projected 2013 USD issuance total.

KFW and EIB have already placed $9bn of the total in the 5y and 10y sectors, which are the very parts of the curve that have outperformed most. With 5y EIB paper at L+11bp and KFW 5bp through that, these levels are headed for tightest the SSA space has been to agencies since late 2011 (Figure 5).

TVA and AID bonds pick up spread as an alternative to super-long end agencies

FIGURE 3 TVA historical performance relative to housing GSEs

FIGURE 4 Healthy spread pickup of TVA, AID over agencies

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FNM 7.25 5/30 TVA 7.125 5/30

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SSAs have outperformed despite heavy USD issuance

Barclays | Global Rates Weekly

10 January 2013 15

Part of the reason for the outperformance may be a consequence of the revisions to the Basel III framework’s LCR rules. While much has been made of the expansion to AA rated RMBS and investment-grade non-financial corporate bonds rated below A-, our European colleagues note the definitions remain strict enough to continue to favor sovereign debt and, to a lesser degree, SSA paper.4 Sovereign debt of any rating qualifies as a Level 1 (ie, unlimited) asset, even for entities without a 0% risk weight. By contrast, SSAs are only Level 1 for 0% risk weight entities, while paper with a 20% risk weight is considered Level 2A and subject to a 15% haircut. Covered bonds rated AA- and higher are also classed as Level 2A, and altogether the category cannot exceed 40% of total high-quality liquid assets. Thus, we concur with our European colleagues that this treatment puts SSA paper at a marginal advantage, especially those of 0% risk weight entities, and would, thus, be likely to have increased bank demand.

From a relative value standpoint, while there may be more room for SSA paper to outperform agencies, spread pickup is becoming harder to find. When factoring in their parent countries’ sovereign CDS levels, value appears better in the Nordic countries, although we believe core European sovereigns such as Germany and the Netherlands are reliable as well (Figure 6).

At the same time, the supply backdrop for SSA paper is likely to remain robust, especially relative to agencies. Consider that forecasted SSA supply of $150bn gross and $40bn net both far outstrip our estimates of $110bn in gross and -$50bn in net agency bellwether issuance. More broadly, these projections do not factor in potential supply from domestic bank wind-up agencies, which have not yet been created, skewing the risks for more supply to the upside. Contrast this with the US housing GSEs, which must shrink their balance sheets by at least $120bn this year per the PSPA terms. Lastly, while the economics of issuing USD SSA paper and swapping the funding back to EUR have worsened somewhat, they remain advantageous to issuing EUR paper directly.

4 The AAA Investor: In the sweet spot – SSA bonds, 10 January 2013

Demand expectations may be boosted by the change to LCR rules, while supply is robust

FIGURE 5 SSA outperformance continues despite supply

FIGURE 6 Relative value across SSA names

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FNM 5y FRE 5y KFW 5y EIB 5y

5y $ Swapped 5y EUR CDS

BNG 39 -3 4 49

KBN 21 -21

20

KFW 13 -27 -12 42

OKB 37 -5 -5 47

RENTEN 8 -35 -18 42

SEK 32 -10

21

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42

EIB 14 -26 1

IBRD -4 -45 -13

Source: Barclays Research Source: Barclays Research

Barclays | Global Rates Weekly

10 January 2013 16

UNITED STATES: SWAPS

Spread trading opportunities near the debt ceiling Swap spreads appear consistent with the market’s expecting no further reduction in deficits apart from the forced spending cuts already in place. Further deficit reduction should point to wider long-end spreads, but any noise about a US ratings downgrade could provide a short-term tightening opportunity before spreads widen again.

The long end of the spread curve has had an eventful few weeks. In the weeks leading to the fiscal cliff, 30y spreads widened from a low of -26bp in November to -16bp on December 31, likely because either the market anticipated that there would be a plan that would reduce deficits significantly or the chance of going over the cliff. Unfortunately, what it got was neither, with the final outcome not going much in the way of deficit reduction. This has resulted in the market’s partially reversing the widening and tightening all the way to -22bp a few days before the bond auction.

We now think that the market is priced for status quo even as the debt ceiling/sequester debate approaches. Figure 1 shows fair values for the spread curve based on our framework, which uses 5y deficit projections as a measure of the fiscal risk premium in Treasuries, under a number of different possible fiscal outcomes.

On one hand, one can think of an outcome in which the $1trn automatic spending cuts to defense and non-defense discretionary spending will be “turned off”. This would amount to an increase in the deficits of nearly $240bn in the next five years and should imply a spread curve that is 4-5bp tighter at the long end.

On the other hand, one can think of an outcome in which the House Republicans are able to enforce a dollar of deficit reduction for every dollar increase in the debt ceiling. If the ceiling were to be raised by $1trn, assuming that at least one-fourth of it occurs over the relatively near horizon of five years, our framework would imply a spread curve that is 3-4bp wider than where it is.

Amrut Nashikkar +1 212 412 1848

amrut.nashikkar@barclays.com

The risks to swap spreads from the debt ceiling/automatic spending cuts debate appear symmetric with the market priced for the status quo

FIGURE 1 The risks to swap spreads are symmetric as far as most feasible scenarios for the debt ceiling are concerned

FIGURE 2 An initial tightening after the US downgrade in August 2011 was followed by a reversal

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30y MM spd (bp, LHS) 5s-30s spd curve (bp, RHS) Source: Barclays Research Source: Barclays Research

Barclays | Global Rates Weekly

10 January 2013 17

One can also imagine a disorderly outcome under which the US rating gets downgraded further. To understand the potential consequences of a ratings downgrade on long-end spreads, it makes sense to look at the mid-2011 experience.

Figure 2 shows what happened to 30y spreads and the 5s-30s spread curve in the days following the S&P US downgrade from AAA to AA+ on August 5, 2011. On August 4, 30y matched maturity spreads were at -26bp, not far from where we are today. The 5s-30s spread curve was at -53bp. The downgrade on August 5 sparked a narrowing in long-end spreads and a flattening of the spread curve. Outright 30y spreads bottomed a week later at -39bp, while the spread curve bottomed at -67bp on August 24. Following this price action, 30y spreads widened back to pre-downgrade levels and were at -22bp by September 24, with the spread curve steeper (-48bp) than pre-downgrade.

The summary is that although the downgrade did lead to an immediate and substantial tightening of swap spreads, the tightening did not last long. One possible explanation is that the focus on deficit reduction that resulted from the downgrade eventually led to wider spreads. There is little reason to believe that the reaction will be any different this time around.

This suggests that for those who think that a US downgrade is possible over the coming months because of the stalemate about raising the debt ceiling and the possibility of the cancellation of already planned spending cuts, spread tighteners or 5s-30s spread curve flatteners could still be a good tactical trade. But the key point is that any tightening purely because of a downgrade would likely be short term and should be used as an entry point for wideners. Over the medium to long run, we believe that there will continue to be plenty of focus on additional deficit reduction, and the path of long-end spreads in that case would be to head wider. As we discussed in Swap spreads: Calm amidst turbulent waters, the fair value of 30y spreads in a scenario that truly stabilizes the fiscal profile of the US is over -10bp.

Any potential downgrades are likely to result in a sharp spread tightening, likely followed by a reversal as the market prices in a renewed political focus on deficits.

Barclays | Global Rates Weekly

10 January 2013 18

UNITED STATES: VOLATILITY

A trade for higher rates Buy 1y single look 10y CMS cap funded with payer swaption to participate in an unexpected large increase in rates. The convexity adjustment is currently small and allows an attractive range to benefit.

• Buy $820mn 1y single look 10y CMS cap 2.5%

• Sell $100mn 1y*10y payer swaption 2.5%

• Approximately premium neutral, as of January 10, 2013

The main difference between CMS cap and payer swaption is convexity adjustment. The adjustment is made to the CMS swap rate and, therefore, to the CMS cap to account for the positive convexity in vanilla swaps. Essentially, the vanilla swap loses less in a rising rate environment due to a declining duration exposure.

Figure 1 shows the convexity adjustment in 1y forward 10y swap in a historical perspective. Clearly, it is on the low side.

The adjustment is driven by a) implied vol, and b) vol of vol. Higher vol and vol of vol cause a larger adjustment. As volatility has come off in the past few years – 1y*10y vol from 100bp/y at the beginning of 2012 to about 77bp/y now – the convexity adjustment has fallen from 5.3bp at the beginning of the last year to 3.6bp currently. Furthermore, as Figure 1 shows, the adjustment has been as high as 14bp in the peak of the credit crisis and as tight at 2bp just before the onset of the crisis.

FIGURE 1 Convexity adjustment has come off, driven by vol and vol of vol

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1y10y convexity adjustment (bp) Regression Value Note: Data period: January 21, 2004–January 9, 2013. The actual adjustment is the difference between 1y10y CMS swap rate and 1y10y vanilla swap rate. The regression value is determined by one-year rolling regression between actual adjustment and a) 1y*10y ATM normal vol (bp/y) and b) 1y*10y 100bp wide vol of vol (bp/y). Source: Barclays. Research

While vol will likely come off more as rates fail to sustain a sell-off and due to an excess supply of options (see “Vol does not live here anymore,” December 7, 2012, for more details), being long convexity adjustment in a rate sell-off is a good hedge to our base case rate and vol view (both lower over 2013).

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

Barclays | Global Rates Weekly

10 January 2013 19

Figure 2 shows the performance of the trade at 1m, 3m, and 1y horizons. The trade’s structure looks like a short 1x2 payer spread. Investors can lose a limited amount, akin to owning payer or payer spreads, but gain five to six times if there is a large rate sell-off.

Such attractive risk-reward is mainly due to the collapse in convexity adjustment over the past few years (Figure 1).

We like the trade now because the recent sell-off has brought rates to levels from which there will likely be either a large sell-off or none at all. With the 20bp sell-off in Treasuries following the fiscal cliff deal, rates now have decent room to rally. As a result, outright short duration or long payer swaption positions are not attractive. However, if fundamentals improve and a debt ceiling- or eurozone-related incident can be avoided, rates could sell off more. But if such a scenario does unfold, rates will likely sell off a lot.

Being premium neutral, the trade should lose nothing if a muddle-through scenario persists, but gain a great deal if the environment is completely different a year from now.

FIGURE 2 Long 1y SL 10y CMS cap vs 1y*10y payer is a limited loss trade

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Note: As of January 10, 2013. The above scenario analysis is done on long $820mn 1y SL 10y CMS cap 2.5% vs $100mn 1y*10y payer 2.5%. The analysis assumes unchanged ATM normal vol. Source: Barclays Research

As Figure 2 highlights, the biggest risk to the trade is a limited sell-off in rates. This could happen especially if Capitol Hill falters on the debt ceiling debate, causing a decline in yields that is eventually reversed. However, the trade is limited loss in nature, and the current level of both rates and volatility attractive, in our view, for the trade.

Barclays | Global Rates Weekly

10 January 2013 20

UNITED STATES: MONEY MARKETS

Lightening the LCR burden Last week, the Basel Committee on Bank Supervision (BCBS) modified its liquidity coverage ratio (LCR) calculation. We believe this is particularly significant for non-financial CP issuers, especially as this sector has been growing rapidly.

• The BCBS reduced the drawdown rate on the unused portion of “committed liquidity facilities” for non-financial borrowers from 100% to 30%.

• This will reduce the cost to banks of providing liquidity backstops to non-financial borrowers. And the smaller buffer reduces banks’ negative carry.

• These changes could boost the willingness of large banks to backstop non-financial CP outstanding.

• However, the BCBS did not change the liquidity rules related to AB-CP and financial CP backstops. These facilities are subject to the full LCR charge.

Demand for non-financial CP is likely to remain robust, as prime funds like the diversification away from the over-emphasis on financial paper in their portfolios. Moreover, even if prime funds move to a floating NAV, the very short maturities of non-financial CP may keep money fund demand for the paper robust.

Changing the LCR Under Basel III, banks will be required to maintain sufficiently large liquidity buffers of high quality assets to survive a funding crisis lasting 30 days. During such a crisis, the BCBS assumes that banks would lose access to wholesale funding markets such as repo and commercial paper – similar to their experience in September and October 2008. To meet their own funding needs and operate from day to day, banks would need to sell off their holdings of high quality liquid assets. Simultaneously, the BCBS assumes that the demand for liquidity from the banks’ customers would increase. Nervous depositors would withdraw balances, while borrowers, fearful about their own liquidity, are likely to draw on their unused credit lines.

Last week, the BCBS made three important and not entirely unexpected changes to the LCR to lighten the burden on banks.5 It extended the deadline for full compliance from 2015 to 2019 (although banks are expected to meet 60% of their requirement by the earlier date and an additional 10% per year thereafter). At the same time, it broadened the definition of Level 2 liquid assets. These are assets that count toward the numerator of the LCR but are subject to haircuts and limits, unlike Level 1 assets, which have no discounting factor when included in the calculation of the ratio (such as Treasuries, cash at the central bank, and GNMA MBS). And importantly, the BCBS also modified some of its assumptions about how quickly deposit withdrawals and drawdowns of liquidity backstops and credit lines would occur. Keep in mind that local banking rules may trump the BCBS liquidity changes and some bank managements may opt not to relax their buffer assumptions.

Backstopping Non-financial CP is typically issued with a bank-provided liquidity backstop to insure the payment is made at maturity. The size of the backstop provision depends on the credit rating of the borrower, with lower rated ones generally applying a full backstop on both

5 Please see “LCR: Easing the rules and liquidity pressure on banks,” Barclays Euro Money Markets Weekly, January 8, 2013.

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

The BCBS loosened LCR requirements

Non-financial CP is typically issued with a bank-provided liquidity backstop

Barclays | Global Rates Weekly

10 January 2013 21

their outstanding borrowings and their unused lines of credit. Recognizing that banks have large outstanding loan commitments and unused credit lines, the initial BCBS guidelines required them to hold 100% of the value of these obligations to non-financial institutions (over a 30-day window) in high quality, easy-to-sell assets.

LCR costs This posed a bit of a challenge for large banks. Raising term money to invest in very low yielding, high quality liquid assets generates significant negative carry for banks – even though bank funding costs have come down sharply since 2011. Likewise, the size of the buffer (and its associated cost) is determined by the degree to which banks provide liquidity backstops to non-financial CP issuers, municipals, and other borrowers. Even though the liquidity facilities are seldom ever drawn and generally syndicated across a group of banks, the 100% LCR weighting (and its associated negative carry) represents a significant charge to banks, which until last week made no distinction across the type of borrower.

Unsurprisingly, the LCR carry cost is larger for the biggest banks, given their bulkier liquidity backstop and loan commitments. That said, the top four US banks by asset size have already met their LCR under the previous guidelines – their average LCR exceeds 100%. Interestingly, although the smaller institutions are less involved in the liquidity backstop business, they are behind in meeting their LCRs.6 This distinction reflects the fact that while the largest banks have significantly larger 30d commitments and potential drawdowns, they also hold proportionally more liquid assets and cash as a share of their overall assets. The smaller banks, by contrast, have larger loan/asset shares.

6 See “Basel III: A Shadow Tightening of Policy,” Barclays Interest Rate Research, May 17, 2012.

FIGURE 1 Non-financial CP (sa, %y/y)

FIGURE 2 Other CP holdings (% total CP holdings in money market funds)

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Source: imoney.net

Commitments and backstops are large and expensive

Barclays | Global Rates Weekly

10 January 2013 22

For the largest banks, we estimate that the unused portion of the authorized program limit on non-financial CP could be as much as $800bn. Data on loan commitments from the Shared National Credit program for 2012 suggest that total short-term loan commitments were about $300bn (11% of the total).7

Coping with higher costs To reduce the burden of their LCRs, the banks would need to either increase the numerator – that is, buy more safe assets – or reduce the denominator by lowering their exposures to activities that could create higher 30d outflows. We assume that banks would concentrate on buying assets, as the proportion of their LCR being funded by cash would start to decline once the Fed (along with other central banks) began tightening policy and draining reserves. In turn, this generates negative carry to the extent that the assets are purchased from funds raised in term unsecured markets.

To address the denominator and outflows, banks could reduce their activity in the syndicated lending and commercial paper markets, or raise the fees they charge borrowers for providing commitments and liquidity backstops. Although it is difficult to identify the cause, this past summer, there was a pronounced slowing in the growth of non-financial CP outstanding (Figure 1). While some of the decline may relate to the slowing of the economy, we suspect that a portion might reflect expectations of higher liquidity backstop charges. Indeed, some institutions appear to have become less willing to underwrite liquidity facilities for certain types of very short-term municipal debt programs beyond January 2015.

Strong and getting stronger? But now that the assumed drawdown rate on the unused portion of committed liquidity facilities to non-financial firms has been lowered from 100% to 30%, the largest banks are significantly over their LCRs. As a result, they might be more willing to use some of this excess capacity to ramp up their provision of liquidity backstops on non-financial CP programs.

Demand for non-financial CP is already strong, which is a reason the rates on the highest rate non-financial CP trade rich relative to similar-maturity unsecured paper. Holdings of “other CP” in taxable money funds reached $62bn at the end of November, from $45bn in December 2011, and account for nearly 17% of their overall holdings of commercial paper (Figure 2).

Moreover, the bulk of this paper has very short tenors, which appeals to prime money market funds interested in diversifying their holdings away from an over-reliance on financial paper (wholesale deposits and financial CP account for 55% of prime fund assets). In addition, non-financial CP typically has shorter maturities than comparable financial paper. Indeed, roughly 75% of non-financial CP has a maturity of less than 20 days, compared with 50% for financial issuers. In the event that money funds are pushed to adopt floating NAVs, this short maturity could make the paper even more attractive to funds.

7 See http://www.federalreserve.gov/bankinforeg/snc.htm

Large banks are now significantly over their LCR

Barclays | Global Rates Weekly

10 January 2013 23

EURO AREA: RATES STRATEGY

2013 off to a roaring start 2013 has started with moves pushing the level of rates higher in swaps and core markets, and lower in peripheral markets. With some levels now approaching our end-Q1 13 targets, it is time to take stock and re-assess.

Peripherals: a strong start to the year Peripheral markets have continued to do well recently, even in the face of renewed supply (see the Sovereign spread section). This was paricularly the case for Spain, where if anything the announced 2013 funding needs were above expectations.

The good performance has been helped by the general ‘risk-on’ mood, but also by beginning of year allocations by real money investors – as we have noted before, the active hedge fund short is probably close to fully covered by now. The Spanish market has likely been helped by support from domestic banks: the weaker ones have been recapitalized over the Christmas period, and the stronger ones probably made room for new buying with their selling in September/October. The eventual picture in terms of buying will take time to emerge (2 to 3 months), but we believe the recent good performance is if anything more likely to generate further buying and covering from underweight positions than profit taking at this stage. With the underlying economic data having seemingly stabilized in Spain (at a low level), the key domestic item that could turn sentiment back to negative is the full-year budget deficit data. This should be out probably around the beginning of March, but there might be indications of the likely slippage before that. We expect around 1pp slippage from the revised 6.3% target, and think that this is unlikely to change investors views (see Spain: non-financial accounts show further de-leveraging up to Q3, 9 January 2013). Of course, other factors could also have a bearish impact on peripheral spreads (the Italian elections, or the Cyprus situation).

As at the time of writing, the 2- and 10-year Spain-Germany spreads are at 190bp and 330bp, down 75-100bp from the Q4 averages, with 2y and 10y Spain respectively at 2% and 5%, and the same maturities in Italy at 1.35% and 4.15%. In the Global Rates Outlook published 6 December 2012, we had mentioned outright levels between 2.5-4% in 2-3y maturities and 5-6% for 10y Spain (4-5% for 10y Italy) in the absence of OMTs, and expressed the view that tightening would occur even if the OMT programme was not

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

A continuation of the positive trend in peripheral markets

FIGURE 1 Peripheral curves have rallied and steepened…

FIGURE 2 … but the core level of rates has not moved much

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Source: Barclays Research Source: Barclays Research

Barclays | Global Rates Weekly

10 January 2013 24

activated (on activation, we had looked for yields to be around 1.5-2% in the short end and 3.5-4.5% in 10y).

From here, we believe the tightening will hold, or even continue a little more, as real money investors grab the yield still available in very short end rates – Figure 3 shows various forward rates on the Spanish curve vs German rates and also vs the 3m EONIA. While these yields are already at low levels vs our initial forecasts and by recent standards (more so in absolute terms vs EONIA than vs Germany, as the general level of rates has rallied vs EONIA), they are still substantially higher than what is available in other market segments (eg. 1y Spanish T-bills are at around 1.5%, 1y GC repo on Spain is at below 50bp, 1y Belgium T-bill is at 5bp), and so we would expect a continued decline in yields from current levels. Still, we are close to the levels of the second phase of the crisis (post July 2011), and it will probably require clearer signals on the fundamental economic front to move towards the much lower pre-July 2011 types of levels. So we expect a further decline in yields but smaller, say 50-75bp across maturities (with the 3 to 5y sector performing best) and more gradual than seen up to now.

FIGURE 3 Spain: various forward rates on the government curve, vs EONIA and German rates (%)

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Average 1 to 5y Spain fwd vs 3m EONIA

Source: Barclays Research

The 3s/10s Spanish curve is likely to continue steepening a bit more from here, but looking at Figure 3 makes clear that from an historical perspective, medium-term forward rates have probably the biggest room to come down from current levels in the remainder of the year, and this should limit the medium-term steepening also in the very near term.

We continue to expect that a large idiosyncratic sell-off in peripheral risk (say, pushing 2y Spain back above 4.5%) is quite unlikely from here. If anything, we suspect any mild sell-off is more likely to be taken as an opportunity to cover remaining underweights from here, especially at the shorter end of the curve. In that respect, it is worth noting that the rally that has developed in peripheral spreads since the Draghi speech in late July is already the longest rally we have seen since the beginning of the crisis, in 2010.

Still, the experience of the past few years suggests that we can move quickly to multiple equilibriums and it is too early to completely rule out the possibility of an ESM precautionary programme, even if the economic and financial fundamentals, as well as potential ‘pressure points’ are not the same as before (eg, the bank funding and capital fragility has been to a large extent addressed). Clearly, as yields rally, the probability of OMT activation diminishes (the extra benefit for Spain from current levels of requesting help is more limited). All other things being equal, we had put such a probability at around 60%, but it is lower now.

The tightening will hold, or continue, although likely be smaller and be more gradual

The Spanish curve is likely to steepen a bit further, but medium term forwards offer value

We do not expect a large sell-off from here

… but multiple equilibriums can still happen

Barclays | Global Rates Weekly

10 January 2013 25

We remain positive on Spanish risk, and continue to hold short-end rates outright: be in 2s/10s steepeners (vs Italy) and be long 5s vs 2s and 10s. International investors might also move a bit more from Italy to Spain, given the relative pricing at the short end (Italy 1y is at 85bp, 60bp lower than Spain).

Rate levels look too low Against the positive backdrop of lower peripheral rates, ‘safe’ euro rates have sold off recently, although they have performed better than those in the UK and US, which are at the higher end of their past 6-month levels. We think there is room for euro rates (in Germany, swaps, etc) to sell off a bit more from here, even if USTs do not move or rally back a little bit. We expected a range between 1.5% and 2% for 10y Bunds for most of the year, starting with a move towards 1.6% by end Q1 13. This was predicated on tighter peripheral spreads and a reduction in flight to safety premium, and we stick to that broad multi-quarter view.

If anything, given the large tightening in peripheral spreads, the sell-off should have been a bit bigger, especially since, in contrast to US and UK rates, euro rates actually rallied through most of November and December. We have estimated in previous articles (eg, the Global Rates Outlook) a beta of around 0.4-0.6 between changes in 2y Spain/Germany and the level of 5y5y fwd euro rates (ie, corresponding to a beta of around 0.2-0.3 vs 10y euro rates). Figure 4 illustrates the richness/cheapness of 5y5y fwd and 10y German rates in such a model. It shows that 10y rates are currently around 25bp richer than they were already in early December (and for most of H2 12, at which point they were already 20-30bp rich).

FIGURE 4 The rally in peripheral rates is pushing the fair value in 5y5y fwd and 10y rates deeper into rich territory

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Fundamental+ SP vs DE 2y (1999-Apr12)

Light blue: Current fair value based on LT nominal growth, inflation

volatility and 2y rates: 4.3%

Cyan: fair value based on a similar model, but including the 2y Spain vs Germany spread as an

indicator of flight-to-safety premium: 3.70%

3m fcst

Source: Barclays Research

While such models need to be taken with care, some safe-haven premium will remain, and the current richness is not entirely unseen, it is very large by historical standards, and suggests that the risks remain biased towards higher outright euro rates and an underperformance in the near and medium term vs US rates. This is especially the case since the prospects of an ECB rate cut in Q1 13 have receded following the ECB January Press Conference, and the economic data have if anything surprised slightly to the upside. Thus, despite the sell-off, we would not advise going long duration on euro rates, despite having broadly reached our end-Q1 targets. Instead, we see better value in expressing such a more-bullish view via a long position in swap spreads (please see the Europe: Swaps section).

We remain positive on peripheral risk

Safe euro rates have sold off… but likely not enough

10y rates look 25bp richer than they were in December… when the were 25bp rich

There could be some decoupling vs the US

Barclays | Global Rates Weekly

10 January 2013 26

EUROPE: SWAPS

Buy 5y5y fwd EUR ASWs There are risks that can push EUR ASWs tighter still; however, fundamentally we find them cheap enough to start buying gradually here and increasing the position if they tighten or widen more. We recommend buying 5y5y fwd EUR ASWs.

After their notable tightening over the past few weeks, EUR swap spreads have tightened 2bp or so more on the back of swapped issuance in the past week and Bund ASW stabilised around -18bp (versus Libor) and EONIA + 10bp.

As we highlighted in our European Rates Trade Ideas 2013 report, and touched on last week, if we reached EONIA + 10bp levels in Bund ASW, it would look fundamentally cheap to buy. We have reached that level now and whichever fundamental valuation model we look at, we find the Bund ASW fundamentally attractive. Indeed, our fair value model, with 1y ahead German deficit expectations and short rates, and with just 1y ahead euro area deficit expectations, signals cheap valuations at least in the order of 10bp (fair values EONIA – 14bp, EONIA – 7bp, EONIA flat respectively). Indeed, when we look at the tightening in 5y5y fwd spreads (constructed from Bobl and Bund ASW), the tightening looks much more aggressive by historical standards, with levels very close to all-time tights. There are still risks of some more tightening from here (which we discuss below). Given this, we recommend gradually buying Bund ASW and increasing the position if we tighten or widen more. Moreover, we also like being long Bund ASW versus Bobl ASW on a cash-for-cash basis (ie, long 5y5y fwd ASW).

Below, we discuss the risks for outright long Bund ASW and 5y5y fwd ASW recommendations and the reasons we recommend entering into our longs more gradually.

1) Swapped issuance: This had slowed down notably during spring and summer months of 2012 on the back of increasing concerns about the peripheral market (in particular Spain). However, since Draghi’s “whatever it takes” speech at the end of July and the powerful OMT backstop announcement, financial market conditions have improved

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

We find Bund ASW cheap in all of our fundamental models

FIGURE 1 Bund ASW looks cheap in any fundamental model

FIGURE 2 5y5y fwd EUR ASWs have cheapened even more aggressively and not far from their historic tights

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Barclays | Global Rates Weekly

10 January 2013 27

remarkably, which in turn has helped investment grade, SSA and covered bond issuers to come back to the market. In particular, in Q4 2012, non-financial IG issuers issued a decent amount of paper. However, taking into account the seasonality of low issuance in December, swapped issuance was still on the relatively low side by historical standards at the end of the year on a rolling 3m basis (Figure 3). Therefore, there is room for the pipeline of swapped issuance to continue at a decent pace in the coming weeks before it slows down, as issuers will probably want to take advantage of market stability for now.

2) Bund valuation: Despite the 25bp sell-off in Bunds in recent weeks, at 1.55% in our long-term fundamental models, it still looks expensive given the sharp moves elsewhere in risky assets as well as where 10y Treasury yields are. However, we are not very worried about a big sell-off in the very near term for two reasons. First, we are not far from our end-Q1 target of 1.60% already, although we project a further sell-off in Bunds post Q1 (please refer to the Euro Strategy section of this document for more on this). Second, most of the factors that could have made Bunds sell off notably have already materialised in the near term: 2y Spain and Italy yields are already at 2.10% and 1.30%, respectively (as we have been projecting), the levels which an OMT programme would likely have targeted; also relatively bearish ECB is out of the way for now as well. Therefore, given that the Bund has held in relatively well in the sharp tightening of peripheral spreads, if we see some temporary rewidening correction in peripheral spreads, we believe Bunds can rally back quickly. The only risk we see for a further notable sell-off in Bunds in the near term is that if the US rates keep selling off in the coming weeks. However, our US colleagues believe US Treasuries are unlikely to sell off further amid the host of uncertainties that the US still faces in the coming months (debt ceiling, spending cut agreements, etc).

3) Global swap spreads: Notable swap spread tightening has been a theme not only in Europe but also in US, and, in particular, UK swap spreads have been tightening notably recently as well (Figure 4). However, after the recent remarkable tightening, we also find 10y UK swap spreads looking cheap in our fundamental models. Similar to Bund ASW, while we see 10y UK spreads potentially tightening a little more from here, if that materialises it would leave them very cheap as well, in our view.

FIGURE 3 Despite the fact that swapped issuance has picked up since Q4 12, there is still room for more in the near term

FIGURE 4 Recent ASW tightening has been global

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Barclays | Global Rates Weekly

10 January 2013 28

The bottom line is that there are risks that can push EUR ASWs tighter still; however, fundamentally we find them cheap enough to start buying gradually and increasing the position if we tighten or widen more. We recommend gradually buying Bund ASW and also we like being long Bund ASW versus Bobl ASW on a cash-for-cash basis (ie, long 5y5y fwd ASW) and would drop the Bobl ASW leg and just be left with outright long Bund ASW as swapped issuance slows down.

We recommend buying 5y5y fwd EUR ASWs and Bund ASW gradually

Barclays | Global Rates Weekly

10 January 2013 29

EUROPE: MONEY MARKETS

Countdown to payback From 30 Jan. banks will have the option of repaying the first 3y LTRO. We maintain our call for €200bn to be repaid in Q1/Q2. Even though EONIA fixing is unlikely to be affected, we would expect volatility on short rates, especially in the case of large and frequent initial repayments.

In the Euro Money Markets section of the 2013 Global Rates Outlook, we highlighted the ECB’s decisions on policy rates, the 3y LTROs repayment and the Basel III’s liquidity regulation (LCR) as the three main focal points for the euro money markets in 2013.

On the regulation side, last Sunday the Basel Committee on Banking Supervision announced the final version of the Liquidity Coverage Ratio (LCR), which shows less stringent rules on liquidity, thus reducing pressure on banks. As we discuss in the Special Focus section, this has lessened, but not eliminated, the effect in terms of banks’ lower participation in the very short-term liquidity market.

At its January meeting, the ECB left policy rates unchanged, as expected. During the Q&A session, President Draghi pointed in particular to the improvement in financial conditions, stabilization of cyclical indicators of economic activity, and to evidence of reduced fragmentation, as the main reasons behind the Governing Council’s decision, which was “unanimous”. The hurdle for a rate cut from here seems relatively high.

Starting from Wednesday 30 January, the 523 banks that borrowed €489bn at the first 3y LTRO settled on 22 December 2011, have the option of exiting from the operation on a weekly basis until its maturity (on the day that coincides with the MRO settlement, usually a Wednesday). Giving one-week’s notice, banks must inform the domestic central bank of the amount of 3y liquidity that they want to pay back. Starting from 27 February the option to exit from the second 3y LTRO (settled on 1 March 2012) can be exercised by the 800 banks that borrowed €529bn, with the same modalities8. During the press conference of the January meeting, President Draghi stated that the ECB will publish weekly data on the total

8 See the ECB’s 8 December 2011 press conference http://www.ecb.int/press/pr/date/2011/html/pr111208_1.en.html

Giuseppe Maraffino +44 (0)20 3134 9938

giuseppe.maraffino@barclays.com

Laurent Fransolet

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

Easing in the liquidity rules

ECB keeps policy rates on hold

FIGURE 1 Unsecured vs secured bonds yields: tightening trend

FIGURE 2 No further rate cuts expected in the market

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Countdown to the early payment of the first 3y LTRO

Barclays | Global Rates Weekly

10 January 2013 30

amount of the 3y liquidity repaid, along with the number of banks that repay their borrowing (but, as usual, not any specific names).

Since the beginning of the year, market sentiment has been quite positive as signalled by the EGB spreads tightening, the increase in capital flows and the rise in the banks’ medium-/long-term bond issuance (secured and unsecured). This should support our view of a larger reimbursement than generally expected in the market. Indeed, we still expect a total repayment of the two 3y LTROs of about €200bn in Q1/Q29 The easing in liquidity requirements likely will make some banks more willing to repay partially, or totally, the amount borrowed, although other kinds of considerations (related to deleveraging, conditions in the unsecured market, usage of collateral, etc) will probably play a more important role.

Our expectations by country The table in Figure 3 summarizes our estimate and show the breakdown by country The Italian banking system as a whole (including foreign banks that borrowed via Bank of Italy) borrowed a total of €255bn at the two 3y LTROs (94% of their end-of-December borrowing) of which €116bn was at the first 3y LTRO (23% of the total first 3y allotment) and €139bn at the second one (26% of the total second 3y allotment). We expect Italian banks to reimburse a total of €40bn. However, the uncertainty regarding the election outcome could see them refraining from beginning to repay the ECB’s 3y liquidity at the end of January. Note also that €30bn was borrowed by foreign banks to fund their assets in Italy. Therefore, we think it is unlikely that they will repay their borrowing, at least until some of the regulators’-driven market fragmentation is addressed (it is worth noting that the case of Unicredito being unable to repatriate liquidity to Italy by Bafin is being looked at a European level).

According to our estimates, the Spanish banking system borrowed €120bn at the first 3y LTRO (and €180bn at the second one). Since the end of March, Spanish banks’ usage of the deposit facility has been around €35bn – we believe some big banks likely borrowed for precautionary reasons. With the re-opening of the unsecured market, it is likely that part of the deposited liquidity could be repaid gradually in the coming weeks.

It is worth noting that for peripheral banks (especially those in Italy), the repo market has been working more normally since last September. Anecdotal evidence suggests that activity has increased, with small banks being able to fund themselves (using government bonds as collateral). GC rates have declined to about 5bp for short-dated maturities and to about 50bp (and even lower into the domestic market) for longer tenors (1 year). Additionally, deposits for both Italian and Spanish banks have increased. Should the momentum in the market remain positive, banks could decide to shift part of their borrowing from the ECB to the market.

After Italy and Spain, French banks have been the third-biggest borrowers at the first 3y LTRO with €105bn, according to our estimates. As highlighted in the table, their usage of the deposit facility has increased significantly since the beginning of last year. Also we note that over the last few days some French banks have issued FRNs with 2y maturities, which potentially could be used to replace the ECB liquidity maturing over the next two years.

Regarding German banks, we estimate their borrowing at the first 3y LTRO at about €39bn. So far, only Commerzbank has announced its intention to reimburse its borrowing at the first 3y LTRO (€10bn, this is the only such public announcement across Europe). We believe that if important banks repay their borrowing, other big banks (even in peripheral countries)

9 See the Euro Money Markets Weekly 15 October 2012 report “3y LTROs: moderate and gradual payback”.

The positive momentum in the financial market supports our view of an early repayment of €200bn in Q1-Q2

Italian banks likely to wait for outcome of general elections on February 24-25

Spanish banks likely to repay the amount that is used to redeposit at the ECB

Among big banks, any repayment could be viewed as a signal of liquidity strength

Barclays | Global Rates Weekly

10 January 2013 31

could follow, sending a message to the market of their ability to get funding in the market, rather than from the ECB.

The total amount to be repaid in the coming months is difficult to estimate, and the timing of such reimbursements is even more difficult, in our view: a lot will depend on the overall risk environment and the situation of the unsecured long-term money markets. With the Italian banks likely to wait until after the Italian elections, probably about €60bn of the first 3y LTRO (before the option to exit from the second 3y LTRO on 27 February) could come back to the ECB in February.

FIGURE 3 3y LTROs borrowing and early repayment by banking system: our expectations (€bn)

Germany 39 30 69 7% 263 25

Ireland 38 40 78 8% 5 0

France 105 60 165 16% 121 80

Spain 120 180 300 29% 35 30

Belgium 12 21 33 3% 28 15

Greece* 13 0 13 1% 0 0

Netherlands 7 5 12 1% 131 2

Italy 116 139 255 25% 12 40

Luxembourg 3 2 5 0% 54 0

Austria 8 6 14 1% 20 5

Portugal 25 25 50 5% 2 0

Finland 0 1 1 0% 55 1

Others/unallocated 6 20 26 3% 3

Total 3y liquidty 489 529 1,019 100% 201

Totol OMO borrowing 1,139% of 3y liquity over the total

89%

x memo

78 7%

15 1%

28 2%

% of the total 3y liquidty allotted

Usage of the depo facility (Jun12)

Expected Initial Repayment

MRO allotment, curr. amount and % of total OMO liquidty

STRO allotment, curr.amount and % of total OMO liquidty

Tot. 3m LTROs borrowing, curr. amount and % of total OMO

Dec 3y LTRO Feb 3y LTRO Total 3y liquidty

Note: as reference we use the level of the deposit facility in June, as from July, banks started to use more the current account at the NCB to deposit their liquidity. (Both the excess reserve and the deposit facility are not remunerated); *For the Greek banking system, the LTROs borrowing is almost zero as they shifted almost the entire amount on OMO borrowing into ELA in 2012. Probably they have shift bank part of the ELA borrowing into the MRO at the end of December following the ECB decision’s to make securities issued or guaranteed by the Greek government eligible again at the ECB’s refinancing operations.

Source: National Central Banks, ECB, Barclays Research

Market implications: muted effect on EONIA fixing, volatility on EONIA rates With the liquidity surplus currently slightly above €600bn (and likely to remain approximately at these level in the near future), we do not expect the early reimbursement (€200bn in total, of which €60bn in February) to have an impact on the liquidity conditions, and consequently on the EONIA. This is because the liquidity surplus should move down gradually towards €400/500bn, still a large amount of liquidity. In the past, the EONIA fixing became sensitive to liquidity conditions when the surplus moved down below €200bn.

In general, we expect the EONIA fixing to creep down in the coming reserve periods to levels closer to zero, as a consequence of technical factors related to the exit of some banks from the EONIA panel. In particular, the exit of Deka and Bayerische Landesbank has reduced

EONIA fixing should be not affected…

Barclays | Global Rates Weekly

10 January 2013 32

significantly the impact that small German banks (that traded at a higher rate than the market for overnight unsecured liquidity) had on reported volume and the EONIA fixing.

The effect of the early repayment should be more significant on the EONIA rates, especially on the medium-/long-term part of the curve, in the case of large and frequent repayments in the first few weeks. This would increase the liquidity premium on expectations that more banks could follow and repay. Such an effect would likely be more muted should the payment be very gradual and moderate (as we expect). Therefore, in February, after the beginning of the exit option, volatility is likely to affect the EONIA curve especially on the day of the announcements. The increase in the liquidity premium should favour also some widening of the FRA/EONIA spread, particularly in the forward space, with a consequent increase in the unsecured rates.

The early repayment should affect also the Target 2 imbalances10 via the reduction both in the credit position for central banks in core countries, like Germany (via a drop in deposit facility usage) and in the liability position for central banks in peripheral countries (via lower ECB borrowing). This should affect positively market sentiment as it would be likely read as a reduction in money market fragmentation.

Finally, on the repo market side, the repayment should make more collateral available in the market. According to ECB’s data in the first half of 2012, 18.6% of the total collateral pledged is made up of government bonds (regional and central)11. A large part of that is likely to be formed by peripheral bonds used by peripheral banks. It is difficult to evaluate the impact on the repo market as it depends on the frequency of the repayment, and also on the effective usage of the collateral in the repo market (banks could leave it in the collateral pool, ie, posted but not pledged at the central bank’s operation or banks could exit from the ECB’s 3y LTROs when bills or bonds with initial maturity below 3y mature). In general, we do not expect a massive impact on the repo market for peripheral countries, with a moderate and gradual cheapening of the value of collateral.

10 The Target 2 imbalances reflect the credit/debt positions of each central bank vs. the eurosystem related to liquidity flows among central banks. As there is no settlement the positions can build up without any limit. The imbalances are related to several factors: OMO borrowing; current account payment; and the usage of banknotes in excess of the amount implied by the ECB capital key allocation. 11 See Instant Insight, 2 October 2012, “ECB collateral in H1 12: Non-marketable assets, government and covered and uncovered bank bonds all up sharply”

…while EONIA rates should become more sensitive to the expectations on repayment

The consequent reduction in the Target 2 imbalances should support the sentiment

Limited effect on the repo market

Barclays | Global Rates Weekly

10 January 2013 33

EUROPE: SOVEREIGN SPREADS

Euro area 2013 supply Following the release this week of final official bond issuance forecasts for Spain, we now expect gross bond issuance in the euro area to fall by c.€36bn in 2013; we forecast total gross issuance of €826bn vs an estimated €862bn for 2012.

We expect net bond issuance to fall by a lower amount to around €235bn from the net €246bn issued in 2012. These forecasts assume no return to bond markets for Greece; however, Portugal and Ireland, according to official programmes, will return to the market with €6.6bn and €10bn of bond supply, respectively, indeed Ireland has already successfully tapped markets with a €2.5bn syndicated reopening of a 5y bond in early January and further syndicated supply followed by a return to scheduled issuance seems likely for Ireland going forward. Bill issuance looks set to edge up in 2013, with Spain in particular looking to increase bills outstandings by €12bn. Germany will keep Bubill auctions in line with 2012’s level. Portugal and Ireland should continue to roll T-bills, while Greece has abandoned the target of reducing T-bills as originally outlined in the second Greek programme.

In terms of individual issuers, France and Italy (BTPs, CCTs and CTZs) should both see around €190bn of gross bond supply, respectively, although the French target will actually be €169bn net of buybacks. Germany has announced an official bond funding need of €173bn – however a move to regular monthly linker auctions means linker supply may increases y/y to about €12bn, and thus we expect that country to issue c.€185bn of bonds, roughly the same amount as in 2012. The Netherlands has announced gross bond sales of €50bn vs. €65bn seen in 2012. Spain has announced a target of around €121bn, partly as a result of a €23bn regional funding requirement.

Belgium has a total funding requirement of c.€39.99bn, translating into OLO issuance of c.€37bn and negative bill issuance of €2bn, with MTN and retail issuance making up the balance. Austria has announced a bond supply target of c.€20-24bn in 2013. Finland has announced a net funding need of €7bn, which would translate into roughly flat bond funding needs of €13bn in 2013, assuming no increase in T-bills.

FIGURE 1 Estimated 2013 euro area government cash flows versus 2012 by country

Medium and Long-Term Funding

€ bn Gross

Issuance (Δ vs. 2012e) Redemptions (Δ vs. 2012e) Net

Issuance (Δ vs. 2012e)

Planned change in

bills issuance

Total net Issuance (bonds

and bills)

Germany 185.0 2.0 157.0 -2.8 28.0 4.8 0.0 28.0 France (inc buybacks) 190.0 -12.1 106.9 8.0 83.1 -23.4 -0.7 82.4 Italy 190.0 -42.0 157.8 -42.0 32.2 -20.6 -4.0 28.2 Spain 121.0 23.4 61.7 11.8 59.3 12.4 12.0 71.3 Belgium 37.0 -7.4 30.2 4.2 6.8 -11.7 -2.0 4.8 NL 50.0 -15.2 31.5 1.9 18.5 -5.0 -4.0 14.5 Portugal 7.0 7.0 5.9 -6.9 1.1 2.0 0.0 1.1 Finland 13.0 0.2 6.7 -0.2 6.3 -2.0 0.0 6.3 Austria 23.0 2.0 15.6 0.2 7.4 -0.7 0.0 7.4 Greece 0.0 0.0 12.3 0.4 -12.3 16.7 0.0 -12.3 Ireland 10.0 5.8 5.6 0.1 4.4 8.8 2.0 6.4 Total Euro 826.0 -36.3 591.3 -25.2 234.7 -18.8 3.3 238.0 Note: France is forecast gross issuance; net of buybacks the French target is officially €172bn. Source: Barclays Research

Huw Worthington +44 (0)20 7773 1307 huw.worthington@barclays.com

Cagdas Aksu +44 (0)20 7773 5788

cagdas.aksu@barclays.com

We expect gross bond issuance by country in the euro area to decrease by about €36bn in 2013, with gross issuance forecast at €826bn

Spain has a €121bn funding need while Belgium has a total funding requirement of c.€39.99bn, with €37bn in bonds

Barclays | Global Rates Weekly

10 January 2013 34

T-bills supply outlook: big rise in Letras

We expect total outstanding eurozone T-bills to amount to about €560bn at end-2012, approximately the same level as at the end of 2011. We expect a c.€3bn increase in the outstanding amount next year to €563bn mainly because of the rise in Spain’s issuance, being almost partially offset by flat or marginally negative net supply from other European countries.

Spain’s total net funding requirement in 2013 will be €71bn, including regional needs, and will be partially covered by an increase in Letras net supply of approximately €12bn. The Letras outstanding in 2013 should be €103bn, which would correspond to c.15% of the total marketable Spanish debt, up from 14.2% in 2012.

Italy should close 2012 with an increase in its net supply of BOT of about €20bn, which would bring the amount outstanding to about €152bn (9.2% of total marketable Italian debt vs. 8.3% in 2011). In 2013, we expect the Italian Treasury to reduce its gross issuance of T-bills because of the lower amount of bond redemptions. We forecast gross BOT issuance at around €220bn (from an expected €240bn in 2012), which would correspond to a negative net supply of about €4bn.

For the other peripheral countries, Portugal will close 2012 with T-bills outstanding of €17.3bn. After the €5.3bn increase in total outstanding this year, in 2013 we would expect Portugal to target a flat net supply of T-bills. Ireland resumed its T-bills issuance in 2012 and we expect it to continue next year, with the issuance of the 3m line likely to be more regular. In Greece, the current outstanding amount of T-bills is €15.8bn. We expect stable volumes next year, unless cash needs lead the Greek Treasury to use T-bills again as a source of funding.

For core countries, a stabilization or reduction of their T-bills outstanding is likely, in order to increase the average maturity of the debt. Germany is likely to keep gross issuance approximately in line year-on-year. The Netherlands has already reduced its T-bills outstanding in 2012 (by about €13bn) and will keep reducing next year in order to bring volume to the 2007 level (€17bn). For France the Treasury predicts that net supply will be marginally negative in 2013, after the €10bn drop expected in 2012. In Belgium, the net supply was almost flat in 2012. For 2013, we expect net supply of -€2bn.

FIGURE 2 Evolution of T-bill issuance by country and our tentative expectations for 2012 and 2013 (€ bn)

IT SP FR DE HO BE PO IR

volume % tot

mkt debt volume

% tot mkt debt

volume % tot

mkt debt volume

% tot mkt debt

volume % tot

mkt debt volume

% tot mkt debt

volume % tot

mkt debt volume

% tot mkt debt

2006 123 9.8% 31 10.6% 66 7.5% 36 3.8% 14 6.6% 27 9.7% 9 8.5% 21 58.5%

2007 128 10.0% 32 11.0% 78 8.5% 36 3.8% 17 8.0% 30 10.7% 9 8.0% 21.45 57.1%

2008 145 10.7% 52 15.1% 138 13.6% 39 4.0% 70 24.1% 42 13.6% 13 10.9% 22 43.7%

2009 140 9.7% 86 18.5% 214 18.6% 104 9.9% 52 18.4% 40 12.5% 17 13.2% 16 21.3%

2010 130 8.5% 90 17.0% 187 15.2% 85 7.7% 48 15.7% 40 11.8% 19 12.7% 6.1 5.6%

2011 132 8.3% 91 15.6% 178 13.6% 61 5.7% 34 10.6% 35 9.6% 12 9.2% 4.6 4.8%

2012 152 9.2% 91 14.2% 170 12.2% 56 5.1% 21 6.3% 35 9.7% 19 14.9% 1 1.1%

2013 148 8.8% 103 15.0% 171 12.3% 56 5.1% 11 3.3% 33 9.2% 22 18.3% 3 3.3%

Note: In the table we only consider countries that have a liquid and traded t-bill market. 2012 and 2013 figures are Barclays expectations Source: National Treasuries, Barclays Research

2013 EUR IG supply outlook

We expect gross, unsecured, investment grade issuance to accelerate to €480bn in 2013, from c.€445bn in FY 2012. Our forecast is that €230bn of this will come from non-financial credits, representing a continued growth of the market and an ongoing loan-to-bond

We expect about a €3bn increase in the eurozone t-bill outstanding in 2013 to c.€570bn In 2013, Spain is expected to increase Letras net issuance by €12bn, while Italy should reduce the BOT net issuance by c.€4bn For other peripheral countries, net issuance should be flat or marginally negative

Core issuers are likely to reduce their T-bills issuance

Barclays | Global Rates Weekly

10 January 2013 35

transition for European borrowers. This implies a fourth year of negative net issuance, again driven by large redemptions for financials. We see risks as balanced; with upside risks in more positive scenarios offset by the potential for Spanish (or Italian) “national champions” to migrate to high yield.

FIGURE 3 Barclays unsecured, euro corporate issuance estimates

2013 2012 FY

Gross Redemptions Net Gross Net

EUR Fin 250.0 371.4 -121.4 245.3 -201.9

Non-Fin 230.0 139.1 90.9 199.4 92.3

Note: 2012 issuance as of 30 November. Source: Dealogic, Barclays Research

In the corporate space, issuance has got off to a decent start. Our credit team estimates that corporates (both financial and non-financial) have brought €24bn of debt to market already this year. This pace of issuance is similar to that seen last year, as is the breakdown between financial and non-financial supply. Our credit colleagues expect the flow of deals to continue through at least the first half of February, provided that volatility does not rise sharply. For context, they estimate that a combined €101bn of unsecured issuance was brought to market in January and February 2012.

Next week’s cash flows Germany auctions a new 10y bund on Wednesday for 5bn. On Thursday Spain is scheduled to auction bonds, while France will issue 2-5y BTAN’s alongside regular linker taps auctions. Support for the market will be substantial, with France returning €17.9bn of redemptions and €2bn of coupons, while the Netherlands returns €15.5bn and €3.9bn, on the same basis on the week.

FIGURE 4 Barclays Research cash flow expectations for week beginning 14 January

Beginning Auction Date Issuance Redemptions Coupons Net Cash Flow31-Dec 10.41 Germany 5.00 0.00 0.00 5.00

Weekly 07-Jan 19.44 France 10.00 17.87 1.98 -9.84

Net 14-Jan -21.06 Italy 0.00 0.00 0.36 -0.36

Cash flow 21-Jan 16.68 Spain 4.50 0.00 0.00 4.50

28-Jan -31.72 Belgium 0.00 0.00 0.00 0.00

Greece 0.00 0.00 0.00 0.00

Finland 0.00 0.00 0.02 -0.02

Ireland 0.00 0.00 0.30 -0.30

Holland 0.00 15.54 3.90 -19.44

Austria 0.00 0.00 0.58 -0.58

Total issuance 19.50 Portugal 0.00 0.00 0.00 0.00

Total redemptions 33.41 Total 19.50 33.41 7.149 -21.06Total coupons 7.15

Net cash flow -21.06

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

Source: Barclays Research

Barclays | Global Rates Weekly

10 January 2013 36

UNITED KINGDOM: RATES STRATEGY

The year of living dangerously? Despite the recent rally, there is a growing perception of negative risks to current gilt valuations. We express the need for higher risk premium via Gilt 5/30s steepeners.

The first week of the New Year has seen gilts participate in an early sell-off for major fixed income markets as the eleventh-hour resolution of the fiscal cliff in the US triggered a strong “risk-on” move in asset markets. High frequency data have been mixed, with the December Services PMI survey notably weak. Anecdotal evidence from retailers suggests that trading conditions have been difficult over the holiday period; and there have been concerns over a further rise in inflation in 2013. All this contributes to an uncomfortable backdrop for gilts and makes the corrective rally we have seen look optimistic. Figure 1 shows that the GDP- weighted composite PMI has trended lower, while the forward indicators from the individual series have also weakened. Peripheral Europe has tightened back to Bunds after the ECB’s OMT announcements. This, combined with the cessation of QE has coincided with gilts losing their lustre across markets and underperforming bunds (Figure 2).

The decision by National Statistics to make no changes to the calculation of the Retail Price Index was a surprise to the market, although it was widely supported by those who had responded to the consultation exercise. While the limitations of the RPI measure have been acknowledged, by remaining in its current form, the integrity of the market has largely been preserved. Nonetheless to undertake the whole process of consultation and build expectations of change to then decide to do nothing, gives the impression of unstructured policy-making.

Taking a step back, this backdrop has coincided with a series of government announcements, which have resulted in the market being vulnerable to incrementally growing negative sentiment. First, the government’s decision to consolidate the accrued cash from the Bank of England’s Asset Purchase Facility back into central government. However much this is explained as efficient cash management and mirroring best international practice, it was portrayed as a piece of “sharp” fiscal practice which had the serendipitous effect of flattering the public finances and reducing gilt issuance. In the

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

Investor sentiment towards the gilt market may turn more negative in 2013

UK data have been mixed with weak news from the high street and the continued weakening trend in the PMIs

RPI will remain in its current form but the consultation process reflects poorly on the authorities

FIGURE 1 PMIs continue to look soft and the forward indicators weak

FIGURE 2 Gilt /Bund has widened as peripheral Europe has tightened

30

40

50

60

70

80

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

UK PMI: Manufacturing New Orders (3m MA)UK PMI: Services Business Expectations (3m MA)UK PMI Construction Business Expectations (3m MA)GDP weighted composite PMI (3m MA)

0

20

40

60

80

100

120

0

100

200

300

400

500

600

700

Jan-10 Jul-10 Dec-10 Jul-11 Dec-11 Jun-12 Dec-12

10yr Spain/Germany

10yr Gilt/Bund (RHS)

Source: Haver Analytics, Barclays Research Source: Barclays Research

Recent policy decisions have begun to tarnish the government’s reputation in the market

Barclays | Global Rates Weekly

10 January 2013 37

aftermath of a set of fiscal forecasts that saw the government extend the period of austerity, the second major factor to assess is the increase in sovereign ratings risk. All three major rating agencies now have the UK’s AAA rating on negative outlook, S&P moved to a negative outlook in December, joining Moody’s and Fitch which had moved to a negative outlook in Q1 12. Fitch said that it had accelerated the timeline for its assessment from mid-2014 to after Budget 2013. Previously, we believed that a sovereign downgrade would be of more political rather than economic importance. However, to draw an analogy from Claude Levi-Strauss and his theory of ‘totemism’, for all the criticism directed at ratings and rating agencies, “ratings are good to think with”, so their symbolic importance should not be underestimated. The move towards a loss in the AAA rating which seems likely currently, is just another factor that might play on the mind of international investors questioning the overall credibility of the UK’s policy framework.

Another factor that may leave gilts more vulnerable this year is the decision to loosen the Basel III capital requirements and delay their full implementation until 2019. Over the past few years, UK MFIs built up their holdings of gilts and had also been structural supporters of the asset swap market. However, recently, gilt holdings have fallen coinciding with some curve flattening (Figure 3). While the new Basel III standard is an easing compared with the original proposal, it may not trigger acceleration in the selling of gilts from MFIs. Despite their current cheapness vs OIS rates, gilt asset swaps may come under further pressure in the event of a downgrade and ongoing fiscal weakness, so buyers may wait for better levels before any resumption of gilt buying by structural investors.

The longer end of the curve, which has come through the CPAC decision, must now face upcoming supply via syndication of the 2044 gilt as well the uncertainty over the DWP’s consultation on pension liability discount rates. With Governor-designate Carney taking over the BoE in July, he may be more open to more radical or unorthodox approaches to monetary policy – for example, his recent speech floating the idea of nominal GDP targeting. His appearance in front of the Treasury Select Committee on 7 February, where he will ostensibly be discussing QE, will be closely watched. In summary, the uncertainty of the backdrop should be reflected in a higher risk premium across the curve. We would express this via the Gilt 5/30s steepener which, as Figure 4 highlights, already looks too flat given the level of the market.

The loosening of the Basel III capital standards also may weaken new flow into gilts from liquidity buffers

The APF cash transfer flattered the public finances and a loss of the AAA rating seems probable, which may unnerve international investors

FIGURE 3 UK MFIs have been reducing gilt holdings (£mn)

FIGURE 4 Gilt 5/30s vs Gilt 5y - too flat versus the market

-50

0

50

100

150

200

250

300

-40,000

-20,000

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Total bank and building society holdings of gilts and billsGilt 2/10s

y = -37.04x + 269.85R² = 0.7919

100

120

140

160

180

200

220

240

260

280

0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50

Gilt 5/30s

Gilt 5y

Source: Bank of England, Haver Analytics, Barclays research Source: Barclays research

With supply and the DWP consultation exercise and a new Governor at the BoE, gilt 5/30s should be steeper

Barclays | Global Rates Weekly

10 January 2013 38

COVERED BONDS AND SUPRANATIONAL, SUB-SOVEREIGN & AGENCIES

In the sweet spot - SSA bonds (This is an extract from The AAA Investor, 10 January 2013)

We examine the implications of the revised Liquidity Coverage Ratio (LCR) rules for SSA and covered bond markets. We do not expect any material short-term impact but some bank treasury portfolio managers may move away from covered bonds to SSA paper.

One of the changes in the LCR framework, which could have an important medium-term impact on banks’ demand for AAA paper, is that the scope of unencumbered high-quality liquid assets (HQLA) has been enhanced to include at least AA-rated RMBS notes and A+ to BBB- rated non-financial corporate bonds.

The outstanding amounts of the various types of fixed income securities from European issuers available under the revised HQLA guidelines suggest that banks may have more room to diversify their liquidity portfolios. Compared with the initial proposal, the guideline enhancements add EUR664bn of available fixed income securities to the HQLA portfolio, using pre-haircut YE 12 figures.

FIGURE 1 HQLA fixed income securities from European issuers (YE 12, pre-haircut)

4,205

1,098

572

96 38

568

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

Govt. Bonds (IG)

Govt. related excl. GGBs (IG)

Covered (AAA - AA-)

RMBS (AAA / AA)

Non-fin. corp. (AAA - AA-)

Non-fin. corp. (A+ - BBB-)

EUR bn

Source: Barclays Research

For our calculations, we have mainly used benchmark bonds included in the Barclays Euro Aggregate Index. On the SSA side, we have excluded government guaranteed bonds issued by financials, as these would not qualify for the liquid asset portfolio unless they are issued by a “public sector entity” (PSE). We have made no further adjustments for ratings here, as the eligibility of SSAs is tied to the risk weighting rather than ratings. On the covered bond and corporate bond side, we have included only bonds which fulfil the respective rating criteria. For RMBS we have taken the number of outstanding UK RMBS notes fulfilling the rating criteria, as currently these would be the only European RMBS instruments fulfilling the respective criteria12.

12 For further reading please have a look at “European ABS: Finally some positive news from regulators for ABS investors”

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

Michaela Seimen +44 (0) 20 3134 0134

michaela.seimen@barclays.com Jussi Harju, CFA

+49 69 7161 1781 jussi.harju@barclays.com

Barclays | Global Rates Weekly

10 January 2013 39

We doubt that banks will make large use of the enhanced opportunities to diversify HQLA assets away from central bank deposits, government and SSA bond holdings. First, it is important to note that high haircuts apply to the newly included assets types. When taking into account the haircuts, we calculate that the value of the overall bond portfolio shrinks from EUR 6.6trn to EUR 6.1trn and the enhancement effect from the revised HQLA criteria shrinks from EUR664bn to EUR356bn. Furthermore, the higher capital charges and also the high haircuts that are applicable when using such assets for central bank repo operations may further limit the appetite to diversify HQLA portfolios towards RMBS and corporate bonds. Finally, spread volatility has been more pronounced on the corporate bond side compared with covered bond and agency paper, for example.

We also believe that the quality criteria will ensure that the focus of many bank treasury portfolio managers will firmly remain on all non private sector debt securities. The LCR rules allow for unlimited use of sovereign debt irrespective of any rating, as non-0% risk-weighted assets (assets rated below AA- according to article 53 of the Basel II regime) may

We do not expect banks to make substantial changes to their liquidity portfolios following the changes

FIGURE 2 Composition of HQLA portfolio pre haircut (EUR 6.6trn)

FIGURE 3 Composition of HQLA portfolio post haircut (EUR 6.1trn)

Govt. Bonds (IG)

63.9%Govt.

related excl. GGBs (IG)

16.7%

Covered (AAA - AA-)

8.7%

RMBS (AAA / AA)1.5%

Non-fin. corp. (AAA

- AA-)0.6%

Non-fin. corp. (A+ -

BBB-)8.6%

Govt. Bonds (IG)

68.7%

Govt. related excl. GGBs (IG)

17.0%

Covered (AAA - AA-)

7.9%

RMBS (AAA / AA)1.2%

Non-fin. corp. (AAA

- AA-)0.5%

Non-fin. corp. (A+ -

BBB-)4.6%

Source: Barclays Research Source: Barclays Research

FIGURE 4 Max swap spread change over 5 weeks (Weekly: Jan 2002 - Jan 2013)

FIGURE 5 Average swap spread change over 5 weeks (Weekly: Jan 2002 - Jan 2013)

0

20

40

60

80

100

120

140

160

180

3-5Y 5-7Y 7-10Y

(bp)

Covered (IG) Corporate (IG)

0

2

4

6

8

10

12

14

3-5Y 5-7Y 7-10Y

(bp)

Covered (IG) Corporate (IG) Source: Barclays Research Source: Barclays Research

Bank treasuries are likely to continue focusing on non private sector debt

Barclays | Global Rates Weekly

10 January 2013 40

also be used as Level 1 assets. The use of agency debt remains indirectly subject to a rating restriction, as the above exception only applies to sovereign or central bank debt. However, the treatment of agency debt is tied to the risk weighting and thus leaves more room for discretion to supervisory authorities compared with private sector debt, including covered bonds. The treatment of all qualifying private sector debt is directly subject to rating limits. This creates a disincentive for any substantial use of such assets. Banks’ liquidity managers may not wish to find themselves exposed to the risk of a substantial shortfall in the LCR just because of a rating downgrade.

While European authorities introduced some enhanced quality criteria under the CRD IV rules, the final Basel III text seems to leave no room for discretion. Also, under the CRD IV text, some covered bonds may have potentially qualified for a Level 1 treatment. This is now off the table, as in jurisdictions with insufficient availability of Level 1 assets, Basel III rules under the so-called ‘option three’ only allow for an enhancement of Level 2 assets beyond the 40% limit, but not for private sector debt to qualify directly for Level 1.

Overall we would expect the revised Basel III rules to bring SSA debt further into the ‘sweet spot’. Due to the limited supply of covered bond debt, spread differentials have become minimal in recent weeks. Persistently strong SSA issuance combined with the relatively more relaxed quality criteria under the revised Basel III regime provide sufficient incentives for bank treasury managers to favour SSA debt over covered bonds. This is particularly true in the 2-5y segment, the typical maturity bucket for HQLA holdings.

The revised Basel III LCR rules – a brief overview13 On Monday, the Basel Committee on Banking Supervision published the full document with revised Liquidity Coverage Ratio (LCR) rules. It can be found under the following link:

http://www.bis.org/publ/bcbs238.pdf.

The most important changes (vs. the initial proposal from December 2010) include: the introduction of a phase-in of the LCR between 2015 and 2019; rules for the use of liquid assets in periods of stress; and the introduction of a Level 2B bucket within the portfolio of unencumbered high-quality liquid assets (HQLA). The latter effectively enhances the initial Level 2 bucket by including, double-A rated RMBS notes, single-A to triple-B rated corporate bonds and blue-chip non-bank common equity shares; Figure 6 gives a summary of the stock of HQLAs.

13 For a detailed overview, in particular with regards to money market and monetary policy implications, please see Euro Money Markets Weekly: A ‘wait-and-see’ ECB’

SSA debt likely to be the main beneficiary of the changes

Barclays | Global Rates Weekly

10 January 2013 41

FIGURE 6 Overview on the basic structure of eligible HQLAs

Bucket Factor (to be multiplied by the total amount)

Level 1 assets (no limit)

• Coins and bank notes

• Qualifying marketable securities from sovereigns, central banks, PSEs, and multilateral development banks

• Qualifying central bank reserves

• Domestic sovereign or central bank debt for non-0% risk-weighted sovereigns

100%

Level 2 assets (maximum 40% of HQLA)

Level 2A assets

• Sovereign, central bank, multilateral development banks, and PSE assets qualifying for 20% risk weighting

• Qualifying corporate debt securities rated AA- or higher

• Qualifying covered bonds rated AA- or higher

85%*

Level 2B assets (maximum 15% of HQLA)

• Qualifying RMBS rated at least AA

• Qualifying corporate debt securities rated between A+ and BBB-

• Qualifying common equity shares

75% 50% 50%

*Note: 80% will apply for those assets exceeding the 40% limit under the so-called ‘option 3’, which applies in case of insufficient availability of Level 1 assets. Source: Basel Committee, Barclays Research

Importantly, the Basel Committee’s revised LCR document introduces some criteria and principles in the event the authorities of a currency regime wish to deviate from the general rules. In particular, in cases where the medium-term (3-5 years) supply and the availability of a certain type of HQLA has been assessed as insufficient, a deviation from the above-mentioned general rules is possible. In order to illustrate such insufficiency, authorities must provide relevant information on the supply of HQLAs, the primary and secondary market for HQLAs and the demand for HQLAs by banks and other investors. Importantly, in the case of a monetary union, the common currency is considered the domestic currency, which means that the relevant assets available over the whole currency area are considered as being available for all jurisdictions in this union.

In the UK, authorities highlighted that EU legislation will always follow the Basel III timetable. Now, as the final LCR regime has been posted, authorities might consider amending some of the existing rules and eventually enhancing the spectrum of assets qualifying for the liquid assets buffer by allowing the inclusion of Level 2A and 2B debt. Over the medium term, as long as the UK continues to participate in the CRD IV process, the UK will be subject to the EU’s single rule book and the technical standards provided and controlled by the European Banking Authority (EBA).

On a more technical note, we also find it surprising that the Basel Committee did not recognise that some covered bond jurisdictions, like France and Germany for example, already stipulate rules for the coverage of liquidity risk. In these cases, covered bond issuers need to include maturing covered bonds in the outflow calculation, but they are not allowed to count the encumbered substitute assets within their HQLAs, although by law these must be held to protect against liquidity risk. Thus, under the revised Basel Committee rules, covered bond issuers will be obliged to cover the same outflow twice.

Barclays | Global Rates Weekly

10 January 2013 42

SCANDINAVIA: RATES STRATEGY

Economy approaching the trough? We hold on to small short-end SEK/EUR cross market tighteners for now, although we also maintain our base case of unchanged policy rates. Furthermore, given the recovery in leading indicators, we see value in entering SGB 2s5s10s spread wideners.

Heading into 2013, we warned against underestimating the cyclical headwinds facing the Swedish economy (Cyclical headwinds likely to remain at the fore, Global Rates Outlook 6 December 2012). Indeed, the recently released November production data, in our view, supports expectations of a consecutive decline in GDP during Q4 12 and highlights risks to the Riksbank’s (RB) forecast (Barclays preliminary estimate -0.8% q/q; RB -0.2% q/q). The weak new orders data also suggest that the Swedish economy is flirting with the possibility of a shallow technical recession during Q4 12-Q1 ’13. That said, going into 2013 we also stressed, in particular, that the Swedish tradable sector, heavily concentrated in the investment and durable goods sectors, would benefit greatly from any meaningful reduction in global uncertainty.

While our monthly leading turning point indicator for Sweden’s main European trading partners (TPI), excluding Norway, remains at a disheartening level, it has improved during the past two months, suggesting that our monthly business-cycle indicator (BCI) will start to improve during the beginning of ’13 (Figure 1). Given the composition of Swedish exports, we also find it encouraging that various measures of capital goods orders started to recover in recent months. Furthermore, the general improvement in financial conditions suggests additional room for progress, in our view, although fiscal headwinds remain significant and the risk for setbacks can’t be disregarded.

Although we still believe it’s too early to sound the ‘all clear’ on the magnitude of the eventual cyclical lows in Sweden, recent domestic indicators also support the view that the trough in activity will be reached during the winter months. Indeed, recent survey data have if anything strengthened us in our view that GDP-growth troughed already in Q4 12. Going forward, we also see further room for Swedish survey data, like the manufacturing PMI, to continue to improve, not least given reported lean inventory levels in the manufacturing sector, Figure 2.

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

Our turning point indicator for Sweden’s main European trading partners has started to recover.

Swedish growth likely troughed already in Q4 ‘12

FIGURE 1 Turning point indicator for Sweden’s trading partners

FIGURE 2 Manufacturing PMI and order/stock level

-5

-4

-3

-2

-1

0

1

2

3

4

Jan-91 Nov-93 Sep-96 Jul-99 May-02 Mar-05 Jan-08 Nov-10

1 Stdev TPI BCI

0.50.60.70.80.911.11.21.31.41.51.61.7

25

35

45

55

65

75

85

Nov-94 Dec-97 Jan-01 Feb-04 Mar-07 Apr-10

PMI Order/Stock, lagged 3mth (RHS)

Source: Reuters EcoWin, Barclays Research Source: Reuters EcoWin, Barclays Research

Barclays | Global Rates Weekly

10 January 2013 43

Earlier this week, the RB released the minutes from its 17 December policy meeting, when the Executive Board decided to cut policy rates by 25bp to 1.0% (for more details please see Sweden: Riksbank cuts rates by 25bp to 1.0% and signals some potential for further cuts, 18 December 2012). While the decision was supported by the ruling majority of the Board (Ingves, af Jochnick, Jansson and Wickman-Parak) the minutes surprisingly reveal that two of the members (Jansson and Wickman-Parak) contemplated a 50bp cut to 0.75%. We hold on to our base-case call that policy rates will be left unchanged at 1.0% during H1 13 for now, as we expect data to continue to improve. However it is not surprising, in our view, that this revelation, taken together with the views of the more dovish minority of the Board (Ekholm and Svensson), nourished market expectations of another 25bp cut at the 13 February meeting.

Although RB rhetoric and near-term risk to lagging hard data continue to suggest value in holding SEK/EUR 1y6mth fwd spread tighteners for now, we would look to take profit on the back of any further performance from here. Indeed, given our base case of a continued gradual economic recovery, we look to enter more bearish front-end strategies in the coming weeks, notwithstanding the possibility of further RB cuts. In our view, it is noteworthy that the majority of the RB Executive Board continues to express concerns that a ‘too low policy rate for too long’ might nourish potential medium-term systemic risks, suggesting that a gradual normalisation of policy rates might come sooner rather than later in a continued recovery scenario.

Interestingly, our fair value calculations using domestic money market investors’ repo rate expectations, as measured by the December Prospera survey, suggest the short end is discounting a rather substantial negative term premium amounting to c.15bp in 1y1y fwd swap rates. However, rather than entering front-end steepeners, we see better value in starting to enter 2s5s10s SGB outright spread wideners, which lagged recent steepening front/reds.

We also continue to see value in holding 5y SGB ASW tighteners versus Bobl, not least considering the relatively high cyclical sensitivity of Swedish public finances. While Swedish fiscal metrics will likely remain favourable compared with most developed countries, the risks that Swedish public finances are entering a period of relative underperformance versus Germany is also, in our view, compounded by FM Borg’s statement that there is scope to introduce more short-term demand-enhancing measures. In this context, it is also notable, in our view, that available statistics suggest that foreign ownership of SGBs, after having increased substantially in the past years, have stabilised in recent months.

Riksbank minutes nourished market expectations of further rate cuts.

Hence we hold on to our SEK/EUR 1y6mth fwd tighteners for now

Look to enter SGB 2s5s10s spread wideners

Hold 5y ASW tighteners versus Bobl

Barclays | Global Rates Weekly

10 January 2013 44

INFLATION-LINKED MARKETS: EURO AREA

The supply spectre We are tactically bearish on €i breakevens ahead of the resumption of issuance in January. Given real yield levels, the upcoming supply is unlikely to be taken down without some cheapening beforehand.

European breakevens have widened since the start of the new year, with inflation swaps also rallying. The widening in core breakevens has been helped by the nominal sell-off, while the BTP€i rally above that of nominal BTPs seems to have been driven by continued interest in asset swap. In the near term, focus turns to the resumption of supply, with auctions likely from all three issuers by the end of January now that Germany has stated its plan to issue on a monthly basis. At current valuations, we believe that supply is unlikely to be taken down easily without some cheapening correction. As a result, we are tactically bearish breakevens over the coming weeks.

European breakevens do not strike us as being rich but are not enticing value either. However, real yield levels are low enough, in our view, to limit real money demand as the primary market kicks off. In particular, it appears most likely that Germany will conduct issuance on the 22nd this month, which implies that the market would need to take down auctions three weeks in a row. Furthermore, supply into a new year in the past tended to coincide with fresh allocations into the asset class but, as we argued in the Global Rates Outlook 2013, 6 December 2012, there is much less scope for such allocations this year into European linkers given their volatility over 2012. Core linkers have also eroded most of the discount they held versus inflation swaps such that those looking to position for higher inflation expectations may be driven to express such views via swaps instead. We note also that the equity market has had an almost uninterrupted bullish ride since mid-November and any near-term correction will also potentially weigh on breakevens, especially as supply needs to be absorbed.

The tone in BTP€is has remained firm recently amid ongoing buying interest, in asset swap mainly. However, we now see little value in BTP€is, even though they still offer a discount versus core issues. Except for the longest bonds, absolute and relative BTP€i asset swaps have richened back towards August 2011’s levels, ie, before the relative cheapening

Khrishnamoorthy Sooben +44 (0)20 7773 7514 khrishnamoorthy.sooben@

barclays.com

FIGURE 1 €i breakevens not expensive but vulnerable...

FIGURE 2 ...ahead of supply given rich real yields

1.2

1.5

1.8

2.1

2.4

Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13

Bund€i20 BEI

OAT€i22 BEI

Bund€i23 BEI

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13

Bund€i20 RY

OAT€i22 RY

Bund€i23 RY

Source: Barclays Research Source: Barclays Research

Limited scope for new year allocations in 2013

BTP€is at unattractive levels

Barclays | Global Rates Weekly

10 January 2013 45

triggered by the ECB conducting purchases in nominal BTPs. We would not expect asset swap interest for BTP€is to extend much more as valuations versus nominals tighten further, so January’s supply could be challenging to some extent. Furthermore, BTP€i real yields are at or close to their richest levels and with breakeven and real yield spreads versus core having tightened considerably, broader real money interest is likely to be limited too. We note that while there is potential for an Italian buyback in the near future, it is far from certain that it will include BTP€is given their recent strong performance.

We see most value in a tactical short breakeven position in 10y bonds as we expect most of this month’s supply to be in that sector. We see value in shorting both the OAT€i22 and Bund€i23. From a pure valuation standpoint, shorting the OAT€i22 appears most attractive but it is likely that the bond will not be reopened this month. On the other hand, we see a high probability for the Bund€i23 to be tapped and, therefore, from a supply-perspective, shorting the 10y German benchmark in breakeven is more appealing. Longer on the curve, we continue to see little value in the 30y sector OAT€is. The very long end has cheapened this year but we see scope for more cheapening. Unless real yields there move towards 1%, we expect demand to remain subdued. We therefore recommend to stay underweight the OAT€i32 and OAT€i40.

FIGURE 3 BTP€i absolute and relative ASWs back to Aug 2011’s levels

FIGURE 4 BTP€i real yields at unattractive levels

-100

0

100

200

300

400

500

600

700

Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12

BTP€i21 z-spread ASW

BTP€i21 relative z-spread ASW

0

1

2

3

4

5

6

7

8

May-10 Nov-10 May-11 Nov-11 May-12 Nov-12

BTP€i21 RY

BTP€i21 minus OAT€i22 RY

Source: Barclays Research Source: Barclays Research

Barclays | Global Rates Weekly

10 January 2013 46

INFLATION-LINKED MARKETS: UNITED KINGDOM

Better the devil you know

The National Statistician proposed no change to RPI aggregation, contrary to our and market expectations. Despite a sharp breakeven rally, we see further upside for shorter-dated breakevens while the IL29 auction in the coming week should be easily absorbed.

After almost a year of uncertainty and diminished liquidity in UK inflation-linked markets, clarity on RPI has finally emerged. The decision by the National Statistician not to alter RPI was unexpected by markets, as was the intention to produce a new Jevons-based RPI index, the RPIJ. The market significance of RPIJ is minimal given the confirmation by the Treasury that existing and new index-linked gilt issuance will continue to reference the existing RPI. The ONS has also announced that it does not intend to alter the RPI aggregation formulae at a future date, which is a significant relief for holders of RPI-linked products, particularly corporate RPI-linked bonds where fundamental changes to the index have potential legal implications. Gilt linker real yields, breakevens and RPI swaps all repriced sharply richer following the National Statistician’s announcement at 7am on Thursday, broadly consistent with our expectations of the market reaction on this outcome as outlined in the previous edition of this publication. The decision not to change the RPI aggregation formula is likely to be welcomed by investors, several of whom had voiced concerns about the detrimental effect on the market of implementing a change that would serve to reduce inflation accrual. The only change proposed by the National Statistician is changing to a new source of data for private rental statistics ahead of the introduction of the new CPIH inflation measure. Given the ONS acknowledges the RPI measure of inflation to be flawed, the government may choose to consider issuance of CPI or CPIH-linked gilts at some future stage.

The January Consumer Prices Advisory Committee papers noted that the ONS recommends that “the basic RPI is accepted as currently defined” and that any alterations should be limited to routine updates (such as weights, data collection and so on). To us, this reaffirms the status of RPI as a protected series, and should give market participants clarity on the medium-term outlook for the RPI/CPI basis, which is an important determinant of breakeven value. In our view, even after the sharp rally (Figure 1), breakevens are still cheap versus the MPC 2% CPI target in maturities up to the IL29. This is based on our assumption

Henry Skeoch

+44 (0)20 7773 7917 henry.skeoch@barclays.com

Breakevens out to IL29 still offer economic value relative to MPC 2% CPI target

FIGURE 1 Breakevens have recovered sharply, scope for further rally

FIGURE 2 Real yield curve steep relative to level of nominal market

2.0

2.2

2.4

2.6

2.8

3.0

3.2

3.4

3.6

3.8

4.0

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

IL42 breakeven

IL22 breakeven

IL17 breakeven

1.4

1.6

1.8

2.0

2.2

2.4

2.60.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1.2

Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13

IL42 vs IL22 real yield slope

10y benchmark gilt yield (RHS inv)

Source: Barclays Research Source: Barclays Research

Barclays | Global Rates Weekly

10 January 2013 47

of 25-40bp per annum for the housing components of the RPI/CPI basis over the medium-term (please see RPI beyond the formula effect, Euro Weekly, 23 November 2012 for details of how these are estimated) and a formula effect of 0.9pp. At the long-end of the curve, demand tends to be heavily dependent on the level of real yields, which form the basis for hedging target levels for many pension funds. Long breakevens tend to be more significant for influencing relative asset allocation decisions between gilts and linkers. The sharp rally after the RPI announcement leaves long real yields again close to zero or negative, which may limit demand. Current breakeven levels suggest only limited asset allocation demand for long linkers although some investors may look to capture the value offered by longs on the real yield curve, which is steep relative to the level of the nominal market (Figure 2).

The removal of uncertainty related to RPI is positive for the £1bn notional IL29 auction on Thursday 17 January. The bond looks fairly valued on the linker curve once accounting for its poor seasonality as a March maturing issue, which accounts for 3bp of its yield pick-up versus the November maturing IL27. The rally in breakevens after the RPI announcement on Thursday was driven by a sharp richening in real yields, which were briefly negative across the curve once again, leaving real yields unattractive value. However, liquidity in the market is now likely to improve with the binary uncertainty surrounding the status of the formula effect gone. We therefore expect the supply to be comfortably absorbed given its relatively small size. The auction will have negligible impact on all-linker indices and will shorten over-5y indices by 0.01y, so is unlikely to benefit from significant index extension demand.

Tactically, we see most upside in relatively short-dated breakevens such as the IL17 rather than those in the belly of the curve through the release of the December 2012 RPI on Tuesday 15 January which fixes the redemption value of the IL13. The IL13 effectively becomes a nominal bond after the release, which could prompt switching interest out of the issue into other linkers. Our economists’ forecast a 246.9, 3.1% y/y, 0.5% m/m print for the December RPI, which implies a final value for the IL13 of £276.79 per £100 notional and a total of £21.4bn of cash flows returned to the market when the IL13 redeems in August. Our economists’ forecast implies a 44bp money yield for the IL13. This is marginally higher than the 28bp offered by 2013 redeeming conventional gilts at the time of writing; the marginal cheapness of the IL13 likely reflects the typical margin of forecasting error surrounding an RPI release. Our economists’ forecast implies a respective 8bp and 4bp of mechanical cheapening to the IL16 and IL20 real yields. Ahead of the National Statistician’s announcement on the RPI formula, RPI releases became of secondary importance for all but the shortest-dated issues. We would therefore expect the market to react more notably to any surprises in forthcoming inflation prints, as the market reprices the near- and longer-term prospects for UK inflation.

IL29 auction should be easily absorbed following removal of RPI uncertainty

December 2012 RPI release will determine redemption value of the IL13

Barclays | Global Rates Weekly

10 January 2013 48

EUROPE: VOLATILITY

Buy GBP 1y*5y payer ladder GBP 1y*5y vol could continue to come off as the BoE likely maintains easy monetary policy for an extended period. We recommend buying a GBP 1y*5y payer ladder, which takes a short vol view, along with fading the richness in payer skew and the recent rates sell-off.

Implied vol on intermediate expiry, mid tenors in GBP have steadily moved downwards over the past one year, as GBP rates have leaked lower. For example, GBP 1y*5y vol has fallen from c.75bp/y in early Jan 2012 to about 64 bp/y currently, over a period in which the GBP 5y rates rallied about 45bp. In the coming months, we believe that vol on mid-tails in GBP should continue to face similar downward pressure as rates likely stay in an extended period of low-for-long. There are two reasons for this.

First, a low-for-long policy rate is a recipe for low delivered vol by short rates. But being sticky, implied vol takes time to come off. In US, where the Fed has been on hold for about four years now and has implemented non-conventional tools such as date- and (more recently) data-based rate guidance, vol on short-end rates have dropped to new lows. For example, 1y*2y and 1y*5y are currently at 34bp/y and 60 bp/y respectively, having traded in tight ranges of 50bp and 100bp since the onset of the rate guidance policy in Aug 2011. The experience in the UK has also been similar – despite differences in the methods of the central banks – where volatility has declined whenever BoE has stayed on hold (Figure 1).

Going forward, the weak economic recovery in the UK, along with potential downside risks from the debt crisis in the Eurozone and the fiscal drag in the US, should force the BoE to keep monetary policy easy, despite the inflation concerns. Therefore, as policy rates likely remain pinned for some time to come, realized volatility on short-to-mid rates should stay low and cause further drop in implied vol.

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

Hitendra Rohra +44 (0)20 7773 4817

hitendra.rohra@barclays.com

Implied vol on short-to-mid tails should fall as BoE keeps policy rate on hold for long

FIGURE 1 Realized volatility falls to low levels when the BoE is on hold

FIGURE 2 The trade does not lose if 5y rate stays between 1.6% and 2.4% in one year

0

2

4

6

8

30

50

70

90

110

130

150

Jan-98 Apr-02 Jul-06 Oct-10

5y rate - 60d Realized Vol (bp/y) BOE Policy Rate (%)

-150

-100

-50

0

50

100

150

1.3% 1.7% 2.1% 2.5%

P&L (cts)

Spot GBP 5y rate

6m 11m 1y Note: Light blue line shows the 50d realized vol of GBP 5y swap rate. The realized vol tends to fall during periods in which the BoE stays on hold. Last data point is as of January 10, 2013. Source: Barclays Research

Note: Shows the P&L for the GBP 1y*5y payer ladder, for different values of spot 5y rate and different time intervals. Data are as of January 10, 2012 Source: Barclays Research

Barclays | Global Rates Weekly

10 January 2013 49

Second, the implied vol is high for the range in which rates have stayed over the past one year. For example, a GBP 1y*5y payer struck at 1.55% (~ATM), costs about 25bp. This means that even if the 5y rate rises to 1.8%, the highest level reached in the last one year, the option would only just have covered the initial premium. Clearly, the implied volatility needs to come down in order to provide better pay-offs on options. Therefore, we are bearish on GBP 1y*5y and like trades that fade the richness in the vol.

Buy GBP 1y*5y 1x1x1 payer ladder One way of initiating such a trade is through GBP 1y*5y 1x1x1 payer ladder, specifically:

• Buy £100mn 1y*5y payer struck at 1.60%;

• Sell £100mn 1y*5y payer struck at 1.85%; and

• Sell £100mn 1y*5y payer struck at 2.15%.

As of January 10, 2013, this trade can be executed at zero initial premium (at mid-levels). The reasonably high level of vol implies that the trade has a wide range over which it takes in a profit. As Figure 2 shows, the trade has a positive P&L if the GBP 5y rate is between 1.6% and 2.4%, at the end of one year. It has a zero pay-off if rates stay low, and loses only in the unlikely case of a sharp sell-off in 5y rate of beyond 2.4%, a level not reached since July 2011.

Apart from the short vol position, the trade also fades the relatively rich payer skew in GBP 1y*5y (Figure 3). Arguably, some skew is justified in a low rate environment, as rates and normal vol tend to become more correlated due to lognormal behaviour. As a result, skew in not just GBP, but even in USD, EUR and JPY, have been quite high. However, as Figure 4 shows, the anticipated correlation between rate and implied vol has not materialized in GBP, with the two being fairly uncorrelated over the past year. This is in contrast with the JPY market, where a definite positive correlation between rates and implied vol justifies a high skew. Therefore, the payer skew in GBP could come off and profit the trade. Also, apart from an actual fall in the skew level, the trade can also benefit from skew monetization if rates fail to sell off more.

GBP 1y*5y is high for the range in which rates have stayed

The trade monetizes the rich payer skew of GBP 1y*5y

FIGURE 3 GBP 1y*5y payer skew is currently rich…

FIGURE 4 … even as rates and implied vol are only weakly correlated

-5

0

5

10

15

20

Nov-04 Apr-06 Aug-07 Dec-08 Apr-10 Sep-11

GBP 1y*5y 100bp wide skew (bp/y)

-50%

-25%

0%

25%

50%

75%

100%

Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13

GBP 3m*5y JPY 3m*5y

60day Rate-Vol Correlation

Note: Shows the 100bp wide payer skew for GBP 1y*5y. Last data point is as of January 10, 2013. Source: Barclays Research

Note: Shows the 60 day correlation between daily changes in 3mf 5y rate and 3m*5y implied vol for GBP and JPY. Last data point is as of January 10, 2013. Source: Barclays Research

Barclays | Global Rates Weekly

10 January 2013 50

The entry levels for the trade have been enhanced by the recent sell-off in GBP rates. For example, the same trade is now about 3cts cheaper than what it was about one month ago, when the 1yf 5y rate was over 20bp lower. Hence, a quick retracement of the rate to the low levels seen in December 2012 should benefit the trade too.

Finally, the trade carries positively, about 14cts in 6 months. It is therefore easier to hold from a mark-to-market perspective and can be exited mid-way, likely with a profit, if the rates stay where they are.

The recent sell-off in GBP rates has improved entry levels

Barclays | Global Rates Weekly

10 January 2013 51

EUROPE: SPECIAL TOPIC

LCR: Easing in the rules and liquidity pressure on banks This is a reprint of part of the Euro Money Markets Weekly, 8 January 2012.

The final version of Basel III’s Liquidity Cover Ratio shows less stringent rules for banks. This should reduce pressure on banks’ liquidity and lessen, but not eliminate, the effect of banks’ lower participation in the very short-term liquidity market.

On 6 January 2013, the Basel Committee on Banking Supervision announced the final version of the Liquidity Coverage Ratio (LCR), with important amendments endorsed by the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision 14.

The LCR, which requires banks to hold enough high-quality liquid assets to survive a 30-day funding squeeze, was reaffirmed as an essential component of the Basel III reforms in terms of liquidity regulation. However, the final version is more flexible with respect to the draft announced in 2010.

• It widened the range of the assets eligible as high-quality liquid assets to the computation of the ratio (it includes equities and certain residential mortgage-backed securities, with rating limits and haircuts). In addition, and probably more importantly, there were also some changes in the way the net liquidity outflows are calculated.

• It extended the timetable for the phase-in period, aligning it with the capital adequacy rules. Indeed, while the introduction on 1 January 2015 was confirmed, a more gradual approach will be followed, as the minimum requirement will be 60% in the first year and then will increase by annual steps of 10% to reach 100% on 1 January 2019.

• It reaffirmed the usability of the stock of liquid assets in periods of stress, including during the transition period.

Also, the Basel Committee announced that it will continue to conduct further work on the interaction between the LCR and the provision of central bank facilities. This is because the deposits with central banks are the most reliable source of liquidity for banks – indeed, in some cases, the only source.

Basel III: Regulatory Liquidity Standard The new liquidity risk framework in the Basel III regulation consists of two main measures: the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR). While the former aims at establishing a minimum of high-quality liquidity assets to address a stress situation on liquidity lasting one month, the latter, with a time horizon of one year, is a more structural measure designed to ensure that long-term assets are funded by more stable long-term instruments.

While a final version of the LCR has been presented, no final decision has been taken on the NSFR. The Committee stated that it will turn its attention to the NSFR, which will be under observation ahead of its planned implementation in 2018.

14 See also the US Money Markets section of the GRW and 8 January Instant Insight “Revised Basel III LCR rules confirm initial preference scheme, but also stipulate principles for discretion”

Giuseppe Maraffino +44 (0)20 3134 9938

giuseppe.maraffino@barclays.com

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

The final version of Basel III LCR is more flexible than the draft announced in 2010

LCR and NFSR comprise the new liquidity risk framework in the Basel III regulation

Barclays | Global Rates Weekly

10 January 2013 52

In the report “Basel III: International framework for liquidity risk measurement, standards and monitoring” December 2010, the Basel Committee on Banking Supervision provided an extensive and accurate description of the two new liquidity measures (LCR and NFSR), along with their calculation methodologies. In our report we outline the main aspects of the liquidity regulation in terms of LCR, specifically on the main component of the LCR and their impact on liquidity markets.

Liquidity Cover Ratio: Definition As stated by the Basel Committee, the Liquidity Cover Ratio “aims to ensure that a bank maintains an adequate level of unencumbered, high-quality liquid assets that can be converted into cash to meet its liquidity needs for a 30 calendar day time horizon under a significantly severe liquidity stress scenario specified by supervisors”.

The calculation methodology of the LCR is based on that already used internally by banks to assess their exposure in stress situation. The total net cash outflows for the scenario are to be calculated for 30 calendar days into the future. The standard requires that the value of the ratio be no lower than 100% (ie, the stock of high-quality liquid assets should at least equal total net cash outflows).

LCR = Stock of unencumbered high-quality liquid assets (HQLA)/Total Net cash outflows over a 30-day stress scenario (NCOF) = HQLA/NCOF >=100%.

High Quality Liquid Assets (HQLA) To qualify as liquid, assets have to be liquid during a stress period and, ideally, be central bank eligible. “Unencumbered” means not pledged (either explicitly or implicitly) “to secure, collateralise or credit-enhance any transaction”. The regulator distinguishes two main categories of assets that can be included in the HQLA stock. Described below are the two categories under the first formulation of the LCR (2010). This does not include the changes which will be presented in a separate section:

• Level 1 assets: Include, without any limit, cash, central bank reserves and debt securities issued or guaranteed by public authorities (sovereigns, central banks, non-central government PSEs, the Bank for International Settlements, the International Monetary Fund, the European Commission, or multilateral development banks) that have 0% capital risk weight under Basel III.

• Level 2 assets: Include debt securities issued by public authorities (marketable securities representing claims on or claims guaranteed by sovereigns, central banks, non-central government PSEs or multilateral development banks) with a 20% risk weight under the Basel II Standard Approach, in addition to highly rated non-financial corporate bonds (not issued by a financial institution or any of its affiliated entities) and covered bonds (not issued by the bank itself or any of its affiliated entities). Both corporate bonds and covered bonds need to have a credit rating of at least AA- (if they do not have a credit assessment by a recognised ECAI they must be internally rated as having a probability of default corresponding to a rating of at least AA-). The regulator is very cautious on Level 2 assets, assuming that they are less liquid and of lower quality than Level 1 assets. Indeed, it established that Level 2 assets are subject to a 15% haircut when they are included in the HQLA and also that Level 2 assets can amount only up to 40% of the total HQLA stock (after the application of haircuts),

LCR “aims to ensure that a bank maintains an adequate level of unencumbered, high-quality liquid assets that can be converted into cash to meet its liquidity needs for 30 days”

Definition of High Quality Liquid Assets

Barclays | Global Rates Weekly

10 January 2013 53

Total Net Cash Outflows (NCOF) It is an estimate of the total amount of liquidity that the bank is not expected to roll in the case of stress period lasting 30 days. It is calculated as the total expected cash outflows minus total expected cash inflows, under a specified stress scenario for a period of 30 calendar days.

• Total expected cash outflows are calculated by multiplying the outstanding balances of various categories or types of liabilities (and off-balance-sheet commitments as well) by the rates at which they are expected to run off or drawn down. The so-called run-off rate is estimated based on the stability of the liability as a source of funding. The regulator provides an accurate description of the liabilities that are considered in the calculation of the outflows along with the run-off rate associated. For example, regarding the retail deposit (demand deposit and term deposit), the regulator distinguishes between “stable” deposits and “less stable” deposits, with the former being those deposits fully protected by an effective deposit insurance scheme or public guarantee. Therefore, they receive a run-off rate of 5%, while “less stable deposits” a run off rate of 10% or higher.

In the new liquidity regulation framework there are several definitions of unsecured wholesale funding, which in general is considered as liabilities raised from non-natural persons (legal entities) who are not collateralised that is callable within the LCR’s horizon of 30 days or with an undetermined maturity.

Total expected cash inflows are calculated by multiplying the outstanding balances of various categories of contractual receivables by the rates at which they are expected to flow in under the scenario.

Importantly, the regulator has established that the total expected cash inflows can amount up to 75%, in aggregate, of total expected cash outflows.

LCR: Main implications for the liquidity market… In the euro money market section of the Global Rates Outlook 2013, we discussed the primary effect of the LCR on the liquidity market in terms of the reduction in banks’ participation in the very short-term interbank market. We argued that lending in the overnight unsecured liquidity market would increase banks’ net cash outflows over the next 30 days and, therefore, would require more liquid assets to avoid a reduction in their LCRs. Hence, banks are likely to prefer longer-than-30-day market borrowing, or to borrow reserves from the central bank (Level 1 liquid assets – no haircuts or limits, and therefore increase the numerator of LCR) or deposit their excess cash at the central bank as insurance against unexpected liquidity outflows, rather than lend the surplus cash in the market. This may indirectly affect EONIA, as a reduced number of unsecured overnight transactions likely would make the cost of liquidity more volatile. Therefore, EONIA will be a less reliable indicator of euro area liquidity conditions (prices and volumes). On the market side, the increase in EONIA fixing volatility would place upward pressure on EONIA rates. The consequent increase in the liquidity premium should favour steepening in EONIA curves and higher unsecured money market rates.

… and for the implementation of monetary policy In the medium term, the LCR also will have an impact on monetary policy implementation, as well.

Indeed, the fact that banks are likely to prefer to have excess reserves for precautionary reasons makes estimating the Eurosystem structural liquidity deficit much more difficult and will require the ECB to be more active in its fine-tuning operations. Also, demand for ECB liquidity is likely to remain high, given than central banks reserves are considered Level I

Definition of Total Net Cash Outflows

Barclays | Global Rates Weekly

10 January 2013 54

assets. Due to the higher demand for long-term liquidity, LTROs will have a much more important role than MROs in the new framework.

Main changes in the final version of the LCR… The final version of the LCR contains several changes to both the definition of high-quality liquid assets (HQLA, the LCR numerator) and the calculation of net cash outflows (the LCR denominator). For a full description of the technical details of the changes see the BIS website (http://www.bis.org/publ/bcbs238.htm), along with the BIS report, January 2013, “Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools.

Regarding the HQLA, Level 2 assets were divided into groups: Level 2A, which corresponds to the former Level 2 assets; and a new Level 2B, which includes the assets that are now eligible for the HQLA stocks, namely corporate debt securities with ratings between A+ and BBB- (with a haircut at 50%). Also certain unencumbered equities are subject to a haircut of 50%, along with certain residential MBS with a minimum rating of AA and a 25% haircut.

However, the Committee decided that net of haircuts, total additional assets (ie, those that are eligible under the changes) could account for, in aggregate, up to 15% of HQLA. Regarding Level 2 assets, local rating scales can be used and qualifying commercial paper can be included.

Importantly banks are allowed to use their pool of HQLA during period of stress.

With respect to the computation of net outflows, several changes were made in order to reduce the run-off rate for some liabilities, including retail insured deposits and non-financial corporate deposits. Importantly, the outflow rate on maturing secured funding transactions with central banks was reduced to 0% from 25% (ie, it assumes all central bank transactions will be rolled over).

Due to the significant haircut and cap on the amount of the new liquid assets (eligible under the changes) on total HQLA, the changes on the “run-off rate” (ie, those affecting the LCR denominator) probably will be more important than those related to the widening of the HQLA in increasing the LCR and reducing the pressure on banks’ liquidity.

… likely to reduce liquidity pressure; structural changes to the liquidity market are inevitable15 The new version of the Liquidity Cover Ratio should reduce pressure on banks’ liquidity, thereby providing a boost to confidence. However, it is important to stress that in terms of monetary policy implementation, the final version of the LCR is likely to reduce (because of the lower liquidity needs) but not eliminate banks’ dependence on central bank liquidity, as central bank reserves are Level I assets and the run-off associated with them is now zero. This creates an incentive for banks – especially small banks with limited access to the market – to prefer central banks’ refinancing operations to the market liquidity, which for calculating the LCR receives a run-off of 100% that reduce the LCR. This is not likely to make it easier for central banks (and the ECB in particular) to exit from their current accommodative stances. Such an issue was raised in the final statement, with the Committee willing to conduct further work to examine the relationship between LCR and central banks’ facilities16.

15 See the US Money Market section for an analysis of the impact of the final version of the LCR on the US banks 16 See U. Bindseil, J. Lamoot (2011) “ The Basel III framework for liquidly standards and monetary policy implementation”, Humboldt-Universitat zu Berlin SFB 649 Discussion Paper 2011 -041 See also S. Schmitz (2011) “The impact of the Basel III framework for Liquidity Standards and monetary policy implementation, available at SSRN: htpp://ssrn.com/abstract=1869810

Change related to the composition of HQLA

Change related to the calculation of the net outflows

The final version of the LCR is likely to reduce (because of lower liquidity needs) but not eliminate banks’ dependence on central bank liquidity,

Barclays | Global Rates Weekly

10 January 2013 55

In our opinion, the introduction of the LCR will continue to affect the euro interbank market, particularly the EONIA market, through the reduced participation of banks. Indeed, we expect banks to continue to prefer liquidity (from the market or from the ECB) with maturities longer than 30 days, which will not be considered in the calculation of the LCR.

However, the easing in the liquidity rules should temper this impact relative to the scenario under the preliminary version of the LCR. This should lessen the increase in the liquidity premium on the EONIA curve.

In terms of repaying the 3y LTROs, the easing in liquidity requirements likely will make some banks more willing to repay partially, or totally, the amount borrowed, although other kinds of considerations (related to deleveraging, conditions in the unsecured market, usage of collateral, etc) will probably play a more important role. We continue to expect a total repayment of the two 3y LTROs of about €200bn in Q1 as we explained in our 11 October 2012 report “3y LTROs: expect €200bn to be repaid in Q1 13”. The recent increase in banks’ issuance in the unsecured market seems to be supporting our view of a larger reimbursement than generally expected in the market.

From an economic point of view, the easing in the LCR rules should avoid a drastic contraction of banks’ lending (that would have resulted from the initial formulation of the LCR, which was more stringent on liquidity requirements than the final version). However, we do not expect a large direct boost to lending from the new rules, as other factors related to strict rules on capital, weak demand for loans and uncertainty about the economic outlook will continue to weigh on lending volumes.

Finally, the wider range of liquid assets eligible under the LCR rules should favour a reduction in banks’ investment in government securities, although the impact is likely to be limited as the newly eligible assets can account only for the 15% of the total HQLA. In the Instant Insight, Revised Basel III LCR rules confirm initial preference scheme, but also stipulate principles for discretion, 8 January 2013, we discuss the impact of the new rules on the SSA and covered bonds market in the Eurozone (we believe that it is too early to asses the impact as the final treatment will also depend on the ability to use national discretions).

As we argued before, the effectiveness of the changes in terms of easing the liquidity requirement is much more related to the changes in the rules for the calculation of the net cash outflows rather that in the widening of the liquid assets stocks.

The introduction of the LCR will continue to affect the euro interbank market, particularly the EONIA market, through the reduced participation of banks

The easing in liquidity requirements likely will make some banks more willing to repay partially, or totally, the amount borrowed

The easing in the LCR rules should avoid a drastic contraction of banks’ lending

The effectiveness of easing the liquidity requirement is much more related to the changes in the calculation rule for net cash outflows rather than to the widening of the liquid assets stocks

Barclays | Global Rates Weekly

10 January 2013 56

JAPAN: RATES STRATEGY

Clearing hurdles for the next BoJ easing The BoJ may consider changes in its JGB purchases, including its rinban operations, for its next monetary easing. One idea is to fuse its JGB purchasing under its rinban and Asset Purchase Program. However, an optimal solution is likely to prove elusive.

We forecast in our 7 December report that the BoJ would respond to the Abe government’s intensifying pressure for a monetary easing by expanding its rinban (outright JGB purchasing) operations, one of the remaining tools in its policy arsenal. We observed that its two other logical choices would be problematic: 1) a reduction in interest rates on its current account deposits would lead to lower lending rates and thereby hurt earnings at private banks, which have no further capacity to reduce their own deposit rates; and (2) an extension of the bank’s Asset Purchase Program (APP) would put downward pressure on yields in the intermediate sector, causing disproportionate swings in bank earnings from year to year.

We reiterate our belief that the BoJ is likely to increase its rinban operations. However, it will have to clear several hurdles when determining the specifics.

The first problem is that in order to increase its rinban, the bank will have to decide whether to maintain or jettison its self-imposed BoJ Note Rule, which restricts its JGB holdings to the volume of outstanding BoJ note issuance. If it were to raise its rinban from the current ¥1.8trn monthly pace, it would quickly approach the limits imposed by the rule. One solution might be to shift the portion of bond purchases shared by the rinban and APP (ie, under 3y JGBs) to the APP, which as a special program is exempt from the rule. In addition, the APP currently targets a specific balance within specific timeframes, but this could be changed to an open-ended scheme with defined monthly purchasing volumes to conform with rinban operations. This would make the APP a more powerful easing measure.

However, if under-3y bonds were shifted to the APP, the BoJ would have to consider whether its over-3y rinban should continue to be portrayed as a means of monetary control. The bank presently distinguishes its two programs by positioning APP as a monetary easing measure and rinban operations as a means of ensuring a smooth supply of funds. If it takes this step, it would not be able to justify increases in its over-3y JGB purchasing when it eases again in the future.

This suggests the opposite approach, that is, a sharp lengthening in APP maturities – not just a slight stretch to 4y or 5y, but a sudden sweep to 10y or 20y. In that case, the bank would have to switch its market purchasing method to a bidding system based on the previous day’s close, as with rinban operations.

The trouble is that if some sort of limit is placed on JGB purchases under the APP, where the BoJ Note Rule is currently not applicable, it could not be switched to an open-ended scheme. Even with the present APP approach, denoting final purchasing targets within specific timeframes, the bank’s JGB holdings could expand indefinitely unless there is some sort of objective indicator such as the balance of outstanding BoJ notes. This would contradict the BoJ’s long-voiced insistence that all efforts should be made to avoid the impression in the markets that the bank is monetizing government debt.

Thus, while we believe the BoJ should immediately begin considering an expansion in its JGB purchases beyond the intermediate sector to the long or even super-long sectors, we recognize that the details make it extremely tough to find the optimal solution. It is nearly impossible for us to be convinced of specific Boj action now to forecast JGB supply/demand. As it will take

Chotaro Morita +81 3 4530 1717 chotaro.morita@barclays.com

Reiko Tokukatsu, CFA +81 3 4530 1532

reiko.tokukatsu@barclays.com Noriatsu Tanji

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

One decision: whether to keep or jettison the BoJ Note Rule

Lengthening maturities purchased under the APP – not just a stretch, but a sweep to 10y or 20y

Barclays | Global Rates Weekly

10 January 2013 57

time to determine the best approach, the bank could simply raise the APP purchasing target by ¥5-10trn this month and delay any fundamental change in its JGB purchasing scheme until February or beyond. We believe a position such as a 10y-20y flattener predicated on an expansion in the bank’s JGB purchasing policy is still risky at this time.

FIGURE 1 Rinban operations vs Asset Purchase Program

Rinban APP

Eligible maturities Up to 30y Up to 3y

Volume purchased (monthly) JPY1.76-1.84trn Around JPY2.1trn

Purpose To supply long-term funds, in line with BoJ note balance

To enhance the impact of monetary easing

Cap(Target) Balance of outstanding BoJ notes JPY44trn (Up to Dec 2014)

Auction method Competitive auction whose rates vary with previous day’s closing yield

Competitive auction with absolute yields

Source: Barclays Research

Trade recommendation Sell 1mx10y receiver (K=0.8%) for 20 sen, 3mx20y receiver (K=1.65%) for 74 sen

This week, the JPY weakening since last December saw a small retracement for the first time (88->86), although it was short lived. As the JPY has digested one correction in currency markets, we think volatility is likely to be low for some time – until there is a new development in domestic fiscal and monetary policy – therefore, selling volatility to earn carry is attractive. At the same time, implied volatility has risen since November (Figure 2).

On the domestic front, increased JGB supply in the FY 2012 supplementary budget and FY 2013 budget is hardly likely to come as a positive surprise – that is, a reduction in supply. In addition, both 10y and 20y swap rates fell about 5bp during when the JPY fell to 86/USD from 88/USD, but both remain at that level while the JPY has returned to 88/USD. Therefore, selling receivers is a natural choice. Selling receivers is a more attractive way of expressing bearish view when volatility is likely to be low than paying a premium for payers.

FIGURE 2 Implied volatility for 3mx10y and 3mx20y (bp/day)

FIGURE 3 Recent moves in 10y and 20y swaps vs implied vol

1.5

1.7

1.9

2.1

2.3

2.5

2.7

2.9

3.1

3.3

Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13

3mx10y 3mx20y

10y 20y

current level 0.836% 1.716%

distance from recent low 15.2bp 19.bp

distance from recent high -4.8bp -4.5bp ratio of

20y/10y

Recent trading range 20.bp 23.5bp 1.175

implied vol (bp/day) 2.35 2.63 1.122

Source: Barclays Research Source: Barclays Research

Volatility likely to remain low…

… therefore selling receivers is more attractive than buying payers

Barclays | Global Rates Weekly

10 January 2013 58

We compared the recent move of 10y and 20y in Figure 3. While the fall in swap rates since their recent peak is about the same, trading range for the 20y is about 4bp wider. But the difference in trading range is basically reflected in the implied volatility, since the ratio of trading range and implied volatility are roughly the same (1.175 versus 1.122). So, it looks marginally more attractive to sell a 10y tail, but selling 20y tail is similarly attractive.

If we choose a 1m expiry, we cannot choose a strike that is too far OTM since the premium would be too low. Therefore, we would recommend a 10y tail for the 1m expiry, since the 10y swap is less likely to exhibit extreme moves. Also the 10y swap spread has now cheapened back to near Libor flat, a historically cheap level, while the 20y swap spread is still at a somewhat rich level (L+6bp). On the other hand, we can choose a more OTM strike for the 3m expiry, so choice of 20y tail becomes more suitable. We compare the swap rates versus the JPY and assume the level corresponding to 85 JPY/USD is an acceptable strike. They are 0.8% for 10y and 1.65% for 20y. In Figure 4, we show indicative premiums for the recommended receivers. Considering the trade-off between expiries, strikes and premiums, we think those choice are reasonable.

FIGURE 4 Recommended receivers to short

Receiver strike spot ATMF premium (yield equivalent)

1mx10y 0.80% 0.83% 0.84% 2.0bp

3mx20y 1.65% 1.71% 1.74% 4.4bp

Source: Barclays Research

FIGURE 5 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 1y OIS pay 13-Jul 6.0 6.0 6.0 0.6 100bn face 8.0 5.0 1y Hold

2y Tibor 6v1 widener 18-Oct 17.7 17.9 17.5 -4.0 10 22.0 16.0 6m or longer Hold

Swap spread

5s7s box (7y long) 07-Jan 7.5 7.7 8.0 -3.0 10 4.0 11.0 1m Hold

Long futures swap spread 09-Jan -4.0 n/a -3.1 -4.5 5 4.0 11.0 1m New (RV package on Jan 9)

Swaption

long 10x10 straddle vs. 5x5 straddle

28-Nov 90.0 95.0 98.0 3.0 10bn face 120.0 60.0 3-6m Hold

long 6mx5y payers vs. 6mx10y payers (ATM+10bp, strike spread =50bp, 0.92-0.42)

29-Nov -33.0 -34.0 -24.0 10.0 10bn face 0.0 -40.0 3-6m Hold

short 1mx10y receiver (K=0.8%) 10-Jan -20.0 n/a -23.0 -3.0 10bn face 0.0 -43.0 1m New short 3mx20y receiver (K=1.65%)

10-Jan -74.0 n/a -77.0 -3.0 5bn face 0.0 -100.0 3m New

Xccy basis

Pay 1yx1y 10-Nov -44.0 -43.6 -44.0 -2.0 5 -30.0 -80.0 medium-

long Hold

Pay 8y 21-Dec -66.5 -66.5 -63.5 24.0 8 -35.0 -80.0 medium-

long Hold (Increase position)

Weekly P&L =18.1; Total P&L since 2012: 18.1; Balance sheet 20.0 Note: Current levels based on the absolute maturity to capture rolldown correctly; therefore, it is different from the constant-maturity spread. Source: Barclays Research

Barclays | Global Rates Weekly

10 January 2013 59

TRADE PORTFOLIO UPDATE

Portfolio registers marginal gains Since last week (January 4, 2012), the portfolio gained $1.4mn, driven by long duration and short volatility trades. It has gained $49.6mn since inception.17

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

$49.6

0

10

20

30

40

50

60

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

mn

Note: As of January 10, 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.

17 Since January 2009.

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

Vivek Shukla +1 212 412 2532

vivek.s.shukla@barclays.com Igor Zoubarev

+1 212 526 5518 igor.zoubarev@barclays.com

Barclays | Global Rates Weekly

10 January 2013 60

TRADE PORTFOLIO

New Positions

Inception Date

Theme TradeWeights/Notional

AmountLevels @ Inception

Current Level

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

Total Stop Loss (bp)

HorizonInitial

MarginVariation Margin

Total Margin

US TIPS1/10/2013 Front-end

UnderpricedLong $250mn TIIJan14s

hedged with sell 100 CLZ4

$250mn -134bp, 91.74

-130bp, 91.74

($100,000) ($600,000) 1y $1,000,000 $100,000 $1,100,000

US Treasury1/10/2013 Long front end Long 4y $50k DV01 59.4bp 59.3bp ($5,000) ($500,000) 1m $3,000,000 $5,000 $3,005,000

Eurozone Sovereign debt1/10/2013 Fundamental

cheapnessLong 5y5y fwd EUR

ASW$30k dv01 -4 -5 ($30,000) ($450,000) 3-6m $1,000,000 $30,000 $1,030,000

JPY Swaps1/10/2013 5s swap spread

too rich5s7s box spread 120k dv01 7.5 8 ($60,000) ($400,000) 6m $300,000 $60,000 $360,000

JPY Options1/10/2013 Low vol sell 1mx10y receiver

(0.8% at 20 sen)$80mn -20 -23 ($24,000) ($200,000) 1m $500,000 $24,000 $524,000

1/10/2013 Low vol sell 3mx20y receiver (1.65% at 74 sen)

$50mn -74 -77 ($15,000) ($200,000) 3m $500,000 $15,000 $515,000

Note: All prices as of January10, 2013. Source: Barclays Research

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10 January 2013 61

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 $4,514,740 1/12/2012 Front-end Asset

Swap TightenerLong Jan '14 TIPS ASW $500mn Libor - 13bp Libor + 0 $997,260 ($250,000) 1y $2,500,000 ($997,260) $1,502,740

8/3/2012 Long Core Inflation

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

($100mn): +50 ($376,500) ($145,000) $190,000 ($200,000) 1y $800,000 ($190,000) $610,000

10/5/2012 Carry Long Jan '15 ASW relative to nominals $100mn 14bp 12bp $50,000 ($300,000) 1y $1,000,000 ($50,000) $950,000

10/18/2012 Supply unwind Long Feb 40 Relative ASW $10mn 22bp 28bp ($157,000) ($400,000) 1y $400,000 $157,000 $557,000

1/4/2013 Concession unwind

Long Jan15-Apr17-Jan19 RY Fly 15K -10 -6 ($95,000) ($150,000) 3m $800,000 $95,000 $895,000

UK Inflation $4,450,000 11/16/2012 UK Linker RV Sell IL22 vs IL17+32 RY barbell 62.5k DV01 0bp 1bp $125,000 ($500,000) 3m $2,500,000 ($125,000) $2,375,000

12/12/2012 10y UK breakevens rich

Sell IL22 Breakeven $25k DV01 250 291 ($1,075,000) ($1,000,000) Stop-out $1,000,000 $1,075,000 $2,075,000

EUR Inflation $947,500 1/4/2013 Relative value Buy OATi23 versus OATi22 EUR21.3mn 23s vs

25mn 22s ($35k dv01)

3.5bp 2bp $52,500 ($250,000) 3m $1,000,000 ($52,500) $947,500

US Treasury $5,921,000 9/20/2012 Low funding

ratesLong 3y $50k dv01 35.5bp 33.2bp $219,000 ($500,000) Unwound $3,000,000 ($219,000) $2,781,000

9/20/2012 QE underpriced Long 10y $25k dv01 0.0178 0.0185 ($56,000) ($500,000) 3m $500,000 $56,000 $556,000

11/15/2012 Liquidity Premium

Long OTR 10s vs Old 10s $100K DV01 3.8bp 4.7p ($89,000) ($500,000) Unwound $2,000,000 $89,000 $2,089,000

12/13/2012 Long end Fed purchases

7s30s Tsy curve flattener 25k dv01 175.8 175.7 $5,000 ($500,000) Unwound $500,000 ($5,000) $495,000

Eurozone Sovereign debt $1,823,000 6/15/2012 Relative Value Short Bobl ASW vs. EONIA long Schatz

ASW vs. libor$15k dv01 -48bp -31bp ($255,000) ($350,000) 3-6m $1,073,000 $255,000 $1,328,000

10/5/2012 UFR positioning Receive 5y5y/5y10y/5y15y fwd $15k dv01 102bp 95bp $105,000 ($375,000) 3-6m $600,000 ($105,000) $495,000

JPY Swaps $2,788,000 7/13/2012 Short front-end Pay 1y OIS $160k dv01 6bp 6.39bp $62,000 ($320,000) 1y $1,600,000 ($62,000) $1,538,000

10/18/2012 Widener 2y Tibor 6v1 widener $120k dv01 19 17.5 ($180,000) ($400,000) 6m $180,000 $180,000 $360,000

11/1/2012 Carry Trade Sell 1y1y ATM receiver USD40mn -6 -8 ($8,000) ($100,000) Unwound $300,000 $8,000 $308,000

12/7/2012 Hedge to short 1y1y

long 30y swap spread $60k dv01 14.3 -1 $918,000 ($200,000) Unwound $1,500,000 ($918,000) $582,000

Note: All prices as of January 10, 2013. Source: Barclays Research

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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 $9,647,000 7/19/2012 Short vol Short 1y*10y straddles ($20mn) ($1,220,000) ($810,000) $410,000 6m $880,000 ($410,000) $470,000

9/7/2012 Short vol Short 1y*10y straddles ($20mn) ($1,242,000) ($900,000) $342,000 6m $880,000 ($342,000) $538,000

9/27/2012 Short vol Short 1y*10y straddles ($10mn) ($596,000) ($470,000) $126,000 ($1,000,000) 6m $880,000 ($126,000) $754,000

10/5/2012 Short vol Short 1y*10y straddles ($10mn) ($597,000) ($482,000) $115,000 6m $880,000 ($115,000) $765,000

11/15/2012 Short vol Short 1y*10y straddles ($10mn) ($570,000) ($540,000) $30,000 Expiry $880,000 ($30,000) $850,000

6/14/2012 Relative Value Long 1x11 cap -flr straddles 2% vs 1y*10y straddles 2%

$20mn: ($20mn) $1,964,000 $2,674,000 $710,000 ($500,000) 1y $880,000 ($710,000) $170,000

8/3/2012 Long risk-reversal

Long 1y*30y 100bp wide risk-reversal (long recr), delta hedged

$100mn ($450,000) $525,000 $975,000 ($500,000) 6m $725,000 ($975,000) ($250,000)

8/9/2012 Tactical Long 3y*1y 25bp low-strike recr vs 45bp high-strike payer

$200mn:($200mn) 0 $235,000 $235,000 ($500,000) 1y $800,000 ($235,000) $565,000

8/16/2012 Relative Value Short belly of 2y5y - 2y10y - 2y30y payer fly

+$94mn : ($100mn): +$22mn

($300,000) ($125,000) $175,000 ($500,000) 1y $2,200,000 ($175,000) $2,025,000

1/4/2013 Short vol sell 2y*10y straddles @ 2.65% ($50mn) ($4,105,000) ($4,165,000) ($60,000) ($500,000) 6m $2,200,000 $60,000 $2,260,000

1/4/2013 Tactical 3m*7y vs 3m*30y bear flattener +$75mn:($25mn) ($110,000) ($110,000) $0 ($500,000) Expiry $1,500,000 $0 $1,500,000

EUR Options $2,996,000 6/1/2012 Short vol EUR 1x2 1y5y 1.25 vs 1 recr ladder EUR 20mn: (40mn) 0 $50,000 $50,000 ($250,000) 6m $744,000 ($50,000) $694,000

9/7/2012 Short vol EUR 1x2 1y5y 1.15 vs 0.9 recr ladder EUR 100mn: (200mn)

0 $170,000 $170,000 ($250,000) 6m $1,692,000 ($170,000) $1,522,000

10/5/2012 Long vol Long EUR 1y*10y 1x2 payer spread (2.2 vs 2.6)

(EUR 50mn): EUR 100mn

0 ($230,000) ($230,000) ($500,000) 6m $550,000 $230,000 $780,000

JPY Options $1,020,000 11/28/2012 Volsurface is too

flatLong 10yx10y straddle vs. 5yx5y straddle 120mm 88 98 $120,000 ($250,000) 6m $500,000 ($120,000) $380,000

11/29/2012 Bear flattener ATM+10bp 6mx5y payer long vs. 6mx10y payer short

$100mn -10 -24 ($140,000) ($200,000) 6m $500,000 $140,000 $640,000

Cross-currency $3,468,000 10/11/2012 Carry Pay 1yx1y Xccy basis $40k dv01 -53.5 -50.2 $132,000 ($400,000) 1y $400,000 ($132,000) $268,000

11/29/2012 EUR vs US Long RXH3 std 144.5 vs short TYH3 std 133.5

+400: (740) $100,000 ($100,000) ($200,000) ($1,000,000) Expiry $3,000,000 $200,000 $3,200,000

Note: All prices as of January 10, 2013. Source: Barclays Research

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10 January 2013 63

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 BMA $2,030,000 1/12/2012 Sell Front-end

RatiosLong 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 $180,000 ($250,000) 1y $800,000 ($180,000) $620,000

5/10/2012 Sell Front-end Ratios

Short 3y ratio $200mn 65.375 61 $130,000 ($250,000) 1y $800,000 ($130,000) $670,000

6/7/2012 Sell Front-end Ratios

Short 3y ratio $200mn 66.75 62 $60,000 ($250,000) 1y $800,000 ($60,000) $740,000

Cash 1/4/2013 1/10/2013Cash Used as Collateral/ Haircut $48,047,644 $39,605,240

Fed Funds (residual cash) $60,077,142 $69,955,858

Return on Fed Funds $76,040 $77,592

Return on trades $9,483,506

Total $109,561,098

Note: All prices as of January 10, 2013. Source: Barclays Research

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10 January 2013 64

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) Unwind

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

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

Source: Barclays Research

Barclays | Global Rates Weekly

10 January 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

EUR Inflation6/1/2012 6/22/2012 Macro Receive 5y Euro HICPx Inflation EUR 25mn 0.0135 0.0148 $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 0.0232 0.024 $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

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

4/26/2012 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 0.00525 0.004 $500,000 ($400,000) Unwound

6/14/2012 7/26/2012 Macro Long 10y treasury $25k dv01 0.01635 0.01425 $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 0.00694 0.0068 $50,000 ($500,000) Unwound

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

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

Source: Barclays Research

Barclays | Global Rates Weekly

10 January 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 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) Unwind

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

JPY Swaps5/18/2012 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

5/22/2012 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

Barclays | Global Rates Weekly

10 January 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

JPY Swaps10/5/2012 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

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

Source: Barclays Research

Barclays | Global Rates Weekly

10 January 2013 68

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 Options3/29/2012 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

2/17/2011 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

Source: Barclays Research

Barclays | Global Rates Weekly

10 January 2013 69

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

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

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

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

Source: Barclays Research

Barclays | Global Rates Weekly

10 January 2013 70

GLOBAL SUPPLY CALENDAR

Country Bond Coupon Maturity Size - bn

Euro Area

Jan-13 Belgium New 10y

5.00

Jan-13 Italy New 15y BTP

5.00

Jan-13 Spain New 10y SPGB

5.00

16-Jan-13 Germany New 10y Bund Auction

15-Feb-23 5.00

17-Jan-13 Spain 5y SPGB Auction 4.25% 30-Jul-18 1.30

17-Jan-13 Spain 8y SPGB Auction 4.60% 30-Apr-20 2.30

17-Jan-13 France New 2yr BTAN

5.00

17-Jan-13 France 3yr BTAN 3.00% 25-Oct-15 1.00

17-Jan-13 France 5yr BTAN 2.25% 25-Jul-17 3.00

17-Jan-13 France OATei 2027 1.85% 25-Jul-27 0.50

17-Jan-13 France OATi 2021 0.10% 25-Jul-21 1.00

22-Jan-13 Holland 2y DSL (tot. range €1.5-2.5bn) 1.00% 15-Jan-14 1.50

22-Jan-13 Holland 30y DSL (tot. range €1.5-2.5bn) 3.75% 15-Jan-42 1.00

22-Jan-13 Germany DBRei 2023 0.10% 15-Apr-23 1.00

28-Jan-13 Italy BTPei 2021 2.10% 15-Sep-21 0.50

28-Jan-13 Italy BTPei 2026 3.10% 15-Sep-26 0.50

30-Jan-13 Italy 5yr BTP Auction 3.50% 01-Nov-17 3.50

30-Jan-13 Italy 10yr BTP Auction 5.50% 01-Nov-22 3.50

30-Jan-13 Germany 30yr Bund Auction 2.50% 04-Jul-44 2.00

Feb-13 Austria New 5y RAGB

5.00

05-Feb-13 Japan 10y JGB Auction

2300

06-Feb-13 Germany 5y OBL Auction

23-Feb-18 4.00

07-Feb-13 Spain 2y SPGB 2.75% 31-Mar-15 1.50

07-Feb-13 Spain 3y SPGB 4.30% 31-Oct-15 1.50

07-Feb-13 Spain 7y SPGB 4.30% 31-Oct-19 1.50

07-Feb-13 France 10y OAT

25-Oct-22 2.50

07-Feb-13 France New 30y OAT 2.50% 25-Apr-42 5.00

Japan

16-Jan-13 Japan 5y JGB Auction

2500

18-Jan-13 Japan Liquidity Enhancement Auction

300

24-Jan-13 Japan 20y JGB Auction

1200

29-Jan-13 Japan Liquidity Enhancement Auction

300

31-Jan-13 Japan 2y JGB Auction

2800

UK

17-Jan-13 UK 2029 Linker Auction 0.125% 22-Mar-29 1.00

22-Jan-13 UK 2022 Gilt Auction 4.000% 07-Mar-22 2.50

05-Feb-13 UK 2024 Linker Auction 0.125% 22-Mar-24 1.10

US

08-Jan-13 US 3y Note Auction

32

09-Jan-13 US 10y Note Auction

21

10-Jan-13 US 30y Bond Auction

13

24-Jan-13 US 10y TIPs Auction

16

28-Jan-13 US 2y Note Auction

35

29-Jan-13 US 5y Note Auction

35

30-Jan-13 US 7y Note Auction

29 Source: Barclays Research

Barclays | Global Rates Weekly

10 January 2013 71

GLOBAL BOND YIELD FORECASTS

US Treasuries US swap spreads

Fed funds 3m Libor 2y 5y 10y 30y 10y RY 2y 5y 10y 30y

Q1 13 0.00-0.25 0.25 0.20 0.75 1.80 2.90 -0.95 Q1 13 15 10 5 -20

Q2 13 0.00-0.25 0.25 0.20 0.65 1.60 2.70 -1.00 Q2 13 15 10 5 -20

Q3 13 0.00-0.25 0.20 0.20 0.65 1.60 2.75 -1.00 Q3 13 15 10 5 -20

Q4 13 0.00-0.25 0.20 0.20 0.65 1.60 2.75 -1.00 Q4 13 15 10 5 -20

Euro government (Germany)

Euro area swap spreads

Refi rate 3m 2y 5y 10y 30y 10y RY 2y 5y 10y 30y

Q1 13 0.5 0.20 0.10 0.50 1.60 2.30 -0.15 Q1 13 40 40 30 5

Q2 13 0.5 0.20 0.10 0.60 1.70 2.40 -0.10 Q2 13 40 40 30 5

Q3 13 0.5 0.25 0.15 0.65 1.75 2.45 -0.10 Q3 13 40 40 30 5

Q4 13 0.5 0.25 0.20 0.70 1.80 2.50 -0.10 Q4 13 40 40 30 5

UK government

UK swap spreads

Bank rate 3m 2y 5y 10y 30y 10y RY 2y 5y 10y 30y

Q1 13 0.50 0.55 0.40 1.05 1.90 3.10 -0.50 Q1 13 40 20 10 -15

Q2 13 0.50 0.55 0.45 1.20 2.05 3.15 -0.45 Q2 13 35 15 5 -10

Q3 13 0.50 0.57 0.55 1.35 2.25 3.20 -0.35 Q3 13 35 15 0 -10

Q4 13 0.50 0.60 0.65 1.50 2.40 3.30 -0.30 Q4 13 30 10 0 -10

Japan government

Japan swap spreads

Official rate 3m 2y 5y 10y 30y 10y RY 2y 5y 10y 30y

Q1 13 0.10 0. 20 0.10 0.15 0.70 1.90 0.30 Q1 13 15 11 0 -4

Q2 13 0.10 0. 20 0.10 0.15 0.70 1.90 0.40 Q2 13 15 12 1 -4

Q3 13 0.10 0. 20 0.10 0.15 0.75 1.95 0.50 Q3 13 15 13 2 -10

Q4 13 0.10 0.20 0.10 0.15 0.80 2.00 0.50 Q4 13 15 13 3 -10

Australia government

Official Rate 3y 5y 10y AU-US 10y

Q1 13 3.00 2.85 3.10 3.35 1.55

Q2 13 3.00 2.85 3.05 3.20 1.60

Q3 13 3.00 2.90 3.10 3.30 1.70

Q4 13 3.00 2.95 3.15 3.35 1.75

Source: Barclays Research

Barclays | Global Rates Weekly

10 January 2013 72

GLOBAL RATES RESEARCH

Global

Ajay Rajadhyaksha Head of Rates and Securitised Products Strategy +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

Igor Zoubarev Fixed Income Strategy +1 212 526 5518 igor.zoubarev@barclays.com

Europe

Laurent Fransolet Head of European Fixed Income, Commodities and Credit Research +44 (0)20 7773 8385 laurent.fransolet@barclays.com

Alan James Global Inflation-Linked Strategy +44 (0)20 7773 2238 alan.james@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

Stuart Urquhart European Strategy +44 (0)20 7773 8410 stuart.urquhart@barclays.com

Marcus Widen Fixed Income Strategy +44 (0)20 3134 5632 marcus.widen@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

Chotaro Morita Head of Fixed Income Strategy Research, Japan +81 3 4530 1717 chotaro.morita@barclays.com

Reiko Tokukatsu Senior Fixed Income Strategist, Japan +81 3 4530 1532 reiko.tokukatsu@barclays.com

Gavin Stacey Fixed Income Strategist, Australia and New Zealand +61 2 933 46128 gavin.stacey@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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