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					INTEREST RATES RESEARCH                                                                     Global Rates Strategy | 9 March 2012




GLOBAL RATES WEEKLY
PSI gone, inflation up
                                                                                            Global Views on a Page                        2
The Greek PSI has been agreed but the ECB’s upwardly revised inflation forecasts limit
                                                                                            Global Traders’ Guide                         45
further stimulus for the European economy.
                                                                                            Global Economics Calendar                     46
United States
                                                                                            Global Supply Calendar                        50
Treasuries: A new Twist                                                             3
                                                                                            Global Bond Yield Forecasts                   51
We expect the effect of sterilized QE3 to be small on front-end rates, as Fed hikes
expectations should be simultaneously pushed out in such a scenario. The stock effect
of such a program should also be lower than that of Operation Twist.                        United States

Agencies: A return to normalcy?                                                        7    Ajay Rajadhyaksha
                                                                                            +1 212 412 7669
Swaps: Revisiting the refinancing wavelet                                             10
                                                                                            ajay.rajadhyaksha@barcap.com
Money Markets: Bank funding rates: Survey or transaction?                             14
TIPS: Higher energy prices twist the breakeven curve                                  17
                                                                                            Michael Pond
Volatility: Hedge with Bermudans                                                      20
                                                                                            +1 (212) 412 5051

Europe                                                                                      michael.pond@barcap.com

Euro: Greek PSI: almost done, with success                                        24        Rajiv Setia
Greek PSI deal to go ahead: 95.7% participation reached after use of CACs on domestic       +1 212 412 5507
law bonds. Headline risk now lower.                                                         rajiv.setia@barcap.com

Money Markets: Money markets: low rates, and more stability                           26    Europe
Sovereign Spreads: Spain vs Italy                                                     29    Laurent Fransolet
                                                                                            +44 (0) 20 7773 8385
UK: Tangled up in red                                                                 32    laurent.fransolet@barcap.com
The public finance projections in the Budget on 21 March are likely to be broadly akin to
those published in November 2011. We retain our current view for gilt issuance of           Alan James
£185bn. The risk to this number lies towards a lower number given uncertainties over        +44 (0) 20 7773 2238
the timing of cash measures.                                                                alan.james@barcap.com

Euro Inflation-Linked: Bracing for a Q2 supply bonanza                                37    Japan
Volatility: EUR 5y tails: Too high to buy                                             39    Chotaro Morita
                                                                                            +81 (3) 4530 1717
Australia                                                                                   chotaro.morita@barcap.com
Model update: AU curve still too flat, despite recent steepening                      41
Earlier this week, we recommended an AU 3s10s curve steepener at 37bp                       www.barcap.com

Japan
                                                                                            EUROMONEY FIXED INCOME INVESTORS
Market’s response function to investor sentiment                                      42    SURVEY 2012
JGB market sentiment peaked last December, but we have not seen the usual pattern, in       Voting has begun for the Euromoney Fixed
which a peak is followed immediately by a bearish market. We attribute this largely to      Income Investors Survey 2012. Barclays
                                                                                            Capital would welcome your support. To
the impact of the BoJ’s latest easing. However, we should also recall the case of 2003,     vote, please click on the Euromoney Survey.
when sentiment eventually began to weaken with a significant lag after hitting its peak.



PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 52
Barclays Capital | Global Rates Weekly


VIEWS ON A PAGE
                US                                                                     EUROPE                                                                  JAPAN
 Direction      10y yields likely to remain range-bound around 2%, given               The passage of the Greek PSI deal removes a key uncertainty from       Given the BoJ’s latest easing, we believe the short end of the
                 modest growth expectations and the threat of fiscal                     the market. Focus will now turn to the political process and              curve will remain flat for a prolonged period.
                 tightening.                                                             upcoming elections.                                                    However, if the 2y-5y spread drops below 20bp, there could
                With talk of sterilized QE picking up, we are turning neutral on       QE has been extended by £50bn, with the BOE’s purchase                    be an eventual rebound.
                 our 2s3s steepener view, as the payoff no longer seems                  programme continuing to see a net duration withdrawal from             Overall, we maintain our forecast of bear steepening and
                 asymmetric                                                              the market over the next three months.                                    recommend a short position at around 10y 0.9%.
                Stronger data should steepen the curve, but weaker data
                 could flatten the curve, as odds of sterlization would increase
                 at the same time.

 Curve/         We are turning neutral on our 10s30s Treasury curve                    Keep Schatz/Bund steepener.                                              JGB2-5-10 short
 Curvature       steepeners view, given the 5bp steepening since the                    Hold onto long EUR 2s/5s/10s 6m fwd.                                     JGB 10-30 flattener
                 beginning of the month.                                                For long-end steepening, receive EUR 5y5y fwd/5y10y                      Swap 10s20s bull steepener.
                Expectations of QE3 have been greatly pared back. We                      fwd/5y15y fwd and long EUR 5s/10s/30s.                                 Swap 10s20s steepener.
                 remain long the 5s10s30s fly.                                          UK: the redefining of the maturity baskets for the BOE’s reverse
                                                                                         operations leaves potential buying more evenly distributed. The 20y
                                                                                         sector has borne the brunt of the curve correction but should
                                                                                         stabilise here. Fall in realised vol leaves carry/vol ratio highest for
                                                                                         bonds in the 2017-2020 part of the gilt curve.
                                                                                        Change in MPC rhetoric should see bearish resteepening of the
                                                                                         GBP forward curve. Pay GBP 1y2yf/1y4yf spread.
 Swap           2y1y-4y1y curve flattener as a positive carry protection trade         EUR: Keep short Bund ASW view on a medium- to long-term                  20y ASW long vs 3m.
 spreads           against risk returning.                                               basis.                                                                   Long 10y ASW.
                Receive 7s-10s-30s (2/3:1:1/3 wts) as a dislocation trade.             GBP: 10y10y fwd ASW is cheap relative to other parts of the              Short 5Y ASW.
                30y spread tighteners for asymmetric tightening risk.                   ASW curve. Long 20yr ASW vs 10yr ASW.
 Other          Front-end agencies have continued to outperform Treasuries;            Retain long Gilts versus Bunds. Yield plus roll and carry pick-up      20y 3v6 tightener.
 spread          we recommend moving out to the 5y sector (and 10y, where                  is of increasing interest to international investors.                5-10y Tibor-Libor spread steepener. (Note: for clarity, Tibor-
 sectors         feasible). For investors uncomfortable with extending out the            Long 30y gilts versus Germany or AAA Europe.                            Libor widener means that the swap rate against Tibor
                 curve, MTNs pick up several bp to front-end bellwethers while            SEK: Hold SEK/EUR 2y2y/5y5y fwd steepeners. and 5y SGB (1050)           increases more than the swap rate against Libor. Therefore,
                 giving up relatively little liquidity.                                    ASW tighteners. ,Hold Dec 12/Dec 12 3m FRA steepeners.                  steepener means that the 10y Tibor-Libor spread widens
                We remain constructive on Canadian covered bonds, given                  NOK: Hold cross-market tighteners in 5y5yfwd versus EUR.                more than the 5y Tibor-Libor spread. In previous issues, we
                 their relative isolation from Europe and continued significant           Hold BTP and Spain 2s/10s flatteners.                                   called it a 5-10y Tibor-Libor spread flattener.)
                 spread pickup to agencies.
                                                                                          Long 5yr Netherlands versus 50% 5yr France and 50% Belgium.
 Inflation      Long longer-dated forward breakevens, as the market has not              Front end euro linkers value given rising short-term inflation       Take profit on long BEI.
                    priced in enough risk premium.                                         prospects, 5-10y upside limited by potentially heavy Q2 supply
                   Positive on short breakevens, hedged with crude puts. Long            Front end breakevens are supported by oil while longer dated
                    front-end TIPS ASW for better carry, hedged with 2y floors.            linkers may be supported by asset allocation out of nominal
                   Long the belly of Jan16-Apr16-Jul16 real yield fly, as the floor       gilts
                    premium on new 5s could rise with risk aversion.
 Volatility       Sell mid-tail gamma (3m*10y, TYM2) to benefit from                   ECB-on-hold expectations should pull mid-left and 5y tails lower.      Long 3mx10y volatility.
                    rangebound rates.                                                   Sell 2y5y as part of 2y5y versus 2y30y bear steepener (along with
                  Buy 1y*1y payer spreads to hedge an unexpected blow-out in              selling 5y-30y curve cap).
                    FRA-OIS.                                                            Buy EUR 3y*10y high-strike payer vs. US 3y*10y high-strike payer to
                  Initiate 2y*10y versus 2y*30y bear steepeners to benefit from           position for richening of EUR vol and skew relative to the US.
                    steepening of the rate and vol curve.
Source: Barclays Capital




9 March 2012                                                                                                                                                                                                                 2
Barclays Capital | Global Rates Weekly


UNITED STATES: TREASURIES

                                         A new Twist
                    Anshul Pradhan       We expect the effect of sterilized QE3 to be small on front-end rates, as Fed hikes
                    +1 212 412 3681      expectations should be simultaneously pushed out in such a scenario. The stock effect
     anshul.pradhan@barcap.com           of such a program should also be lower than that of Operation Twist. The recently
                                         released flow of funds data suggest that supply-demand dynamics should remain in
                                         balance post-Operation Twist; however the long end may have to cheapen to
                                         encourage long term investors to reverse their reduced involvement.

                                          The Treasury market remained largely range-bound over the week, as a spike in risk
                                         aversion in the middle of the week faded as a majority of investors agreed to participate in
                                         the Greek debt swap; equity markets and VIX reversed their mid-week moves. Economic
                                         data were, on the margin, stronger than expected; ISM non-manufacturing, factory orders
                                         and unit labor costs surprised to the upside. The payroll report was also stronger, as prior
                                         months gains were revised up 61K; the unemployment rate remained unchanged as the
                                         labor participation rate rose. Offsetting this was a downward revision to Q1 GDP estimates
                                         (our economists are now tracking 1.5%) and the news about sterilized QE3, which was
                                         perceived as increasing the odds of QE3 itself, as the Chairman’s latest testimony did not
                                         mention further stimulus.

                                         Sterilized QE3 is very similar to Operation Twist: in both programs, the purchase of longer
                                         duration securities is being funded with sales of shorter tenor securities. In the latter, this
                                         was done via selling 3m-3y Treasuries; in the former, this could be achieved by doing
                                         reverse repurchase operations (or term deposits). In both cases, the level of excess reserves
                                         stays unchanged. Our money market strategist expects short rate to rise 10-15bp if the Fed
                                         goes down this route (please see “Weekly Fed update” for details); however, one should not
                                         expect short-term coupon Treasuries to cheapen by the same magnitude, for a few reasons.

                                         First, for sterilized QE3 to happen, the case for QE3 itself needs to be strong. Weakening
                                         data should push out Fed hike expectations, putting downward pressure on 2-3y Treasuries
                                         (Figure 1). Second, the program is unlikely to run parallel with Operation Twist, given that


Figure 1: Sterilized QE should have a limited effect on front          Figure 2 : Tsy-OIS basis unlikely to cheapen as much as
end rates as Fed hike expectations should be pushed out                under Operation Twist

 0.8                                                                    16
 0.7                                                                    14
 0.6                                                                    12
 0.5                                                                    10

 0.4                                                                      8

 0.3                                                                      6
                                                                                                      8-9bp
 0.2                                                                      4

 0.1                                                                      2

 0.0                                                                     0
  Mar-12       Sep-12 Mar-13 Sep-13 Mar-14 Sep-14                        Mar-11           Jun-11       Sep-11       Dec-11     Mar-12
                 Fed Funds Rate as implied by FF futures, %                                        2y Tsy-OIS basis, bp
Source: Bloomberg                                                      Source: Treasury


9 March 2012                                                                                                                            3
Barclays Capital | Global Rates Weekly


                                           the earliest it can be announced is at the April FOMC meeting. To the extent there is a flow
                                           effect, sterilized QE3 would be simply replace Operation Twist. Third, the stock effect of
                                           such a program should be lower than that of Operation Twist because the market is also
                                           likely to price in the scenario in which inflation concerns recede, which presumably was the
                                           reason to sterilize to begin with, and the Fed would stop sterilizing and let excess reserves
                                           rise. Hence, expectations of a hypothetical 2y term repo rates should rise less than the spot
                                           repo rates. In contrast, under Operation Twist, the stock of debt held by private investors
                                           has permanently gone up. Judging from the market reaction to Operation Twist, only a 5bp
                                           or so effect on the 2y Tsy-OIS should be expected (Figure 2). Finally, it is entirely possible
                                           that the Fed cuts the IOER to mitigate the effect on front-end rates. Hence, if 2y Treasuries
                                           were to breach 35bp, we would recommend going long.

                                           Flow of funds: Gauging the supply/demand dynamics
                                           Supply dynamics remain favourable
                                           Earlier in the week, the Federal Reserve released the flow of funds data for Q4 11, which
                                           suggested there continues to be almost no net issuance outside the Treasury market. Figure
                                           3 shows net issuance of fixed income products split between coupon Treasury and spread
                                           products over a one-year period for the past decade. As can be seen, even though Treasury
                                           issuance is well above pre-crisis levels, overall fixed income issuance is well below. While
                                           Corporates have been issuing bonds to take advantage of low yields, the steady shrinkage
                                           of the securitized universe is providing an offset (Figure 4).

                                           This year, net term FI supply should decline even further, led by lower net coupon Treasury
                                           issuance. Were the Treasury to keep gross coupon issuance sizes the same through the end of
                                           the year, net coupon issuance should be $975bn, as compared with $1.3trn in 2011, as the
                                           amount of debt coming up for maturity in 2012 is much higher than that in 2011. We believe
                                           the trend will continue into 2013, with net issuance of $910bn. There is a risk of a faster
                                           decline if the Treasury reduces front end coupon sizes to preserve the amount of very short-
                                           term high grade assets (T-bills and potential FRNs). While corporates are likely to continue to
                                           issue debt, the securitized universe should also keep shrinking, providing an offset, and with
                                           GSEs in run-off mode, we expect there to be no reversal in trends there either.



Figure 3: Total net FI issuance well below pre-crisis levels,            Figure 4: …as shrinkage in securitized products and agency
net issuance of spread products remain close to nil…                     debt continues to offset corporate issuance.

  1y Net Supply, $bn                                                      $bn
 2,500                                                                    1,500         1,319
                                                                          1,250
 2,000                                                     -$1trn         1,000                               695                     623
                                                                            750
 1,500
                                                                            500                                     272 282                      284
                                                                                    178           146                                       94
 1,000                                                                      250
                                                                              0
   500                                                                     -250                         -59                    -132
                                                                           -500                                                                       -249
      0
                                                                                                                             Agency



                                                                                                                                       Agency




                                                                                                                                                  Securitized
                                                                                                    Munis
                                                                                     Treasuries




                                                                                                                Corp Bonds



                                                                                                                              Debt



                                                                                                                                        MBS
                                                                                      ex-bills




                                                                                                                                                    Other




  -500
    Dec-03           Dec-05       Dec-07          Dec-09        Dec-11
          Fixed Income        Treasury ex-bills       Spread Products                      Net Issuance, 2007                 Net Issuance, 2011
Source: Federal Reserve                                                  Source: Federal Reserve


9 March 2012                                                                                                                                                    4
Barclays Capital | Global Rates Weekly


                                         Aggregate domestic demand remains strong
                                         At the same time, domestic demand remains strong, even as foreign demand has declined
                                         somewhat. In Figure 5, we tabulate the net demand across products and across investor
                                         classes for 2011. While the Fed was by far the largest buyer in the Treasury universe, that
                                         was not the case when looking at the overall fixed income universe. Mutual funds bought
                                         ~$457bn in FI securities, though mostly in the agency and corporate universes, slightly
                                         more than the $444bn bought by the Fed. Similarly, while foreign investors bought $369bn
                                         in US treasuries, they purchased $258bn of overall FI Securities. Pension funds and
                                         insurance companies bought more. Hence, it seems that the US fixed income market is
                                         becoming less reliant on foreign inflows thanks to the relatively higher savings rate.

                                         Figure 5: Ex-Fed, net fixed income supply was mainly absorbed by domestic investors
                                         Net Supply-Demand of FI Treasury- ex-             Municipal        Agency            Corporate
                                         Securities, 2011            bills                 Securities      Securities          bonds*             Total
                                         Mutual Funds                          63              17              164               212               457
                                         Federal Reserve                      642               0              -198                 0              444
                                         Pension / Insurance                  106               5                14               145              270
                                         Rest of the World                    369             11                -56               -66              258
                                         Banking Sector                       -29              43              141                -15              140
                                         Money Market Funds                   78              -38                1                -25              16
                                         Treasury                               0              0               -118                0              -118
                                         Households                            40             -79               -23              -105             -166
                                         Others                                53             -14               38               -124              -47
                                         Total                               1,323            -53               -37                22             1,254
                                         Note: Corporate bonds include securitized products. Agency securities include debt and MBS. Others include
                                         broker/dealers. Source: Federal Reserve

                                         As the Fed steps back, private investors need to step up. However, with net Treasury
                                         coupon issuance declining ~$350bn in 2012 vs. 2011, the gap that needs to be filled on an
                                         aggregate level is much lower, at ~$100bn. We believe in an environment of moderate
                                         growth, this additional demand is likely to come from terming out of short-term assets.
                                         Figure 6 shows that since the beginning of the year, money market funds have shrunk in
                                         favour of longer duration assets. While outflows out of equity funds have declined, that has
                                         not come at the expense of inflows into bond funds. Unless growth expectations are revised
                                         up significantly, which was the case in early 2011, when inflows into bond funds did indeed
                                         slow, such inflows are likely to keep increasing.

Figure 6: Investors terming out of money market funds into                    Figure 7: Demand for Treasuries from private pension funds
bond funds as well as equity funds                                            has slowed down
   2M annualized inflows, $bn                                                    Private Pension Funds, Net Demand over a 1 year period, $bn
    600                                                                         300
    400                                                                         200
    200
                                                                                100
      0
   -200                                                                              0
   -400                                                                        -100
   -600
                                                                               -200
   -800
 -1,000                                                                        -300
 -1,200                                                                          Dec-06        Dec-07       Dec-08     Dec-09     Dec-10              Dec-11
                                                                                                         Credit Market Instruments
      Aug-10 Nov-10 Feb-11 May-11 Aug-11 Nov-11 Feb-12
                                                                                                         of which Treasuries
              Equity Funds           Bond funds
                                                                                                         of which Agency securities
                   Money Market Funds                                                                    Corporate Equities

Source: Haver Analytics                                                       Source: Federal Reserve

9 March 2012                                                                                                                                                   5
Barclays Capital | Global Rates Weekly


                                         While ex-ante demand is likely to be in spread-products, with little net issuance outside the
                                         Treasury universe, investors would invariably get displaced into the Treasury market. For
                                         instance, in 2011, the Fed and the Treasury sold $315bn in agency MBS, which was
                                         absorbed by the mutual funds and the banking sector. With very marginal flows of this kind
                                         in 2012 (Treasury had only $28bn left to sell at the end of 2011) and agency MBS having
                                         richened significantly, demand from these investors should be more balanced. We expect
                                         Treasury issuance post Fed involvement to be mainly accounted for by foreign investors,
                                         mutual funds, banks and pension/insurance companies. As discussed below, the latter
                                         group would require higher term premium to step up its purchases of the long end.

                                         Long-term investors have reduced involvement in the Treasury market
                                         Even though aggregate demand is likely to keep pace with supply, there are signs that
                                         investors have stepped back from long end Treasuries due to a flatter curve. As the Fed
                                         completes Operation Twist by the middle of this year, the long end needs to cheapen
                                         relative to the rest of the curve to attract these investors back into the Treasury market.

                                         Figure 7 shows private pension funds bought ~$80bn in Treasuries in 2011, compared with
                                         ~$175bn in 2010. While their demand for overall fixed income securities remained stable at
                                         ~$100bn, as they continued to move away from equities, the switch from Treasuries to
                                         Agency securities suggests that duration of their fixed income portfolio may have shrunk.
                                         To incentivize them to extend duration again, term premium at the back end needs to be
                                         higher. Similarly, life insurance companies have also slowed their purchases of Treasuries,
                                         though to a much lesser extent, as they were not large participants in the Treasury market
                                         to begin with. Figure 8 shows that they bought $5bn in 2011 as compared with $25bn in
                                         2010. Again, this was offset by higher purchases of agency securities.

                                         Aggregated across long-term investors, public/private pension funds and life insurance
                                         companies, net purchases of Treasuries declined to $90bn 2011 from $210bn in 2010
                                         (Figure 9). On the other hand, we expect the Treasury to issue ~$195bn at the long end
                                         ($168bn in 30y nominal Treasury and another $27bn of 30y TIPS) over the one year
                                         following Operation Twist. In the absence of the Fed, these investors will need an incentive
                                         to step up to fill the gap. We expect the Treasury curve gradually to steepen and long-end
                                         swap spreads to tighten for the same reason as well.




Figure 8: The same is the case for life insurance companies           Figure 9: Long end needs to cheapen relatively to attract
                                                                      long-term investors

  Life Insuance Companies, Net Demand over a 1 year period, $bn         Net Treasury Purchase of Long term investors, $bn
  200                                                                   250
  150
  100                                                                   200
    50
                                                                        150
     0
   -50
                                                                        100
 -100
    Dec-06       Dec-07    Dec-08     Dec-09     Dec-10    Dec-11
                                                                         50
                          Credit Market Instruments
                          of which Treasuries
                          of which Corporate bonds                       0
                          of which Agency securities                     Dec-06       Dec-07    Dec-08    Dec-09     Dec-10   Dec-11

Source: Federal Reserve                                               Source: Federal Reserve


9 March 2012                                                                                                                           6
Barclays Capital | Global Rates Weekly


UNITED STATES: AGENCIES

                                               A return to normalcy?
                           James Ma            We continue to recommend 5y agencies versus Treasuries, given the steep rolldown
                   +1 212 412 2563             along the spread curve. Supply technicals could paint a more positive picture for USD
           james.ma@barcap.com                 covered bonds and SSA paper in the near to medium term.

                           Rajiv Setia
                                               Spreads stabilize
                   +1 212 412 5507             With the exception of the very front end, agency bellwether valuations have generally
           rajiv.setia@barcap.com              remained stable over the past two weeks. We maintain our view that the agency-Treasury
                                               spread curve appears steep, and continue to recommend owning the 5y sector (at T+24bp)
                                               to investors looking for pickup over Treasuries, especially given the spread rolldown into the
                                               front end (5bp in 2s and 11bp in 3s).

                                               Further in the curve, we believe that very front-end sectors are now more susceptible to
                                               new supply activity. Even as 2-3y Treasury yields have backed up to the high end of their
                                               recent range, agency-Treasury spreads have tightened to levels not reached since Q2 11.
                                               Agencies have also kept pace with the dramatic compression in front-end swap spreads,
                                               and 2y in the L-20bp region appear to be the most likely point for new supply. At these
                                               valuations, investors will likely demand a hefty new-issue concession.

                                               To be clear, we are not looking for any significant cheapening in agency spreads; the rich
                                               valuations are merely symptomatic of favorable supply technicals and a lack of high-quality
                                               alternatives across sectors. As another example of this, consider that par-price new-issue
                                               callable yields in the front end are converging to those of similar-maturity bullets: a 3nc2
                                               European structure yields 0.61%, versus FNM 3/15s at 0.58%. On an LOAS basis, the
                                               callable (at L-17bp) even appears rich to the bullets at L-11bp.

                                               SSA/covered bonds supply and spreads
                                               Recall that earlier this year, we had opined on the somewhat counterintuitive dynamics
                                               between supply and spreads in the SSA and covered bond markets; along with agencies,
                                               both asset classes outperformed despite significant new issuance activity. We believe that
                                               recent price action in those same markets is more consistent with supply activity, and


Figure 1: Agency-Treasury spread curve stays steep                           Figure 2: USD SSA and covered bond supply diverges

    Agy-Tsy spd crv, bp                                                       $ bn
 40                                                                           35
 35                                                                           30
 30
                                                                              25
 25
 20                                                                           20
 15                                                                           15
 10
                                                                              10
  5
                                                                                5
   0
  -5                                                                            0
  Mar-10        Aug-10        Jan-11       Jun-11       Nov-11                   Jan-10          Jul-10   Jan-11       Jul-11      Jan-12

                                       3s-5s        3s-10s                                                  SSA    Covered

Source: Barclays Capital                                                     Source: Barclays Capital


9 March 2012                                                                                                                                7
Barclays Capital | Global Rates Weekly


                                         expect this pattern to drive valuations in the near term. Consider that while USD SSA
                                         issuance activity has plummeted month-to-date after a torrid January-February, supply
                                         activity in USD covered bonds has ramped up (Figure 2).

                                         USD covered bonds
                                         In the USD covered bond space, the recent spate of issuance – totaling $8.5bn in just the
                                         past two weeks – has put a temporary halt to covered bonds’ recent outperformance,
                                         especially in Canada and Australia (Figure 3). However, we do not think USD covered bonds’
                                         previous outperformance is out of line relative to the recent performance of the issuing
                                         banks’ unsecured debt, as well as the tightening in sovereign CDS globally (Figures 4 and 5).

                                         Our European colleagues expect the global pickup in covered bond supply to continue this
                                         month (across currencies) before reducing in April. 1 Much of this is predicated on European
                                         banks’ funding through the LTRO, which would be unavailable to larger USD issuers.

                                         Thus, we believe the outlook for potential USD covered bond issuance is somewhat more
                                         mixed in the near term, but paints a rosier picture longer term regarding the supply
                                         technical. We continue to favor names that are relatively isolated from Europe, such as
                                         Australian and Canadian issuers; the majority of the latter also benefit from a government
                                         guarantee on the cover pool collateral, and Canada’s fiscal metrics generally compare
                                         favorably with, for example, those of the US.

                                         SSA paper
                                         By contrast, our European colleagues expect SSA issuers to steadily reduce their funding
                                         activity from now through April; EIB and KFW, the two largest issuers, are already 35% and
                                         40% through their 2012 funding slates as of this writing, respectively.

                                         Together with the seasonal lull in issuance activity that could last until late summer, we
                                         would expect a positive supply technical to keep grinding SSA valuations tighter to
                                         agencies. Recall that we had recommended SSA paper over agencies earlier, and continue
                                         to do so with KFW and EIB at 15bp and 35bp behind agencies, respectively. 2 However, as we
                                         remain wary of headline risks driven by lingering European sovereign debt concerns, we
                                         would turn neutral if the outperformance continues for another 5-10bp.


Figure 3: USD covered bond outperformance has paused                             Figure 4: Australian covered bonds vs. senior debt, CDS

 L Spd, bp                                                                          bp
 160                                                                               210
 140                                                                               190
 120                                                                               170
 100                                                                               150
   80                                                                              130
   60                                                                              110
   40                                                                               90
   20                                                                               70
    0                                                                               50
  26-May-11            26-Aug-11      26-Nov-11             26-Feb-12               21-Nov-11       18-Dec-11          14-Jan-12   10-Feb-12   8-Mar-12

                  CS 2.6 5/16                 BNS 2.15 8/16                                       ANZ 2.45 11/16 (Cov)             ANZ 3.25 3/16 (Snr)
                  SPNTAB 2.125 8/16           ANZ 2.4 11/16                                       5y Aus CDS

Source: Barclays Capital                                                         Source: Barclays Capital


                                         1
                                             “Short-term supply update,” The AAA Investor, 2 March 2012.
                                         2
                                             “A fat year or a lean year,” Market Strategy Americas, 9 February 2012.

9 March 2012                                                                                                                                              8
Barclays Capital | Global Rates Weekly


                                         Freddie Mac 4Q11 earnings: First impressions
                                         Shortly before press time, Freddie Mac reported its 2011 financial results, posting a Q4 gain
                                         of $619mn before paying $1.7bn in preferred dividends to the Treasury. At first glance, we
                                         believe the following were major drivers of the improvement:

                                            Net interest income was $4.7bn in Q4, a slight improvement from $4.6bn in Q3, as the
                                             decline in funding costs continued to outstrip the decline in portfolio coupon income.

                                            Derivative fair-value losses declined sharply, to $770mn in Q4 from $4.8bn in Q3; this
                                             was consistent with relatively rangebound rates during the period.

                                            Credit loss provisioning continued to reduce, to $2.6bn in Q4 from $3.6bn in Q3. This
                                             squares with our view that the GSEs have already taken cumulative provisions equal to
                                             the vast majority of credit losses from the legacy g-book.

                                         After subtracting dividends from net income, the loss to taxpayers of $1.0bn was offset by a
                                         roughly $850mn mark-up in AOCI, reducing ultimate draws on the Treasury to just under
                                         $150mn (keeping cumulative draws at just over $72bn). We find this consistent with our
                                         earlier projections that the GSEs should be on the cusp of profitability (before dividends to
                                         the Treasury) in 2012. However, we believe Treasury will need to amend the 10% senior
                                         preferred dividend rate by year-end to soothe investor concerns in 2013.

                                         FHFA releases timeline for Strategic Plan
                                         Also shortly before press time, the FHFA provided a roadmap for its previously announced
                                         Strategic Plan, designed to continue oversight of FNM/FRE in conservatorship, in the
                                         absence of a housing finance reform plan. Some relevant milestones:

                                            September 30, 2012: Prepare for competitive disposition of a pool of NPA and a pilot
                                             REO sales program and undertake further risk-sharing transactions.

                                            December 31, 2012: Develop a plan for a single securitization platform that can serve
                                             FNM/FRE and a post-conservatorship market independent of taxpayer support.

                                         While FHFA is clearly proposing serious steps to reform housing finance, the bottleneck is
                                         likely to be in Congress, where little progress is expected until well into 2013, if not later.


Figure 5: Canadian covered bonds vs. unsecured                         Figure 6: SSA outperformance in USD of late

       CCDJ 2.65 9/15 (Snr)                                             ASW, bp
 140                                                                     100
 130
 120                                                                      80
 110                                                                      60
 100
  90                                                                      40
  80
                                                                          20
  70
  60                                                                       0
  50
  40                                                                     -20
       20              40           60             80         100          Jun-11         Aug-11      Oct-11     Dec-11    Feb-12

                            CCDJ 2.55 9/15 (Cov)                                  FNM 5y           FRE 5y      KFW 5y     EIB 5y

Source: Barclays Capital                                               Source: Barclays Capital



9 March 2012                                                                                                                           9
Barclays Capital | Global Rates Weekly


UNITED STATES: SWAPS

                                         Revisiting the refinancing wavelet
                   Amrut Nashikkar       Talk of sterilized mortgage purchases and another presidential proposal have led to a
                   +1 212 412 1848       renewed discussion of issues related to mortgage refinancing. We think that modified
   amrut.nashikkar@barcap.com            HARP in its current form will have a small duration effect. For a significant effect, a
                                         much more drastic program would be needed.

                                         Over the past week, press reports led to some speculation in the market about the
                                         possibility of the Fed conducting mortgage purchases and sterilizing them by conducting
                                         reverse repos. This has some significance because in a recent white paper that the Fed
                                         submitted to Congress, it identified housing finance as a key constraint for the economic
                                         recovery. At the same time, the effects of the administration’s changes to the
                                         Homeowner Affordable Refinancing Program (HARP 2.0) are filtering through, the
                                         president has a new housing proposal, and banks have been discussing expansions of
                                         their mortgage businesses as HARP 2.0 is implemented. In our piece titled Refi wave: Only
                                         a wavelet in rates, 6 October 2011, we had considered some of the issues raised by HARP
                                         2.0. But as time has passed, there has been more clarity around both the implementation
                                         and the effects of HARP 2.0.

                                         What was HARP 2.0?
                                         From the point of view of the duration market, the major changes in HARP were generally of
                                         two types.

                                            Expanding the HARP universe, such as removing the 125 LTV cap. However, the more
                                             drastic changes that we had imagined in our previous piece, such as extending HARP
                                             2.0 to mortgages originated after June 2009, are not under consideration.

                                            Increasing the efficiency of refinancing. These include simplifying loan level pricing
                                             adjustments, harmonising the Freddie and Fannie refinancing processes, using the
                                             automated appraisal system, and changing the reps and warranties policies regarding
                                             refinanced loans.


Figure 1: As rates have rallied, speeds have increased on             Figure 2: Pre-2009 fixed rate 30y mortgages have already
HARP eligible vintages                                                shrunk considerably

                                                                        $tn
 1m CPR                                                     %
                                                                       3.5
 32                                                          4.3
 30                                                                    3.0
                                                               4.2
 28
                                                                       2.5
 26                                                            4.1
                                                                       2.0
 24
                                                               4.0
 22                                                                    1.5
 20                                                         3.9
                                                                       1.0
  Sep-11       Oct-11    Nov-11      Dec-11    Jan-12   Feb-12
                                                                         Jan-09    Jul-09   Jan-10     Jul-10   Jan-11    Jul-11    Jan-12
              FNCL 5.5 2006               FNCL 5.0 2006
              FNCL 6.0 2006              Avg par coupon, RHS                                         30y fixed pre Jun 09 balance

Source: Barclays Capital                                              Source: CPR-CDR


9 March 2012                                                                                                                                 10
Barclays Capital | Global Rates Weekly


                                             Separately, last week, the administration around changes to the FHA program (Ginnie
                                              Maes), such as reducing MIPs, to spur refinancing.

                                         Have prepayment speeds picked up?
                                         Figure 1 shows, through the example of 2006 30y fixed mortgages, that as rates have rallied
                                         over the past few months, there has been an increase in prepayment speeds. This is
                                         generally true across all HARP-eligible vintages. However, it is unclear how much of the
                                         most recent rise is attributable to rates, and how much of it was because of HARP changes.
                                         Given that changes to the program would have a lagged effect, the question for rates
                                         investors is whether these changes will cause an unexpected increase in mortgage duration
                                         supply that the market will have to take down over the next few months.

                                         How much refinancing had already occurred through HARP?
                                         Figure 2 shows the outstanding balance of pre-2009 30y fixed rate conventional mortgages,
                                         which is a proxy for the size of the HARP-eligible universe. As can be seen, by December
                                         2011, it was already nearly half of what it was in 2009. There were a couple of reasons for
                                         this decline. Many of these loans had already slowly prepaid over the previous three years.
                                         Others went delinquent and were bought out by the GSEs. As a result, there has not been a
                                         significant duration effect as the mortgage universe has slowly reconfigured. If the new
                                         HARP rules had been implemented at the inception of the program, they would have
                                         resulted in significantly higher duration supply and, as a consequence, had a much bigger
                                         rate effect than they will now.

                                         How much of an effect will HARP changes have on the duration market?
                                         Figure 3 shows the 1y S-curves for the pre-HARP 30y fixed-rate mortgage universe and our
                                         mortgage modeling team’s expectation of what the S-curve could look like under HARP 2.0.
                                         It also shows the S-curve for post June 2009 vintages, excluding those loans that were
                                         originated through the HARP channel (these loans are likely to prepay slowly). There are
                                         two key takeaways from the chart. First, modifications to the HARP program are likely to
                                         result in increased speeds of 5-10CPR at an aggregate level on the HARP eligible universe.
                                         Considering that the universe of 30y fixed-rate loans originated prior to June 2009 had
                                         shrunk to nearly $1.4tn by December, this would imply mortgage originations of $70-140bn.



Figure 3: S-curves of pre-2009 mortgages are considerably             Figure 4: Primary mortgage rates quite sticky even when
flat, but could get bumped higher because of HARP 2.0                 secondary yields rally

 1y CPR %                                                                bp                                                  %
 35                                                                    130                                                       4.5
 30
                                                                       125
 25                                                                                                                              4.0
                                                                       120
 20
 15                                                                    115                                                       3.5

 10                                                                    110
                                                                                                                                 3.0
   5                                                                   105
       0          25           50        75          100      125
                                                                       100                                                       2.5
           Pre June 2009        WAC-mtge rate (bp)
                                                                          Sep-11 Oct-11 Nov-11 Dec-11      Jan-12 Feb-12
           HARP 2 projected                                                         Prim-Sec Spd, LHS        Par cpn, RHS
           Post June 2009 (ex HARP loans)                                                Primary, RHS

Source: CPR-CDR. Barclays Capital                                     Source: Barclays Capital


9 March 2012                                                                                                                       11
Barclays Capital | Global Rates Weekly


                                          By our estimates, roughly a fifth of these mortgages are held by the Fed, meaning that
                                          absent QE3, the supply the market will need to take down will be between $60-110bn. Even
                                          if all of this was hedged, it would imply duration shedding needs of $30-$50bn. In all
                                          likelihood, the actual amount would probably be smaller than that. In our view, $100bn in
                                          10y supply pushes rates up by 10bp (for details, please refer to the discussion in Refi wave:
                                          Only a wavelet in rates, 6 October 2011). As a result, the duration effect of HARP 2.0, in its
                                          current form, would be in the single digits in terms of basis points.


                                          What would happen in a rally in rates?
                                          The second takeaway from figure 3 is what would happen in a rally in rates. The bulk of
                                          loans outstanding in the pre-HARP universe are in the 75-175bp zone, where the S-curve is
                                          flat. This suggests that putting the effect of HARP 2.0 aside, even a rally in mortgage rates
                                          may not increase speeds dramatically. This is compounded by the fact that primary-
                                          secondary spreads widen out when rates rally (Figure 4), as a result of which it would take a
                                          rally of 40bp in the par-coupon mortgage rate in order to reduce primary rates by 25bp.
                                          This further underscores the difficulty the Fed will have in stimulating the economy through
                                          the housing channel if were to conduct QE3 in mortgages (whether sterilized or not).

                                          What could lead to a mortgage led sell-off in the duration market?
                                          We believe that there could be an impact on rates markets if there are further program
                                          changes as we head into election season. The most important of these, in our view, would
                                          be if HARP is extended to mortgages originated after May 2009 or, alternately, if a
                                          streamlined refinancing program were to be put into place. As figure 3 shows, prepay
                                          speeds on those loans that were originated after 2009 through non HARP channels are
                                          higher, and streamlining could lead to a big change in the situation. Post HARP 30y fixed
                                          rate mortgages ($1.35tn as of Dec 11) now are nearly comparable in outstanding balance
                                          to pre 2009 vintages ($1.4tn), and streamline refis could lead to a bigger increase in their
                                          speeds than the latter. If we get a rise of 20CPR on this portion of the universe, it would
                                          mean an additional $135bn in 10y duration supply. Together with HARP2.0, this could lead
                                          to a sell-off, which could be exacerbated by duration shedding by mortgage hedgers. If the
                                          changes are unexpected, duration supply hitting the market in a short time would be a
                                          surprise. However, even in this scenario, a 2003-like experience is unlikely to be repeated.


Figure 5: Even with changes, speeds should be well short of             Figure 6: 2003 was a much more dramatic event even
the 2003 experience                                                     though mortgage rate incentives were similar

 1y CPR %                                                                  bp                                                        bp
 75
                                                                            4                                                    150
 65
 55                                                                         2                                                    100
 45                                                                         0
                                                                                                                                 50
 35
                                                                           -2
 25                                                                                                                              0
                                                                           -4
 15
                                                                                                                                 -50
  5                                                                        -6
      0              50             100          150           200                                                               -100
                                                                           -8
                               WAC-mtge rate (bp)
                 HARP 2 projected                                        -10                                                     -150
                                                                           1997 1999 2001          2003 2005 2007 2009    2011
                 2003 experience
                                                                                   1m WAC chg (LHS)        Primary - WAC (RHS)

Source: Barclays Capital, CPR-CDR                                       Source: Barclays Capital


9 March 2012                                                                                                                              12
Barclays Capital | Global Rates Weekly


                                         Why is the situation different from 2003?
                                         During the refinancing wave in 2003, portions of the mortgage universe prepaid at speeds
                                         in excess of 60CPR. This can be seen from figure 5, which shows a comparison between the
                                         projected S-curve recently and the 2003 experience. The main difference between the
                                         current situation and that of 2003 is timing.

                                         Figure 6 shows a time series of the weighted average coupon of the mortgage universe
                                         plotted against primary rates for 30y conventional fixed rate loans. This measure roughly
                                         approximates the refinancing incentive for the fixed-rate mortgage universe. As can be seen,
                                         the incentive today is roughly comparable to what it was during the 2003 refinancing wave.

                                         In 2003, a large portion of the mortgage universe refinanced very quickly. For example, the
                                         WAC of fixed-rate mortgages fell by nearly 70bp from nearly 7% to 6.3%. This process has
                                         been much slower post 2009, but has been going on nevertheless. While the WAC only fell
                                         by 20bp in 2011, since the inception of HARP in 2009, the overall decrease in WAC has been
                                         comparable to what occurred during 2003 refi wave. At this stage, the loans which have not
                                         been refinanced have been adversely selected against for a very long time.

                                         Figure 6 also plots the 1m change in the WAC. When there is a greater refinancing incentive
                                         we would expect the WAC of the fixed rate universe to drop quickly, which is what the
                                         figure shows. In 2003, the WAC of the fixed rate universe was dropping at 8-10bp a month,
                                         when the rate incentive was more than 100bp. In contrast, even though the incentive has
                                         been higher than 100 for most of the post 2009 period, the WAC has dropped at 2-3bp a
                                         month. It suggests that refinancing activity in 2003 was nearly three times than has been
                                         the case recently, even though the refinancing incentive is roughly comparable.

                                         All said, for a government-induced refinancing program to produce a 2003-like convexity
                                         event in the rates market, it would have to triple prepayment speeds for the entire universe
                                         of mortgages at the current (sticky) level of primary mortgage rates. The duration market
                                         will get significantly impacted if we get a program that brings about that kind of a dramatic
                                         change. HARP even in its modified form, is unlikely produce that.




9 March 2012                                                                                                                        13
Barclays Capital | Global Rates Weekly


UNITED STATES: MONEY MARKETS

                                         Bank funding rates: Survey or transaction?
                    Joseph Abate         The technicals behind the setting of Libor rates have received a fair bit of attention
                +1 212 412 6810          recently. But these mechanics raise a more fundamental issue: how does one measure
      joseph.abate@barcap.com            bank funding costs?

                                               Unsecured bank financing costs can be measured either from a survey or based on
                                                actual transactions. But both approaches have limitations.

                                               There is some evidence of an anonymity value in the setting of survey rates. The effect
                                                grows when financial conditions are stressed.

                                               Transacted rates are often infrequent and in times of financial market stress exhibit
                                                “success effects.” They also tend to be noisier.

                                         The British Bankers’ Association recently noted that regulators and bankers are meeting to
                                         discuss “future developments” related to the technical details of the rate survey. 3 We prefer
                                         to look at a broad array of data to assess unsecured bank funding conditions.

                                         Survey says
   How should unsecured bank             Recently, the technical details behind the measurement and behavior of Libor have received a
    funding costs be measured?           fair bit of attention. However, we believe the more fundamental issue might be how to measure
                                         short-term unsecured bank funding costs. And, unfortunately, there is no obvious answer.

                                         The 3m dollar Libor rate is derived from a survey of banks with significant dollar operations in
                                         London. Each panel member is asked where it could raise funds in reasonable size in the inter-
                                         bank market across different currencies and tenors. The answers are tallied and a trimmed mean
                                         is calculated, removing the highest and lowest quartiles of submissions. Libor is not the only
                                         survey measure of bank funding costs. Since mid-2008, a similar version has been collected in
                                         New York. A key difference between Libor and the New York funding rate (NYFR) is that the
                                         latter is an anonymous survey. Its sample size can vary and the participating names (along with
                                         their corresponding submissions) are unknown. Additionally, the wording of the survey question
                                         is a little different in the NYFR sample. Banks are instead asked where they think a
                                         “representative” A1/P1 bank could raise money, not where they themselves judge they could
                                         fund. And unlike the Libor panel question, the amount of money is left undefined, although the
                                         “reasonable size” criterion in the Libor submissions is also vague.

                                         Anonymous
 There is an anonymity value in          Differences in the wording and the sample members should produce a spread between the two
         surveyed rate postings          survey measures. A priori we would expect these definitional differences to make the spread
                                         stable over time. But it is not (Figure 1). And importantly, it appears to be correlated with financial
                                         market conditions. We judge this reflects the existence of a shifting “anonymity” value in the
                                         NYFR. To the extent that the Libor survey postings are highly visible and interpreted as signals of
                                         funding conditions, a high posting might actually dissuade would-be lenders, instead of
                                         attracting new money. In times of financial stress, when the scrutiny of individual settings is
                                         highest, borrowers seem to attach more value to anonymity – that is, they might be more willing
                                         to borrow at a higher rate if they could keep their name “off screen.” As illustrated in Figure 1,
                                         anonymity value increased during recent waves of the financial crisis (rising to as much as 10bp)
                                         and since the December LTRO has come down sharply.


                                         3
                                             See “Regulators consider Libor overhaul”, B. Masters and C. Binham, Financial Times, March 5, 2012.

9 March 2012                                                                                                                                       14
Barclays Capital | Global Rates Weekly


                                          In a study of wholesale bank funding markets, Skeie, Kuo, and Vickery found that Libor
                                          tracks average wholesale bank borrowing transacted rates (as measured by a unique
                                          dataset of matched Fedwire “buys” and “sells”) fairly well but does a poor job of capturing
                                          the large dispersion in individual Libor postings over 2007-09. 4 In recent months, the spread
                                          between the maximum and minimum Libor postings has become very wide as a percentage
                                          of the underlying rate and is near 2009 levels (Figure 2). The recent widening has been
                                          driven by falling minimum postings, rather than increasing maximum postings.


                                          Transacted rates
           There are relatively few       There are relatively few direct and systematically observable measures of transacted
       observable transacted rates        unsecured funding rates. Of course, this is not the only front-end market where details and
                                          data on transactions activity are inadequate – Adrian et al note the same problems affect the
                                          tri-party repo market. 5 The closest equivalent to Libor might be the 3m AA financial CP rate
                                          published by the Federal Reserve. This is calculated as the weighted average of CP sales (either
                                          directly placed paper or debt that is instead sold to dealers). Under most circumstances, the
                                          surveyed rates (Libor and NYFR) and the AA financial CP rate are fairly close.

                                          But as we observed earlier this year, this spread widened sharply during the recent
                                          financial strains. Indeed, the spread between these two measures of 3m unsecured
                                          funding costs widened to over 30bp by late last year. As we noted then, the CP rate is
                                          likely somewhat distorted because of a “success effect” that is especially apparent when
                                          financial conditions deteriorate (Figure 3). Only institutions that are able to issue paper
                                          are captured in the Fed’s data. Institutions that are not interested in raising unsecured
                                          money or cannot access the new-issue market are not captured. Consequently, this
                                          measure of actual transacted bank funding rates may have a downward bias that tends to
                                          grow in periods of stress but that may ultimately tend to understate the “true” cost of
                                          unsecured bank funding for most banks.

                                          Transacted rates also tend to be noisier than rate measures based on surveys (Figure 4).
                                          This reflects the fact that the sample of issuers captured in the CP data, for instance,
                                          changes from day to day. The mix between “strong” and “weak” issuers can change every


Figure 1: NYFR-Libor, 3m (%)                                                    Figure 2: Libor, maximum less minimum posting (% of Libor)

 12                                                                                100
                                              Europe                                90
 10
   8                                                                                80
                                Ireland
                                                                                    70
   6       Greece
                                                                                    60
   4
                                                                                    50
   2
                                                                                    40
   0
                                                                                    30
  -2                                                                                20
  -4                                                                                10
                                     Debt ceiling
  -6                                                                                 0
   Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12                                  Jan-07       Jan-08       Jan-09        Jan-10       Jan-11       Jan-12

Source: Bloomberg, Barclays Capital                                             Source: Bloomberg, Barclays Capital

                                          4
                                            See “How well did Libor measure bank wholesale funding rates during the crisis?”, D. Skeie, D. Kuo,, and J. Vickery,
                                          Federal Reserve Bank of New York Conference presentation, September 29, 2010.
                                          5
                                            See “Repo and Securities Lending”, T. Adrian, B. Begalle, A. Copeland, and A. Martin, Federal Reserve Bank of New
                                          York, December 2011.

9 March 2012                                                                                                                                                       15
Barclays Capital | Global Rates Weekly


                                            day, based on the maturity cycle of their debt. As a result, there can be significant day-to-
                                            day swings in these rates that have little to do with underlying market fundamentals but
                                            instead just reflect the daily composition of borrowers.

On any given day, banks may or              Even if these data were available on a consistent basis, the information might not be
            may not need to raise           particularly useful. On any day, a bank may or may not need to raise unsecured money, or
                   term unsecured           it could decide to shift the maturity distribution of its unsecured short-term borrowings by
                                            letting 3m paper roll off and replacing it with shorter (or longer) maturity paper.
                                            Consequently, individual bank issuance tends to be sporadic and lumpy. For example,
                                            across a sample of issuers in the (direct offer) CP market since the beginning of the year,
                                            there were some instances where institutions posted no offerings in either 1 or the 3m
                                            sectors for as long as a week.

                                            Beyond rates
                                            Ultimately, both survey and transacted measures of interest rates have limitations as
                                            indicators of unsecured bank funding costs. Moreover, neither measure indicates the level
                                            of activity in funding markets, which can often be more revealing than the price (rate)
                                            data. A market where just a few banks are issuing a small amount of overnight paper at
                                            very low rates is significantly different from one where the amount of daily issuance is high
                                            but rates are low. Consequently, while we scrutinize the Libor settings as intensely as every
                                            other analyst, we consider Libor to just be one piece in overall bank funding market
                                            conditions that needs to be weighted against trends in CP issuance, tenors, and money
                                            fund investment behavior. That said, it is unclear what regulators, panel member banks,
                                            and the British Bankers’ Association will decide with respect to the technical issues on the
                                            construction of Libor.




Figure 3: Libor-AA financial CP, 3m (%)                                  Figure 4: Standard deviation financial CP and Libor (20d
                                                                         mavg, bp)

  50                                                                       14
                                                                                                                              CP
  40                                                                       12

  30                                                                       10

  20                                                                        8
                                                                                                        Libor
  10                                                                        6

    0                                                                       4

 -10                                                                        2

 -20                                                                        0
   Jan-10          Jul-10          Jan-11     Jul-11      Jan-12            Jan-10          Jul-10         Jan-11    Jul-11   Jan-12

Source: Federal Reserve, Barclays Capital                                Source: Federal Reserve, Barclays Capital


9 March 2012                                                                                                                           16
Barclays Capital | Global Rates Weekly


UNITED STATES: INFLATION-LINKED MARKETS

                                         Higher energy prices twist the breakeven curve
                    Michael Pond         The drop in the forward breakeven implied by TIIApr14s and TIIApr15s does not appear
                +1 212 412 5051          justified by rising energy prices and we recommend longs at 1.65% with a stop at 1.50%
     michael.pond@barcap.com             and target of 1.90%

                                         Higher oil price and near-term forwards
                    Chirag Mirani
                +1 212 412 6819
                                         Last week, we discussed the effect of higher energy prices on spot short-end breakevens.
                                         The impact in breakevens has not all been one way, though. An increase in oil and gasoline
      chirag.mirani@barcap.com
                                         prices should be positive for spot short-end breakevens because the rise should lead to
                                         higher inflation in the near term. However, investors may also be concerned about the
                                         negative effect on real consumer spending, which could then cause disinflationary
                                         pressures. This concern seems to be showing up in breakevens via a decline in forward
                                         inflation expectations, though, in our view, the move in CPI swaps appears more logical
                                         than that in breakevens (Figure 1).

                                         1y forward 1y CPI swaps have dropped more than 30bp since the end of January, about the
                                         time when energy prices began rising. Since a decline in real activity might affect inflation
                                         with a small lag, this decrease in 1yfwd1y CPI makes sense to us if investors believe high
                                         energy prices might lead to a slowdown in real consumption over the coming quarters.
                                         Some forward breakevens implied by TIPS have also declined, though, oddly, the largest
                                         drop, of 20bp, has come from the 2y forward 1y rate implied by TIIApr14 and TIIApr15
                                         (Figure 1 and Figure 3). We believe this is too long a lag to be related to the disinflationary
                                         force of oil, and think this market move presents an opportunity and is largely a sign of the
                                         cheapness of the TIIApr15s.

                                         Figure 1: Forward 1y breakevens and CPI swaps

                                            1.6                            Change in fwd 1y CPI curve from 1/31/12
                                            1.4                            Change in fwd 1y BE curve from 1/31/12
                                            1.2
                                            1.0
                                            0.8
                                            0.6
                                            0.4
                                            0.2
                                            -
                                           (0.2)
                                           (0.4)
                                           (0.6)
                                                Apr-12       Oct-12   Apr-13    Oct-13     Apr-14     Oct-14        Apr-15   Oct-15
                                         Source: Barclays Capital


                                         We can think of two reasons why the TIIApr15s would have cheapened so much, though
                                         neither justify the full move over the past month. First, the oil curve is much more in
                                         contango than it had been. In other words, the energy market is priced for steeper declines
                                         in energy inflation over the next several years and implied oil deflation for a period
                                         consistent with the TIIApr14/TIIApr15 forward breakeven is about 1.5% greater than it had
                                         been at the end of January (Figure 2). However, this drop should have been apparent for
                                         other forward periods as well.


9 March 2012                                                                                                                          17
Barclays Capital | Global Rates Weekly


                                         Figure 2: Change in fwd oil curve versus change in forward 1y breakvens, oil price
                                         changes chart (RHS), FWD BE change (LHS)

                                            0.8                         Change in fwd 1y BE curve from 1/31/12                          6
                                                                        Change in fwd 1y crude inflation (RHS)                          5
                                            0.6
                                                                                                                                        4
                                            0.4                                                                                         3
                                                                                                                                        2
                                            0.2
                                                                                                                                        1
                                            -                                                                                           -
                                                                                                                                        (1)
                                           (0.2)
                                                                                                                                        (2)
                                           (0.4)                                                                                        (3)
                                                Apr-12      Oct-12   Apr-13    Oct-13      Apr-14     Oct-14       Apr-15     Oct-15

                                         Source: Barclays Capital


                                         Another factor could be that investors may be concerned about selling pressure on the
                                         TIIApr15s over the next several months. In May, the TIIApr15s will roll into the Fed’s
                                         eligibility window for TIPS sales. If it is to sell as much as it is buying ($12bn = 3% of
                                         $400bn), it will have to sell very close to all TIPS eligible for sale because it has bought
                                         about $8bn and has about $4bn left in the eligible basket (including TIIApr15s). We expect
                                         that it will fall short of $12bn in total sales because of the $4bn left, $1.3bn is in TIIJul12s,
                                         which will not be eligible after the April sale operation. Instead, we expect it to sell a total of
                                         about $11bn TIPS, though this assumes it will sell all others eligible. Even as the TIIApr15s
                                         roll into the basket, we do not believe they should come under much pressure because the
                                         Fed only owns $0.23bn of them.


                                         Figure 3: Apr14-Apr15 Fwd BE

                                          2.80%                                                                  Apr14-Apr15 Fwd BE
                                          2.60%
                                          2.40%
                                          2.20%
                                          2.00%
                                          1.80%
                                          1.60%
                                          1.40%
                                          1.20%
                                          1.00%
                                              Apr-10                  Oct-10                 Apr-11                  Oct-11

                                         Source: Barclays Capital


                                         We recommend investors take advantage of this apparent curve dislocation by going long
                                         the forward breakeven implied by TIIApr14s/TIIApr15s. In addition to appearing cheap on a
                                         forward breakeven basis, the TIIApr15s stand out as cheap within the relative value
                                         framework shown in our daily Inflation Forwards Packet. One way to see its cheapness is
                                         that it has a 2.7 z-score off our real fitted curve. It is also cheap on ASW in our view.


9 March 2012                                                                                                                                18
Barclays Capital | Global Rates Weekly


                                           Therefore, we recommend that investors not able to put on a forward breakeven position
                                           instead simply shift existing shorter end breakevens out to the TIIApr15s.

Figure 4: Trade table for 10k DV01 of forward breakeven implied by TIIApr14/TIIApr15
         Action                 Security             Price       Yield      Duration     DV01 per 10k notional       Notional

           Sell            TII 1 1/4 04/15/14       106.82       -1.89        2.09              2.384              $87,741,108
           Buy             T 1 7/8 04/30/14         103.27       0.34         2.10              2.164              $96,698,802
                                                   Breakeven     2.234
           Buy             TII 0 1/2 04/15/15       106.63       -1.56        3.09              3.442              $89,846,787
           Sell            T 2 1/2 04/30/15         106.29       0.48         3.02              3.208              $96,385,893
Source: Barclays Capital




9 March 2012                                                                                                                     19
Barclays Capital | Global Rates Weekly


UNITED STATES: VOLATILITY

                                         Hedge with Bermudans
                      Piyush Goyal       Rate-based hedgers looking for protection against low rates should consider long-dated
                  +1 212 412 6793        Bermudan receivers instead of European options. Current levels are attractive because
      piyush.goyal@barcap.com            of supply from callable zeroes, and Bermudans should resist a loss of premium if rates
                                         sell off by a small amount.

                                         A Bermudan option can be thought of as a portfolio of probability-weighted options. For
                                         example, a 1y*30y Bermudan receiver is equivalent to a portfolio of 1y*29y, 2y*28y,
                                         3y*27y, etc European receiver swaptions. Therefore, the value in Bermudan receivers,
                                         relative to comparable Europeans, is driven by the following factors:

                                              Level of volatility – Bermudans have more optionality than European options. Therefore,
                                               they gain value when vol is high.

                                              Level of long-dated vs short-dated volatility – Bermudans have more long-dated options
                                               than comparable European options. Therefore, as long-dated vol richens to shorter
                                               expiry vol, ie, a steeper vol surface, Bermudans become more valuable.

                                              Curve shape – The flatter the curve, the less chance that Bermudan receivers will be
                                               exercised early. As longer expiry options become more probable, Bermudans gain value.

   Bermudan receivers gain from          To verify the above, we regress the available historical data on Bermudan options with the
  higher vol, long vs. short-dated       above factors. Figure 1 shows the actual spread between 1x30 Bermudan receivers and
               vol and flatter curve     1y*30y receivers for the past few years and compares it with the regression value. The
                                         regression is based on 1y*30y vol (level of vol), the 10y*30y to 1y*30y vol ratio (long-dated
                                         vs short-dated vol), and the 2y-30y swap curve (curve shape).


                                         Figure 1: 1x30 Bermudan vs European receiver is driven by vol, long vs short-dated vol,
                                         and rate curve

                                                                                      Actual           Regression Value
                                             1,000
                                              900
                                              800
                                              700
                                              600
                                              500
                                              400
                                              300
                                              200
                                              100
                                                0
                                                Mar-02 Apr-03 May-04 Jun-05                Jul-06    Aug-07 Sep-08 Oct-09 Nov-10 Dec-11

                                         Note: Last data point as of March 1, 2012. Actual data are for October 15, 2009-March 1, 2012. We regress the actual
                                         1x30 Bermudan vs European receiver spread (in cents) with 1y*30y vol, the 10y*30y/ 1y*30y vol ratio, and the 2y-30y
                                         swap curve for this period. The regression value is based on beta parameters generated from this regression. We use
                                         the same parameters to determine the trend for prior years. Admittedly, this makes the historical data sensitive to
                                         regression done for the October 15, 2009-March 1, 2012, period. Source: Barclays Capital.




9 March 2012                                                                                                                                              20
Barclays Capital | Global Rates Weekly


                                         The r-squared is high (= 93%), indicating that the regression is meaningful. Also, each
                                         variable is relevant to the regression, as each has a high t-statistic. Furthermore, as
                                         expected, the beta is positive for vol and long vs short-dated vol and negative for the rate
                                         curve. This confirms our hypothesis that high vol, a steeper vol surface, and a flatter curve
                                         increase the value in Bermudan receivers relative to European swaptions.

                                         Hedge with Bermudans
                                         As shown in Figure 1, Bermudan receivers have gained in value compared with European
                                         receivers over the past year. But it is still a good time to buy, for three reasons.

    They could gain from further         One, Bermudans have richened because the rate curve has flattened 6 and short-dated vol
    steepening of the vol surface        has come off relative to long-dated vol. 7 But the move may not be over yet. Their value will
                                         likely increase further as the vol surface steepens. This should happen because longer rates
                                         will likely remain in a range for much of 2012 as looming spending cuts and the expiration
                                         of various tax cuts hold back the market’s growth expectations. A range-bound rate
                                         environment should cause shorter expiry options such as 1y*30y to cheapen more. The JPY
                                         options market provides context: JPY 1y*30y has traded within 35-90bp/y for all of the past
                                         ten years, with an average of 55bp/y. So, the current 100bp/y for the US 1y*30y is clearly at
                                         the higher end of the range. Further, the JPY 10y*30y to 1y*30y ratio has averaged ~ 1 in
                                         the same period. If 1y*30y and 10y*30y USD vol trade as same level, ie, a ratio ~ 1,
                                         Bermudans should trade about 100cts richer than current levels.

                                         In fact, a longer history of the regression value suggests that Bermudan receivers can be
                                         more valuable than comparable European swaptions (Figure 1). Essentially, the US’s own
                                         history suggests that long-dated vol can be as rich as short-dated vol and the rate curve
                                         flatter, leading to an increase in Bermudan prices.

                                         Two, the receivers would lose value much quicker with a small rise in rates.ATM 1y*30y
                                         receivers would be worthless if 30y swap rates end 15bp higher in one year. On the other
                                         hand, Bermudan receivers would lose maybe 10% of their initial value if rates increase such
                                         small amount. In fact, longer rates would need to rise 75-100bp for Bermudans to lose half
                                         of the initial premium outlay, an amount similar to what long 1y*30y ATM receivers would
                                         lose in a small 15-20bp sell-off. Since rates are low and have been low for a while, a small
                                         rise in rates cannot be discounted.

                                         Finally, Bermudans can probably be purchased at better prices than discussed above
                                         because of the excessive supply from callable zeroes over the past few years (Figure 2).
                                         These are typically 30y notes that are non-callable only for the first year; they pay zero
                                         coupon until called or matured. Given such a structure, these notes lead to supply of high-
                                         strike 1y x 30y Bermudan receivers at the time of issuance. Generally, there is little demand
                                         for such options; therefore, dealers end up managing the risk by dynamic delta/vega
                                         hedging this option supply. Moreover, there has been a spike in issuance lately, leading to
                                         adequate inventory of long-dated Bermudan.




                                         6
                                             The 2y-30y swap curve has flattened about 110bp since March 2011.
                                         7
                                             The 10y*10y to 1y*10y ratio has increased from ~ 0.75 in March 2011 to ~ 0.85 now.

9 March 2012                                                                                                                        21
Barclays Capital | Global Rates Weekly


Figure 2: There has been significant issuance of callable                                                  Figure 3: …and a spike in the past two months
zeroes in the past few years…

   30                                                                                                300       2.7                                                                                                               $2.6 5
                                                                                                                                                                                                                             $2.2
   25                                                                                                250       2.2                                                                                                                    4.5

   20                                                                                                200       1.7                                                                                                                                  4

   15                                                                                                150       1.2                                                                                                                                  3.5

   10                                                                                                100       0.7                                                                                                      $0.3                        3

                                                                                                               0.2                                                                                                                                  2.5
    5                                                                                                50
                                                                                                              -0.3                                                                                                                                  2
    0                                                                                                0




                                                                                                                     Jan-11
                                                                                                                              Feb-11


                                                                                                                                                Apr-11
                                                                                                                                       Mar-11


                                                                                                                                                         May-11
                                                                                                                                                                  Jun-11


                                                                                                                                                                                    Aug-11
                                                                                                                                                                                             Sep-11
                                                                                                                                                                                                      Oct-11
                                                                                                                                                                                                               Nov-11
                                                                                                                                                                                                                         Dec-11
                                                                                                                                                                           Jul-11




                                                                                                                                                                                                                                  Jan-12
                                                                                                                                                                                                                                           Feb-12
         2000
                2001
                       2002
                              2003
                                     2004
                                            2005
                                                   2006
                                                          2007
                                                                  2008
                                                                         2009
                                                                                2010
                                                                                       2011
                                                                                              2012
                  Gross Issuance ($bn)                             Forecast ($bn)
                                                                                                                                          Gross Issuance ($bn,L)                                                        30yr Swap,R
                  2-10 swap curve (bp)

Note: As of February 29, 2012. There has been a total of $4.78bn in the first two                          Note: As of February 29, 2012. Source: Bloomberg
months of 2012. At this pace, there could be a total of $27bn for the entire year.
Source: Bloomberg



                                                                 Weighed down by supply
                                                                 Callable zero notes
        There has been a adequate                                The issuance of callable zeroes has increased notably in the new year (Figure 3). After
         supply of 1x30 Bermudan                                 plummeting to ~ $1bn/month on average in second half of last year, probably because of
 receivers from callable zeroes in                               investor concerns about issuer credit risk, the issuance of zeroes totalled $2.2bn and $2.6bn
                 the past two months                             in January and February this year.

                                                                 Because of higher issuance, there was a $17mn log vega supply from callable zeroes in
                                                                 February, higher than $15mn in January and the average $6mn/month in H2 2011.

                                                                 More important, because of the increase in issuance, dealer desks have an adequate supply
                                                                 of high-strike 1x30 Bermudan receivers. So investors may be able to buy these structures at
                                                                 attractive prices.

                                                                 FHLB callable notes
                                                                 The other source of Bermudans is agency issued callable notes. There was a conspicuous
                                                                 increase in callable note issuance by the Federal Home Loan Banks last month (Figure 4).
                                                                 Roughly $32bn was issued by the FHLBs, considerably more than the $12bn and $6bn in
                                                                 the previous two months.

                                                                 Because of this increase, the log vega delivered to option market was much higher than in
                                                                 any of the previous six months. A total of $12.3mn was dealt to the market, more than the
                                                                 $7mn+ and $2mn- in January and December, respectively.

                                                                 However, the general structure of the note is 2-5y term non-callable for the first three or six
                                                                 months. So the supply is felt in the form of 3m*5y high-strike Bermudan options, essentially
                                                                 the top left.




9 March 2012                                                                                                                                                                                                                                            22
Barclays Capital | Global Rates Weekly


Figure 4: Massive pick-up in FHLB callable notes                       Figure 5: The effects of supply felt by long-dated skew

  90                                                          1.8         100                                                                   20
  80                                                          1.6          90
                                                                                                                                                15
  70                                                          1.4          80
  60                                                          1.2          70                                                                   10
  50                                                          1            60                                                                   5
  40                                                     $32 0.8           50
  30                                                  $6      0.6                                                                               0
                                                                           40
  20                                                          0.4
                                                                           30                                                                   -5
  10                                                          0.2
                                                         $12               20
   0                                                          0                                                                                 -10
        Q1      Q3       Q1       Q3      Q1      Q3      Q1               10
       2009    2009     2010     2010    2011    2011    2012               0                                                                   -15
         Mnth 1                 Mnth 2              Mnth 3                        6m10y        1y10y        3y10y       5y10y       10y10y

         FHLB ($bn,L)           Forecast ($bn)      2y rate, R                   Change (USD)             Change (EUR)           EUR          USD

Source: Bloomberg                                                      Note: Chart shows the cost of 100bp high-strike payers versus 100bp low-strike
                                                                       receivers in cents for various expiry swaptions on 10y tails in US and EUR. The
                                                                       change shows the change in the cost between December 30, 2011, and February
                                                                       29, 2012. Source: Barclays Capital


  The effect of supply is visible in     Put together, there was more vega supply in February than in January ($29mn versus
              the long-dated skew        $23mn) because of the increase in both callable zeroes and FHLB-issued callable notes.

                                         The effect is noticeable in long-dated payer skew. Figure 5 shows the payer skew for various
                                         option expiries in both US and EUR. The two lines correspond to the level of the skew in US
                                         and EUR as of February 29, 2012. Two takeaways:

                                            One, 10y*10y skew is about as expensive in US as in EUR, even though shorter expiries
                                             such as 3y*10y are visibly expensive in US. This highlights the effect of the overall large
                                             supply of callable zeroes over the past three years (Figure 2).

                                            Two, the US 10y*10y skew cheapened between end-2011 and end-February, even as
                                             shorter expiry skew in US richened/EUR long-dated skew did not cheapen. This
                                             highlights the effect of the increase in issuance of callable zeroes in the past two months
                                             compared with H2 2011.

                                         Conclusion
       Buy Bermudan receivers to         Because of the increase in callable zero issuance in the past two months and over the past
        hedge low-rates-for-long         three years, there is adequate inventory of 1y*30y Bermudan receivers. Hedgers looking for
                                         protection against low rates should be able to buy Bermudan receivers cheaply. We think
                                         they are preferable to comparable receiver swaptions because they would benefit from a
                                         steeper vol surface, which is likely in the current range-bound rate environment. Also, if
                                         rates rise temporarily, receiver swaptions would expire worthless, but the Bermudans would
                                         resist a loss of premium.




9 March 2012                                                                                                                                         23
Barclays Capital | Global Rates Weekly


EURO AREA: RATES STRATEGY

                                         Greek PSI: almost done, with success
                Laurent Fransolet        Greek PSI deal to go ahead: 95.7% participation reached after use of CACs on domestic
            +44 (0)20 7773 8385          law bonds. Headline risk now lower.
  laurent.fransolet@barcap.com
                                         Greek PSI news
               Huw Worthington           The Greek Ministry of Finance has indicated in a press release that the PSI has succeeded
            +44 (0)20 7773 1307          and the bond exchange will go ahead as the participation rate has exceeded 75%. A few
 huw.worthington@barcap.com              important points are worth noting:

                                         1) The participation rate on domestic law bonds was 85.8% (€152bn of €177bn), high
                                         enough to legitimise the use of CACs on hold-outs. The government has stated that it
                                         intends to activate CACs to include all domestic law bonds in the exchange. It appears that
                                         domestic law bond holders that have not tendered will receive the same deal as to those
                                         bondholders that have tendered.

                                         2) The addition and trigger of CACs on the domestic law bonds, which will force the same deal
                                         on holdouts, will very likely constitute a CDS credit event, in our view. This is, however, to be
                                         established by the ISDA Determination Committee (DC). ISDA issued a press release early this
                                         morning stating that it had received a question regarding a potential credit event on the Hellenic
                                         Republic and that the DC will meet at 1pm GMT on Friday 9 March to address this question.

                                         Figure 1: Estimated Greek debt ownership before and post PSI at the end of 2012 (€bn)
                                                                                                    Before PSI                   Post PSI end of 2012

                                         IMF loans                                                       20                                 28
                                         EU loan package 1                                               53                                 74
                                         EU loan package 2                                                0                                 88
                                         ECB SMP + Investment portfolio                                  55                                 46
                                         T-bills                                                         15                                 15
                                         Sub total 1                                                    143                                251
                                         Banks                                                           70                                  0
                                         Insurance                                                       10                                  0
                                         Central banks/official institutions                             38                                  0
                                         Other investors (real money, etc)                               70                                  0
                                         Greek Social Security fund                                      18                                  0
                                         Sub total 2                                                    206                                  0
                                         New exchange bonds from PSI                                      0                                 65
                                         Total Greek debt                                               349                                316
                                         Source: Bank of Greece, Troika Greece reports, Reuters, Barclays Capital. Assumes full participation on the total
                                         €206bn of debt subject to the PSI.


                                         3) A total of €20bn of bondholders of foreign law bonds and bonds issued by state-owned
                                         enterprises (SOE) and guaranteed by the state have tendered. According to Bloomberg, of the
                                         €18bn of foreign law bonds, it seems that €12bn have tendered. The latter appears to
                                         correspond to the FRNs issued to Greek banks, which the market had expected to tender.
                                         Overall, combining all bonds, the participation rate would reach 95.6%, a bit higher than
                                         assumed in the 'Troika' DSA. We think that the remaining €6bn of foreign law bonds may well
                                         holdout. The MoF statement also indicated that invitations to offer exchange and submit

9 March 2012                                                                                                                                                 24
Barclays Capital | Global Rates Weekly


                                         consents for these bonds and guaranteed bonds will remain open until 23 March 2012, after
                                         which there will be no further opportunity for creditors to benefit from the package of EFSF
                                         notes, co-financing and GDP linked securities. A question therefore remains open on what will
                                         Greece do after 23 March 2012 to those foreign law bonds holders who do not participate.

                                         As we have indicated in previous research reports, we do not expect that the activation of the
                                         CACs and the likely CDS trigger will be of systemic importance. While we cannot rule out
                                         potential unforeseen problems through the settlement process of CDS or the potential inability
                                         of a counterparty to meet its commitments, we think that the relatively small amount of net
                                         notional exposure (c $3bn), and improvements in counterparty risk management over the last
                                         three years mean that the process is likely to be relatively uneventful.

                                         What next for Greece?
                                         Even if the PSI deal is done, the actual debt reduction for Greece will be limited, and it still
                                         requires optimistic assumptions for the debt/GDP ratio to reach 120% in 2020, as per the
                                         Troika DSA. In our view, the debt would still be barely sustainable, and it is likely that some
                                         kind of official debt relief will have to follow (see Greece post PSI 2: Financing, debt
                                         sustainability and a road map, 2 March 2012).

                                         What the PSI achieves definitely is that it reduces massively the near-term cash needs of
                                         Greece, and pushes back the prospect of a hard default. The headline risk will likely lessen, and
                                         the importance of the elections (due end April) is likely to decline in respect of the debt burden
                                         at least. Still, elections would remain a major risk factor: the traditional parties have lost a lot of
                                         support, and the formation of a coalition government seems arduous at this stage.

                                         Note that it is not in the interests of either Greece or the euro area for Greece to leave the euro
                                         area. It is not our base case either, but clearly, the risks of that happening are not trivial anymore.

                                         What next for the rest of the periphery?
                                         In the periphery, the performance YTD of Italy vs Spain has seen 10y spreads tighten c. 190bp
                                         leaving Italy trading c.15-20bp richer than Spain in the 10-15y area. Earlier in the crisis, Italy
                                         trade in a range from 20bp and up to 80bp richer than Spain. A return to these sorts of
                                         valuations seems unlikely given the similar fiscal consolidation challenges facing both
                                         countries. Similarly, we have seen how Italy can cheapen should the focus move back to more
                                         generalised contagion, when large outstandings of debt held in particular by foreigners, can
                                         work against BTPs. Indeed, in the short term, any moves in Italian vs. Spanish spreads may be
                                         more focused on the very rich 5-7 area in Spain, which still trade flat to BTPs and which may
                                         be more vulnerable especially ahead of Spanish bond auctions next week.

                                         Over the past few months, there has been a lot of focus on Portugal. In a recent note
                                         (Greece post PSI 2: Financing, debt sustainability and a road map, 2 March 2012), we assess
                                         the risk of a PSI on Portuguese bonds. The large stock of public debt, lack of growth and
                                         unresolved macroeconomic imbalances cast doubts over the sovereign’s solvency and the
                                         viability of its adjustment programme. Also, regaining competitiveness through a process of
                                         internal devaluation looks to be a daunting task, especially as the public and private sectors
                                         are deleveraging.

                                         At the same time, we strongly believe the euro area’s “strong rhetoric” in support of
                                         Portugal (eg, “Greece is unique and PSI won’t be replicated in Portugal or any other euro
                                         area countries”), and concern about potential contagion to other peripherals, considerably
                                         reduce the likelihood of a Portugal PSI in 2012.




9 March 2012                                                                                                                                 25
Barclays Capital | Global Rates Weekly


EUROPE MONEY MARKETS

                                         Money markets: low rates, and more stability
                 Laurent Fransolet       The ECB signalled that currently it does not plan to lower interest rates further. With
             +44 (0)20 7773 8385         liquidity expected to remain abundant for a long period, euro money markets appear to
   laurent.fransolet@barcap.com          have entered a period of stability characterized by low and stable rates, but with
                                         EONIA, if anything, still looking too high.
               Giuseppe Maraffino
             +44 (0)20 3134 9938
                                         ECB: No further rate cuts
giuseppe.maraffino@barcap.com             As expected, no monetary policy decisions were announced at the ECB’s March meeting.
                                          However, by referring to "upside risks prevailing" for the inflation outlook, President Draghi
                                          clearly signalled that the Governing Council currently does not plan to lower interest rates
                                         further. This comment accompanied an upward revision to the ECB staff's midpoint projection
                                         for HICP inflation, from 2.0% to 2.4% for 2012, and from 1.5% to 1.6% for 2013.

                                         Consequently, our economists no longer expect a 50bp refi rate cut in Q2 2012, and forecast
                                         the refi rate to be unchanged at 1% (with the deposit facility at 0.25%) until the end of 2013.
                                         This has not changed our expectations on EONIA (which is related to the level of the deposit
                                         facility), which should remain broadly stable at around 35bp in the next reserve periods, with
                                         risks to the downside. For the 3m Euribor we continue to see room for a further decline,
                                         probably to around 70bp by mid-June, with the bottom likely at 65bp by mid-summer. This
                                         would imply a slowdown in the recent pace of decline.

                                         In general, following the big take-up at the two 3y LTROs, we appear to have entered into a
                                         new period of stability for the euro money markets, similar to that observed in H2 2009
                                         (after the flood of liquidity following the first 1y LTRO), characterized by more abundant
                                         and longer-term liquidity. All rates have already started moving down, or are already at their
                                         lowest levels. The exception is the EONIA fixing, where continued frictions seem to be
                                         preventing it from moving lower, closer to the deposit facility, as the current level of the
                                         EURONIA fixing would suggest.

                                         However, before analysing the EONIA’s dynamics, we highlight a few facts linked to the 3y
                                         LTROs that President Draghi mentioned during the press conference.

                                         A bit more information on the 3y LTROs
                                         First, he said that there were apparently 460-odd German banks who participated in the
                                         February 3y LTRO. This, along with the likely high number of Italian banks who participated
                                         (230 Italian banks issued government guaranteed bonds, for a total of less than €20bn, in the
                                         past few months), helps to explain the large increase in the number of banks, to 800 at the
                                         February 3y LTRO (from 523 in December). These small, typically very local, banks probably
                                         did not borrow that much in aggregate, but, currently, there is very limited information on
                                         which banking system, or individual banks, borrowed. As these are local banks, with typically
                                         very simple balance sheets, their borrowing will probably flow more directly to the 'real
                                         economy'. While a lot of small banks borrowed, it is likely that overall, the borrowing has
                                         remained quite concentrated: the c.25 banks that reported their borrowings at a bit less than
                                         €200bn out of €529bn (and in the December 3y LTRO, we estimate that the top 70 banks
                                         borrowed about €300bn out of €489bn).

                                         Second, it appears that around €53bn of borrowing was on the back of the new 'enlarged' credit
                                         claims criteria, of which the bulk (€40bn) was apparently by French banks, with only €3bn by
                                         Italian banks (and the rest being split between the remaining 5 banking systems which opted for

9 March 2012                                                                                                                         26
Barclays Capital | Global Rates Weekly


                                             this enlarged collateral). It appears that the validation of the new credit claims was not fully ready
                                             in some countries in time for banks to use this newly created eligible collateral. In our view, this
                                             was particularly the case in Italy (apparently €70bn worth of such collateral was potentially
                                             available in Italy, but only €3bn were used for the 3y LTRO): this may be why Italian banks have
                                             been buying Italian government bonds and T-bills in advance of the LTRO2. Once the new
                                             collateral is accepted, the banks will be able to swap out their more ‘liquid' collateral and replace
                                             it with the least liquid one, potentially reducing their overall holding of government bonds, and
                                             probably not adding further to their holdings.

                                             The EONIA’s conundrum
                                             An important feature of the euro money markets is currently the spread between EONIA
                                             (36bp) and EURONIA (18bp), which, despite the recent tightening, is still wide given the
                                             current situation of abundant liquidity. It is important to recall that EURONIA is calculated (by
                                             WMBA) on the transactions via brokers, while the calculation of EONIA (by EBF) considers also
                                             bilateral transactions among banks, which are charged higher rates when they involve small
                                             (and, to some extent, riskier) banks. Therefore, the spread between the two fixings can be
                                             considered something of a proxy of the credit risk embedded in the unsecured overnight
                                             liquidity market.

                                             Figure 1 shows that the Euronia/Eonia spread is much higher (about 10bp) than the level
                                             reached towards the end of 2009 (following the flood of liquidity after the first 1y LTRO).
                                             Interestingly, it reflects a more pronounced decline of the EURONIA, which is now below the
                                             level hit in the second part of 2009, indeed EONIA is now stable at around 35bp, as in H2
                                             2009. Also, the breakdown of the transactions by band rate (available for EURONIA but not for
                                             EONIA) shows a gradual decline in the min vs max rate charged since the first 3y LTRO to the
                                             current level of 20bp, after having increased to 80bp in mid-December. This suggests less
                                             differentiation among banks, with a large number of transactions closed at rates below the
                                             deposit facility. Ultimately, we would expect the spread to track down to 10b, its H209. level.
                                             Considering the rates in the breakdown of EURONIA as a subset of the rates in the calculation
                                             of EONIA, it is very likely that some small banks are being charged rates at around 40/50bp or
                                             even higher. This is quite puzzling due to the recent sharp reduction in the refinancing risks
                                             and the abundance of liquidity; we believe that these could be very small banks that have no
                                             access to the ECB’s liquidity, or to the interbank market.


Figure 1: EONIA vs EURONIA (bp)                                              Figure 2: O/n (unsecured) liquidity market: volume

    50                                       Spread, bp (LHS)       5.0        70     (10d mov av, €bn)
                                                                                                                       EURONIA          EONIA
    40                                       EUREONIA (RHS)         4.5
                                                                               60
                                             EONIA (RHS)            4.0
    30
                                                                    3.5        50
    20                                                              3.0
                                                                               40
    10                                                              2.5
                                                                               30
     0                                                              2.0
                                                                    1.5        20
   -10
                                                                    1.0
   -20                                                                         10
                                                                    0.5
   -30                                                              0.0         0
     Jan-07      Jan-08         Jan-09   Feb-10   Feb-11   Mar-12              Sep-08                Nov-09            Jan-11             Mar-12

Source: ECB, Barclays Capital                                                Source: EBF, WMBA, Barclays Capital



9 March 2012                                                                                                                                    27
Barclays Capital | Global Rates Weekly


                                         Another important aspect to consider is the dynamics of the volumes. Figure 2 shows the
                                         evolution of the volume in the overnight unsecured market for EONIA and EURONIA (we show
                                         the 10 days moving average). While for the EURONIA market the volume has declined sharply
                                         since the allotment of the 3y LTRO in December (probably reflecting the big take-up by big
                                         banks at the December 3y LTRO), for EONIA, market volumes have been stable in January and
                                         increased before the 3y LTRO in February, probably reflecting that some small banks
                                         continued to use the overnight unsecured market for funding before moving to the ECB’s 3y
                                         operations. Indeed a gradual decline in the EONIA market volumes occurred after the 3y LTRO
                                         in February (to around €22bn, the lowest level since the beginning of the year). However, a
                                         number of small banks are probably still in the market and the fact that they are being charged
                                         higher prices creates a distortion in the calculation of EONIA, thus preventing the fixing
                                         declining further.

                                         The spread EONIA vs EURONIA averaged 9bp during the life of the first 1y LTRO. If we assume
                                         the same spread should now prevail, this would correspond to a fair value of EONIA around
                                         27bp, based on the current value of EURONIA of 18bp. As long as some price differentiation
                                         remains in the market it will be difficult for EONIA to drop below 30bp, but over time, the
                                         abundance of liquidity is likely to eventually push this rate lower. This suggests some further
                                         downside for Euribor fixings, regardless of the evolution of the FRA-OIS spread.




9 March 2012                                                                                                                         28
Barclays Capital | Global Rates Weekly


EUROPE: SOVEREIGN SPREADS

                                               Spain vs Italy
                  Huw Worthington              Earlier in the crisis Italy traded in a range 20-80bp richer than Spain in 5-15y bonds. A
              +44 (0)20 7773 1307              return to this level will likely be challenging, given the similar fiscal consolidations
 huw.worthington@barcap.com                    challenges and the relative supply/ demand pictures facing both countries.

                                               EGB spreads vs bunds over the past week were mixed in terms of performance. Belgian
                           Cagdas Aksu
                                               bonds led the way outperforming 10y bunds by 6bp, while France and Austria continued
              +44 (0)20 7773 5788
                                               their recent tightening too, contracting 2bp on the week on the same basis; Dutch and
         cagdas.aksu@barcap.com
                                               Finnish bonds were broadly unchanged on the week.

                                               In the periphery Italy also maintained recent moves, coming in a further 20bp on the week.
                                               The move was particularly notable vs. Spain, whose recent performance has been somewhat
                                               lacklustre compared with a widening of 7bp on the week. This move means that YTD, as
                                               Figure 1 below shows, Italy has now outperformed Spain from the spread wides seen at 2011
                                               year-end by c.190bp, such that in the 10y area Italy now trades c.20bp tighter than Spain.

                                               We would contend that the reasons for the outperformance are related mainly to a
                                               refocusing of market concerns away from that of debt burden, and in particular the
                                               ownership structure of peripheral debt, back to the levels of fiscal consolidation required to
                                               bring debt back to sustainable levels, while being consistent with growth forecasts. In this
                                               regard, in Spain, it was announced this week that the fiscal slippage in 2011 was even larger
                                               than the c.8% initially reported in January at c.8.5% of GDP vs. a 6% official target. Notably,
                                               the majority of the shortfall has been in the Spanish regions and as such this week’s rejection
                                               of the budget by the third largest region, Andalucía, seems to have highlighted the challenge
                                               facing the Spanish government. However, we think that this is more likely a short-term
                                               political issue, with elections set for March 25 and polls indicating the Partido Popular may
                                               take the region for the first time. A full Spanish budget is likely in Spain soon after that date.

                                               Concerns over fiscal slippage have also been compounded by Spain revising its 2012 fiscal
                                               target to 6%, without EC involvement, thus somewhat damaging the credibility of the new
                                               fiscal compact and possibly, using up political capital with other eurozone states.



Figure 1: Italy vs Spain 10y Yield Spread                                     Figure 2: Italy and Spain ASW Structure

  200                      10y Yield Spread Italy vs Spain                                      Spain
                                                                               302.4
  150
                                                                                                BTPS
  100                                                                          252.4


    50
                                                                               202.4

     0

                                                                               152.4
   -50

 -100                                                                          102.4
     Jan10 May10 Sep10              Jan11 May11 Sep11        Jan12                Nov 13          Jul 16   Apr 19    Jan 22     Oct 24

Source: Barclays Capital                                                      Source: Barclays Capital

9 March 2012                                                                                                                                  29
Barclays Capital | Global Rates Weekly


                                           The Italian government, for the most, part appears to be delivering on its reform
                                           programme, although challenges lie ahead and labour market reform and privatization news
                                           both have the potential to affect sentiment. In deficit terms, we look for Italy to hit just 2.2%
                                           in 2012 from 3.9% last year, although we would note that in cash terms at least
                                           requirements in Jan and Feb have been some €0.5bn higher Y/Y. Thus, the €24bn official
                                           cash deficit on which borrowing assumptions are predicated may prove challenging (the
                                           cash deficit was €61bn in cash terms in 2011). At the same time, we expect growth to be
                                           negative in both countries in 2012, at -2% in Spain and -1.5% in Italy: any attempt to hit the
                                           original 2012 deficit target of 4.4% in Spain could make this challenging, as further fiscal
                                           consolidations would likely hit near-term growth prospects.

Figure 3: EZ Deficit and Debt burden forecasts
                                    Fiscal balance ( % GDP)                                           Gross debt (% GDP)

                    2008    2009       2010       2011        2012     2013        2008      2009       2010      2011      2012      2013

Austria              -0.9   -4.1         -4.4      -3.0       -2.7     -2.1          64        70        72        71        72         72
Belgium              -1.3   -5.8         -4.1      -4.2       -3.0     -2.1          89        96        96        97        97         96
Finland              4.3    -2.5         -2.5      -0.9       -0.4      0.3          34        43        48        46        46         45
France               -3.3   -7.5         -7.1      -5.5       -4.5     -3.0          68        79        82        84        86         85
Germany              -0.1   -3.2         -4.3      -1.0       -1.0     -0.9          67        74        83        81        80         79
Greece (1)           -9.8   -15.8      -10.6       -9.1       -6.5     -5.3         113       129       145       167        186       192
Ireland              -7.3   -14.2      -31.3      -10.5       -9.1     -7.4          44        65        93       106        114       117
Italy                -2.7   -5.4         -4.6     -3.9        -2.2     -0.7         106       116       118       121        122       120
Netherlands          0.5    -5.6         -5.1      -4.3       -3.7     -3.3          59        61        63        66        68         69
Portugal             -3.6   -10.1        -9.8      -6.0       -5.6     -5.3          72        83        93       110        123       130
Spain                -4.5   -11.2        -9.3      -8.5       -6.0     -3.9          40        54        61        68        79         84
Total euro           -2.1   -6.4         -6.2      -4.2       -3.2     -2.2          70        80        85        88        91         91
Source: Barclays Capital.


                                           In terms of flow dynamics, thus far Spain has completed c.41% of its official €86bn target
                                           for 2012. Even allowing for the fiscal slippage and a more realistic target, Spain would still
                                           be one-third funded here. Cash balances are also at 2y highs and provide a substantial
                                           buffer going forward. Italian issuance, on the other hand, is running at around 17% of
                                           requirements, slightly below last year’s run rate, while cash balances do not provide the
                                           level of comfort seen in Spain and issuance volumes will have to stay constant. Moreover, in
                                           terms of demand, we believe much of the buying ahead of the 3y LTROs is likely over now.

                                           Notably, the move between Italy and Spain has not been consistent across both curves and as
                                           Figure 2 illustrates, the 8-15y sector in Italy trades 15-20bp richer, while shorter bonds are still
                                           more or less flat to one another. Earlier in the crisis Italy traded in a range of 20-80bp richer
                                           than Spain in 5-15y bonds, a return to these sorts of valuations seem likely to be more
                                           challenging, given the similar fiscal consolidations challenges facing both countries. Similarly,
                                           the experience of how Italy can cheapen should the focus move back to more generalised
                                           contagion when the simple large outstandings of debt held, in particular by foreigners, could
                                           work against BTPs. Indeed, in the short term, any moves in Italian vs. Spanish spreads may be
                                           more focused on the very rich 5-7y area in Spain, which still trade flat to BTPs and which may
                                           be more vulnerable, especially ahead of Spanish auctions next week.




9 March 2012                                                                                                                                 30
Barclays Capital | Global Rates Weekly


                                         Next week’s cash flows
                                         Tuesday will see Holland auction its 3y bonds for €2.5-3.5bn, while the following day Italy
                                         will conduct BTP auctions. The following day France will tap 2y, 4y and 5y bonds alongside
                                         7y, 10y and 15y linkers. Spain will also auction 3y,4y and 6y bonds on the same day.
                                         Support for the market will come primarily in the form of redemptions in Germany.

Figure 4: Barclays Capital’s cash flow expectations for week beginning 12 March 2012
                     Beginning                              Auction Date    Issuance    Redemptions    Coupons     Net Cash Flow
                                  27-Feb         -20.10      Germany          0.00         19.00         0.46         -19.46
Weekly                            05-Mar           2.20        France         10.20         0.00         0.00          10.20
Net                              12-Mar          1.33           Italy         6.50          0.00         1.55          4.95
Cash flow                         19-Mar         -11.04        Spain           4.50         0.00         0.01          4.49
                                  26-Mar          -1.51       Belgium         0.00          0.00         0.00          0.00
                                                               Greece         0.00          0.00         0.01          -0.01
 Net Cash Flow is issuance minus redemptions minus             Finland        0.00          0.00         0.00          0.00
 coupons. Negative number implies cash returned to
                                                               Ireland        0.00          0.00         0.45          -0.45
 the market.
                                                              Holland         3.00          0.00         0.00          3.00
                                                              Austria         0.00          0.00         1.39          -1.39
Total issuance                                    24.20       Portugal        0.00          0.00         0.00          0.00
Total redemptions                                 19.00        Total          24.20        19.00        3.872          1.33
Total coupons                                      3.87
Net cash flow                                      1.33
Source: Barclays Capital




9 March 2012                                                                                                                       31
Barclays Capital | Global Rates Weekly


UNITED KINGDOM: RATES STRATEGY

                                             Tangled up in red
                      Moyeen Islam           The public finance projections in the Budget on 21 March are likely to be broadly akin to
             +44 (0)20 7773 4675             those published in November 2011. We retain our current view for gilt issuance of
       moyeen.islam@barcap.com               £185bn. The risk to this number lies towards a lower number given uncertainties over
                                             the timing of cash measures.
                      Henry Skeoch
                                             The Office of Budget Responsibility (OBR) publishes its latest set off fiscal forecasts on
             +44 (0)20 7773 7917
                                             21 March and this will also see the publishing of the new financing remit from the DMO on
       henry.skeoch@barcap.com
                                             the same day. The new remit will be published after the Chancellor completes his Budget
                                             speech in the House of Commons. Given the relatively late timing of the OBR’s November
                                             forecast (published on 29 November 2011), there has been little in the way of economic
                                             news other than the ebb and flow of economic data. Figure 1 shows the OBR’s November
                                             growth forecast versus our own forecasts, the BOE February 2012 Inflation Report forecast
                                             and the latest long-term forecasts from the Treasury’s own “Forecasts for the UK economy”
                                             monthly publication where it compiles independent forecast for the economy. The OBR
                                             forecasts are notably higher than either our own or the average of independent forecasts.
                                             However, we see little reason to suppose that the OBR will materially revise lower its growth
                                             forecasts. The latest PMI surveys are consistent broadly with our expectations for fairly
                                             weak growth in Q112, although overall we see growth bottoming out in Q212.

                                             This relatively soft growth backdrop means that the Chancellor has relatively little, if any,
                                             room at all for discretionary fiscal measures to support the economy With the debt profile
                                             published in November worse than those published in Budget 2010, the Treasury will be
                                             acutely aware of the fact that a material worsening of the debt metrics will probably leave
                                             the UK vulnerable to further rating action from the sovereign ratings agencies. Moody’s
                                             already has the sovereign’s AAA credit rating on negative outlook as it felt that the pace of
                                             fiscal consolidation could be affected by weak growth prospects and the close ties with the
                                             eurozone would also lee it exposed to a material slowdown there. Given the political capital
                                             that has been attached to the preservation of the rating, we judge it unlikely that the
                                             Chancellor would want to let it slip easily so we would not expect the Treasury to be looking
                                             at any fiscal loosening that might materially effect key debt ratios.

Figure 1: Comparative economic forecasts (%)                              Figure 2: Path of the CGNCR FY11/12 vs FY10/11 (£mn)

 4.0        OBR Nov 2011                                                    160,000                  2011/12
            HMT Survey                                                                               2010/11
 3.5        Barcap                                                          140,000
            BOE Feb 2012 IR (Q4 y/y)                                                                 Budget 2011

 3.0                                                                        120,000

 2.5                                                                        100,000
                                                                             80,000
 2.0
                                                                             60,000
 1.5
                                                                             40,000
 1.0
                                                                             20,000
 0.5
                                                                                   0
 0.0                                                                                Apr May Jun Jul Aug Sept Oct Nov Dec Jan Feb Mar
           2012         2013          2014         2015          2016

Source: OBR, Bank of England, HM Treasury and Barclays Capital            Source: National Statistics and Haver Analytics


9 March 2012                                                                                                                            32
Barclays Capital | Global Rates Weekly


Figure 3: Total receipts have remained resilient (£mn)                          Figure 4: 12 month rolling CGNCR (£mn)

 65,000                 2009/10            2010/11            2011/12             225,000
                                                                                  200,000
 60,000
                                                                                  175,000
 55,000                                                                           150,000
 50,000                                                                           125,000
                                                                                  100,000
 45,000
                                                                                   75,000
 40,000                                                                            50,000
                                                                                   25,000                                               rolling 12m CGNCR
 35,000
                                                                                        0
 30,000
                                                                                  -25,000
 25,000                                                                           -50,000
         April            July          October           January                       Jan-07       Jan-08      Jan-09      Jan-10      Jan-11     Jan-12
Source: National Statistics and Haver Analytics                                 Source: National Statistics, Haver Analytics and Barclays Capital


                                                  Figure 2 shows the evolution of the central government net cash requirement (CGNCR) over
                                                  the course of the current fiscal year when compared with the last fiscal year. This has seen a
                                                  relative richness in receipts as the net cash position has been running better than had been
                                                  expected despite the relative weakness in growth. Figure 3 shows the patterns of monthly
                                                  tax receipts. The strength in the current fiscal year has been attributed in part to the rise in
                                                  the VAT rate in January 2011. On average, we estimate that the monthly cash position has
                                                  been £11.6bn better than the comparable month in FY2010/11 for the first ten month of
                                                  the fiscal year. Of this, some £1.4bn per month has been due to higher VAT receipts. So
                                                  while VAT has been an important factor, it has not been the main explanatory factor. Given
                                                  the relative weakness of domestic demand, this receipts performance is all the more
                                                  impressive. Should this mean that we should expect a big undershoot in the CGNCR in the
                                                  Budget and hence a sizeable “overfund” (ie, “too much” cash has been raised in FY11/21)
                                                  that is set against FY2012/13’s requirements? Our preferred measure of the cash deficit, the
                                                  12 month rolling CGNCR, currently is at £119bn compared to the OBR forecast of £135bn
                                                  so seems to imply a degree of improvement. But in its monthly commentary on the January
                                                  public finance data, the OBR noted that growth in receipts for the remaining two months of
                                                  the fiscal year was likely to be lower given low growth in both VAT receipts and tax
                                                  revenues from financial sector bonuses and that expenditure growth may well pick up as
                                                  departmental expenditure is typically back loaded.

                                                  Additionally, there is considerable uncertainly still over intra-public sector financial
                                                  transactions that could produce a material change in the CGNCR. New legislation means
                                                  that there are technical changes in the payments between central and local government.
                                                  These arise from the financing of social housing and will see local authorities transfer
                                                  £13.7bn to central government while central government would reduce local authority
                                                  borrowing by £5.2bn. All told, this would potentially reduce the CGNCR by £8.5bn.
                                                  However, if local authorities were to replace the £13.7bn of financing via borrowing from
                                                  the Public Works Loan Board then net, the CGNCR would increase by £5.2bn. These
                                                  transactions are due to take place in March 2012 so would ultimately might be caught in
                                                  the April restatement of the remit but the OBR may well factor these changes into its
                                                  CGNCR forecasts if they are know to be occurring.

                                                  The Royal Mail Pension Scheme transfer will also have an effect on the CGNCR. Essentially,
                                                  the government is taking on a funded pension scheme and taking on the share of the assets
                                                  and all liabilities accruing prior to March 2012. This is estimated to be £25bn of assets

9 March 2012                                                                                                                                                 33
Barclays Capital | Global Rates Weekly


                                         versus £35bn of liabilities. The assets would be transferred to the government immediately
                                         whereas the liabilities would fall due over time. The overall impact on the CGNCR will be
                                         dependent on the timing of any planned asset disposal. The OBR estimate that the
                                         immediate impact would be a £2bn improvement in the CGNCR reflecting the cash held in
                                         the scheme. While the broader headline measure would also improve, the longer-term
                                         benefits to the public sector are more questionable sine the current present value of the
                                         liabilities is in excess of that of the assets and even after the programme of asset sales
                                         would be executed, we could well find that the liabilities continue to accrue.

                                         So we think that, overall, the revisions to the headline public finances are likely to be
                                         relatively small but there remains considerable uncertainty over the cash deficit measures
                                         which will only be resolved by clarity over policy actions. If the OBR feels that there is
                                         “reasonable certainty” over a specific policy action then this will be reflected in their
                                         forecasts. But as we have no real clarity beyond what has been discussed, at this stage, we
                                         retain our working assumption for gilt issuance in FY2012/13 of £185bn. We outlined our
                                         expectations in the 2012 Supply Outlook published on 12 December 2011. Here, we
                                         outlined an expectation that the DMO will retain the current split of issuance of around 20%
                                         in inflation-linked issuance and 80% in nominals. This is historically very close to the split
                                         that the DMO has presided over since it took over the issuance of gilts from the BOE in
                                         1998. In terms of the split between conventional issuance across maturity bands, we think
                                         that the split will remain broadly as has been seen over the past few years, with a slight bias
                                         to shorter dated issuance, again closer to what has been the average for the most recent
                                         programmes. All told, we expect the conventional-linker split to be £144bn versus £41bn.
                                         Our working assumption for conventional issuance split is £60bn short, £42bn medium and
                                         £42bn of long maturity paper. But given the uncertainties, we would see the risks to this
                                         number as lying towards a lower rather than higher issuance number.


                                         Figure 5: Net linker issuance set to increase sharply

                                           50                Gross Linker Issuance (£bn)                                                        35%
                                           45                Net Linker Issuance (£bn)                                               Forecast
                                           40                Linkers as % total cash sales (RHS)                                                30%
                                           35
                                           30                                                                                                   25%
                                           25
                                           20                                                                                                   20%
                                           15
                                           10                                                                                                   15%
                                             5
                                             0                                                                                                  10%
                                                 FY01/02       FY03/04         FY05/06         FY07/08         FY09/10         FY11/12

                                         Source: Barclays Capital, Note: FY11/12 numbers BarCap estimates, FY12/13 numbers BarCap forecasts


                                         We expect the DMO to issue £41bn cash value of index-linked gilts in FY12/13, up from £39bn
                                         in FY11/12. Our projections imply linkers will comprise 22% of total cash gilt sales in the
                                         forthcoming fiscal year, a similar proportion to the past two fiscal years. While the gross
                                         issuance figure we project is not significantly larger than last year, there are no linker
                                         redemptions until August 2013, meaning that net linker issuance is set to increase almost 40%.
                                         Long linker real yields are near zero, having been pushed negative in the final quarter in 2011 as
                                         the MPC electing to resume QE pushed nominal gilts sharply richer. Initially, this also resulted in


9 March 2012                                                                                                                                      34
Barclays Capital | Global Rates Weekly


                                         breakevens falling until 3% breakeven levels encouraged structural allocation flows away from
                                         nominal gilts into linkers. The historically low level of breakevens make linkers attractive value
                                         versus nominals for investors, even with real yields low, but for the DMO there would be a
                                         compelling argument to reduce linker issuance on cost grounds. On the flip side, the DMO has
                                         in the past stated its commitment to the linker market, and in recent years has generally
                                         maintained linker issuance in line with the proportion of the gilt market they constitute, close to
                                         20%. The annual DMO consultation meetings between investors also highlighted continue
                                         demand from the pension sector for long index-linked gilts, while there have also been
                                         widespread calls from dealers and investors for an increase in linker auction sizes.

                                         For supplementary issuance, we expect one linker syndication per quarter in FY12/13
                                         including one to coincide with the multiple index drops occurring in late November. On CPI
                                         linkers, the Government decided against issuance in the near term in November 2011 after
                                         a DMO consultation with the market on the subject. A potential obstacle to any future CPI-
                                         linked issuance is the possibility of market fragmentation given the split in the market
                                         between “old-style” 8m lag linkers and “new-style” Canadian model 3m lag issues. The
                                         DMO may choose at some point to consult on retiring old-style issues, which presently
                                         comprise 39% of linkers outstanding by market capitalisation. This could be undertaken by
                                         conversions, but would pose operational difficulties given that a reasonable proportion of
                                         old-style linkers were generally purchased by longer-term investors, and an unsuccessful
                                         conversion would arguably heighten market distortions.

                                         We think that the Budget will have a muted impact on gilt asset swap spreads. With the
                                         Bank of England still actively pursuing a QE policy, 10yr spreads trade slight more rich than
                                         cheap but 10yr spreads vs OIS at around +15bp are slightly rich but within the errors of our
                                         fair value model. However, we would see better value in exploiting the relative cheapness of
                                         20yr spreads relative to 10yr and 5yr spreads. Overall, the forthcoming Budget is likely to tell
                                         us far more about how much the Treasury cannot do in terms of fiscal action and will
                                         outline further the long path toward fiscal consolidation.




Figure 6: Real yields rallied sharply in FY11/12                        Figure 7: Breakevens not far from multi-year lows

  2.5                                         IL22 real yield             4.5                                         IL22 breakeven
                                              IL37 real yield                                                         IL37 breakeven
  2.0                                                                     4.0
                                              IL55 real yield                                                         IL55 breakeven
  1.5
                                                                          3.5
  1.0
                                                                          3.0
  0.5
                                                                          2.5
  0.0

 -0.5                                                                     2.0

 -1.0                                                                     1.5
    Jan-08 Sep-08 May-09 Jan-10 Sep-10 May-11 Jan-12                        Jan-08    Sep-08 May-09 Jan-10 Sep-10 May-11 Jan-12

Source: Barclays Capital                                                Source: Barclays Capital


9 March 2012                                                                                                                             35
Barclays Capital | Global Rates Weekly


Figure 8: Asset swaps are broadly in line with the deficit                 Figure 9: 20yr spreads looks cheap (bp)

     0                     Rolling 1yr ahead deficit                 -50       80                            Gilt/OIS 5y5y/10y10y/15y15y
   -20                     Gilt/OIS 5y5yfwd ASW (RHS)                          60
                                                                     -25
   -40                                                                         40
   -60                                                               0
                                                                               20
   -80                                                               25         0
 -100
                                                                              -20
 -120                                                                50
                                                                              -40
 -140                                                                75
                                                                              -60
 -160
                                                                     100      -80
 -180
                                                                            -100
 -200                                                                125
                                                                               Jan-10          Jul-10   Jan-11    Jul-11     Jan-12
    Jan-07      Jan-08     Jan-09     Jan-10       Jan-11   Jan-12

Source: Consensus Economics and Barclays Capital                           Source: Barclays Capital




9 March 2012                                                                                                                               36
Barclays Capital | Global Rates Weekly


EURO INFLATION-LINKED MARKETS

                                                Bracing for a Q2 supply bonanza
          Khrishnamoorthy Sooben                We expect European linker issuance to pick-up significantly in Q2, especially in the 5y to
              +44 (0)20 7773 7514               10y sector. This leaves shorter-dated breakevens as likely to outperform on the curve.
       khrishnamoorthy.sooben@
                                                The European sovereign linker market has seen no issuance of new lines so far this year.
                          barcap.com
                                                This contrasts sharply with 2011 when the first quarter saw a flurry of new benchmarks,
                                                with two new bonds from France and one from Italy. Our current forecasts indicate that Q1
                                                2012 is likely to see the lowest first-quarter issuance since 2009, when the market was still
                                                recovering from the volatility of late 2008 and distressed conditions. First and second
                                                quarters generally see a high concentration of a calendar year’s issuance, indeed due to the
                                                launch of new benchmarks, with the initial supply in the latter typically conducted in sizes
                                                that are well above reopenings. However, in our view, the low pace of issuance so far in
                                                2012 has not been a surprise to market participants. Given the general uncertainty in
                                                European markets maintained by the peripheral-debt crisis, it seemed obvious that issuers
                                                would not resort to the usual front-loading of linker issuance. More importantly, perhaps,
                                                the first quarter was foreseen to carry significant uncertainty specific to the European linker
                                                market, namely in terms of the possibility for BTP€is to be excluded from Barclays’ indices
                                                after ratings downgrades. The response of issuers to low investor demand and probably a
                                                reduced willingness from dealers to warehouse risk has therefore been welcome.

                                                This leaves the second quarter as most likely to see a catch-up in terms of issuance activity.
                                                In particular, we note that the index-related risk for BTP€is is probably no longer a short- or
                                                even medium-term concern, and as for the treatment of linkers within the Greek PSI, there
                                                is little or no uncertainty anymore. Furthermore, the ECB’s 3y LTROs have contributed to a
                                                reigniting of outright, breakeven and asset swap demand for BTP€is, and alongside
                                                negligible SMP purchases over the past months, have played a role in the significant
                                                normalisation in their valuations versus German and French linkers. This is not to say that
                                                distressed BTP€i breakevens were an overwhelming factor limiting the issuance ambitions
                                                of France of Germany, but are likely to have contributed to sentiment that the market was
                                                not fully functional and therefore not in a position to accommodate the usual magnitude of
                                                issuance seen in the first few months of previous years.

Figure 1: 2012 could see highest Q2 issuance ever                              Figure 2: Q2 2012 issuance to be concentrated in 5-10y

 20000                      Quarterly issuance (€mn)                Forecast      5.0                                2012 european linker issuance
                                                                                                                  projections by maturity bucket (€bn)
 18000                                                                            4.5
 16000                                                                            4.0
 14000                                                                            3.5                                                    5    10     15    30
 12000                                                                            3.0
 10000                                                                            2.5
   8000                                                                           2.0
   6000                                                                           1.5
   4000                                                                           1.0
   2000                                                                           0.5
       0                                                                          0.0
       Q1 06 Q1 07 Q1 08 Q1 09 Q1 10 Q1 11 Q1 12                                         Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Note: These forecasts do not include BTP Italia. Source: Barclays Capital      Note: These forecasts do not include BTP Italia. Source: Barclays Capital


9 March 2012                                                                                                                                                37
Barclays Capital | Global Rates Weekly


                                         With France announcing that March’s supply will consist of a €1.2bn to €1.7bn split
                                         between the OATi19, OAT€i22 and OAT€i27, we see Q1 as likely to end without a new
                                         benchmark being launched. Italy has demonstrated a willingness to continue issuing BTP€is
                                         and at current valuations, we expect that willingness to be reinforced. However, for the time
                                         being, and perhaps for the rest of this year, a new BTP€i does not seem to be on the agenda.
                                         That said, Italy has announced the creation of a new class of inflation-linked BTPs that
                                         would be linked to the domestic FOI ex-tobacco index, starting with a 4y issue being issued
                                         in late March. While these bonds are primarily aimed at retail investors, we see no strong
                                         reason why they may not appeal to domestic institutional investors too. This means that in
                                         the medium- to long-term, issuance in the so-called “BTP Italia” could also be directed
                                         towards the institutional investor base. Dealers may also see an interest in this new class of
                                         securities to their hedge exposure in FOIx swaps, although the structure of the new bonds is
                                         very different to the usual back-ended accreting formula applied to current European
                                         sovereign linkers. BTP Italia will pay out principal inflation accretion alongside their semi-
                                         annual coupons, which does not make them an ideal hedge for Italian swap exposures.

                                         In our view, new benchmark issuance this year is likely to come first from Germany. We
                                         highlight that Germany has not issued so far this year and we see a new 10y benchmark as
                                         most likely in April, ahead of the OBL€i13 dropping out of bond indices at the end of the
                                         month. Admittedly, there is still significant room to increase the size of the OBL€i18 but at
                                         the same time, with the Bund€i20 almost an 8y bond, we believe there is a strong rationale
                                         for Germany to bring a new 10y Bund€i to the market to maintain a benchmark status in
                                         the traditionally most liquid point for the market. Assuming a new 10y German benchmark,
                                         we would expect the next new bond from France to be shorter on the curve. In particular,
                                         we see the possibility for an OAT€i 2018, which would fill a gap in the French €i curve. We
                                         would expect such a new bond from France in Q2 also, probably in May. We also see the
                                         potential for an inaugural Belgian linker, possibly by the end of Q2. We do not discard the
                                         possibility that Belgium also opts for a retail-targeted programmed if the “BTP Italia” launch
                                         is a success, but if they opt for €i supply and given the scope for Spain to issue in the
                                         second half of the year if spread conditions become more benign we would not be surprised
                                         to see Belgium issue in June. Overall, assuming €4bn each in new bonds from Germany and
                                         France, alongside typical French and Italian tap auctions, Q2 2012 could see the highest
                                         second-quarter issuance ever in the European linker market and close to an all-time record
                                         if Belgium issues too.

                                         Our current forecasts suggest that sub-5y issuance in Q2 is likely to be negligible. With
                                         longer-dated issuance likely to be particularly heavy, at least based on our expectations,
                                         short end breakevens curve may outperform on the curve. The very positive seasonal carry
                                         in Q2 could be a further supportive factor for the short end, especially if energy prices
                                         continue to increase. We would note also that while a resumption of a more normal
                                         issuance pattern would be an indication of a healthy market, breakeven valuations in the 5y
                                         and longer maturities may cheapen unless real yields back up enough to entice sufficient
                                         real money interest.




9 March 2012                                                                                                                         38
Barclays Capital | Global Rates Weekly


EUROPE: VOLATILITY

                                             EUR 5y tails: Too high to buy
                           Piyush Goyal      Intermediate-expiry 5y tails are rich compared to rest of the surface and could cheapen
                   +1 212 412 6793           as ECB-on-hold expectations spread further out. We recommend selling 2y*5y vol
         piyush.goyal@barcap.com             through 2y*5y-2y*30y capped bear steepeners, which also carry favourably.

                                             The 2y*2y-2y*5y-2y*10y volatility fly in EUR is at its richest level in the past ten years (Figure 1).
                     Hitendra Rohra
                                             Broadly, the higher volatility for the belly is justified when intermediate rates lead the yield curve
              +44 (0)20 7773 4817
                                             in a rally or a sell-off. An investor can buy a 2y*5y payer funded with 2y*2y and 2y*10y payer
     hitendra.rohra@barcap.com
                                             and gain if rates sell off a large amount. Conversely, a 2y*2y-2y*5y-2y*10y receiver fly could
                                             deliver gains in a rate rally. So, 5y tails are richer than 2y and 10y tails.

                                             However, as Figure 2 shows, the 2y5y rate and the 2y forward 2s5s10s rate fly have broadly
                                             moved in opposite directions in the recent past. In other words, the 2y5y rate has lagged the
                                             2y2y and the 2y10y rate during rallies and sell-offs. So the richness of the vol fly is not
                                             justified by the relative yield curve move.

                                             Why so rich?
                                             The US vol surface provides a context. Until recently, 5y and 10y tails in the US had
                                             benefitted from demand from mortgage hedgers. And while this support has fallen off in
                                             the past couple of years, the Fed’s endeavour to push hike expectations further out (such as
                                             at the August and January FOMC meetings) has pummelled 2y tails. Together, this has
                                             caused the fly to trade at an average of 1.02 for the past ten years. Currently, it is trading at
                                             ~1.04, mostly due to Fed-on-hold expectations.

                                             The EUR 5y and 10y tails never benefitted in the manner US intermediate tails did from the
                                             mortgage prepay convexity. As a result, the fly traded below 1.04 for most of the past
                                             decade. However, it has now richened to record levels, for two reasons.

                                             One, ECB-on-hold expectations are taking deeper roots. As a result, the 2y*2y has fallen
                                             more than 2y*5y or 2y*10y over the past few months. Two, there has been a dearth of new
                                             issuance of CMS notes in the past few months (Figure 3). Typically, such issuance leads to
                                             supply of intermediate expiry 5y tails, so the absence of it has benefitted 5y tails.
                                             Going forward, a renormalisation of the fly could happen; at a minimum, it may not richen
Figure 1: 2y*5y is rich on the fly…                                          Figure 2: … even as the 2y5y rate has lagged the curve

 1. 06                                                                         14                                                               4.5

                                                                               12
 1. 04                                                                                                                                          4
                                                                               10
 1. 02                                                                                                                                          3.5
                                                                                8
 1. 00                                                                          6                                                               3

 0. 98                                                                          4
                                                                                                                                                2.5
                                                                                2
 0. 96
                                                                                0                                                                2
 0. 94                                                                          Sep-09      Mar-10          Sep-10        Mar-11   Sep-11   Mar-12
     Nov-02        Nov-04        Nov-06      Nov-08      Nov-10

                             2yf 2y-5y-10y Vol Fly                                                      2yf 2s5s10s fly        2y5y rate
Source: Barclays Capital                                                     Source: Barclays Capital


9 March 2012                                                                                                                                         39
Barclays Capital | Global Rates Weekly


                                         anymore. This is because while the recent drop in 2y*2y was warranted, further declines may be
                                         harder to come by. The cheapening in 2y tails was reasonable because ECB-on-hold
                                         expectations have spread further out, as reflected by lower forward short rates. Eventually, the
                                         EUR top left should resemble the US top left. But longer than 2y expiry options, including 2y*2y,
                                         have already become as cheap as or cheaper than comparable vol in the US and may not fall
                                         more. However, 5y tails could come under pressure if a longer dovish ECB is priced in. Further,
                                         structured note issuance can only, it would seem, pick up, putting downward pressure on 2y*5y.

                                         Capped steepener
                                         Instead of selling the vol fly, we recommend fading the richness of the 5y tails via a capped
                                         bear steepener. The trade involves a vanilla 5s-30s bear steepener and capping the upside
                                         by shorting a 5s-30s single look curve cap. The high level of the 2y*5y vol means that the
                                         steepener can be struck at an attractive point, while a fall in the 5y vol would help improve
                                         the MTM characteristics.

                                            Sell EUR 450mn 2y*5y payer @ 2.2%

                                            Buy EUR 100mn 2y*30y payer @ 2.65%

                                            Sell EUR 2.1bn 2y SL 5y-30y curve cap @ 75bp

                                         Essentially, this is a steepener struck at significantly better than 45bp when the forward is
                                         43bp and the spot curve is 100bp. In the base case, rates largely remain range-bound as the
                                         resolution of the eurozone issues take time. So the trade would benefit from positive carry:
                                         110cts in six months and 200cts in one year.

                                         On the other hand, if the outlook in the eurozone takes a turn for the worse, the curve will
                                         likely bull flatten due to the CVA hedging. In this case, all options (including the curve cap)
                                         would likely expire worthless and the trade would retain the initial premium.

                                         Least likely, but still possible, if the conditions in the eurozone improve considerably and
                                         rates sell off, the 5s-30s curve will likely bear steepen and the trade make a profit. The curve
                                         option would cap the upside at 75bp, but would have still generated 50bp of curve dv01 (=
                                         ~1000cts = 50bp * 20cts).

                                         The major risk to this trade is bull steepening. However, with rates already low, there is not
                                         much scope for this. Besides, the premium intake from the curve cap provides a decent
                                         cushion against the steepening


                                         Figure 3: Structured note issuance has picked up recently

                                             35

                                             30

                                             25
                                             20

                                             15
                                             10

                                             5

                                             0
                                                  Q1 2009           Q3 2009    Q1 2010     Q3 2010      Q1 2011     Q3 2011       Q1 2012


                                                    Fixed Callable        Fixed Step Cpn   Capped Floaters    CMS Notes       Forecast

                                         Source: Barclays Capital

9 March 2012                                                                                                                             40
Barclays Capital | Global Rates Weekly


AUSTRALIA: RATES STRATEGY

                                           Model update: AU curve still too flat, despite
                                           recent steepening
                       Gavin Stacey        This article was originally published on 8 March 2012.
                  +61 2 9334 6128
                                           Earlier this week, we recommended an AU 3s10s curve steepener at 37bp (Australia:
       gavin.stacey@barcap.com
                                           Curve flattener has gone too far; recommend a tactical steepener, 6 March 2012).

                                           Despite our view that troughs in global manufacturing PMIs – the recent bottom appears to
                                           have been reached in November 2011 – tend to be associated with higher short-end rates
                                           and a flatter curve, we thought "risk on" fatigue would likely deliver a partial retracement of
                                           trends seen in both over the past month.

                                           An AU 3s10s steepener provided an attractive risk/return tactical trade, in our opinion. We
                                           saw scope for the market to partially unwind the 25bp of monotonic flattening in the AU
                                           3s10s bond curve over the past month. With less than two 25bp rate cuts priced in by
                                           October, there appeared ample opportunity for the AU market to scale up easing
                                           expectations in the event that upcoming China data undershoot expectations.

                                           Our confidence in the trade was strengthened by the fact that our model for the AU curve
                                           suggested fair value was around 59bp versus its level at the time of 37bp (see Figure 1 and
                                           2). Fair value in the model utilises a range of domestic and offshore economic and market
                                           variables, including US 10y yields, AU 3y yields and BarCap's global PMI. The global PMI was
                                           introduced to capture emerging macroeconomic developments that have been historically
                                           important drivers of AU short-end rates. A lagged dependent variable was also included to
                                           correct for serial correlation.

                                           With the AU 3s10s bond curve currently around 43bp we believe there is still scope for
                                           further steepening. It is worth positioning for, in our opinion.




Figure 1: AU 3s10s bond curve vs fair value                              Figure 2: AU 3s10s bond curve model residual

  1.6                                                                      0.40
  1.4
  1.2                                                                      0.30
  1.0                                                                      0.20
  0.8
  0.6                                                                      0.10
  0.4                                                                      0.00
  0.2
  0.0                                                                     -0.10
 -0.2
 -0.4                                                                     -0.20
 -0.6                                                                     -0.30
    Mar-     Sep- Mar-        Sep- Mar- Sep- Mar-       Sep- Mar-
                                                                          -0.40
      00      01   03          04   06   07   09         10   12
                                                                              Mar- Sep- Mar- Sep- Mar- Sep- Mar- Sep- Mar-
                                 Actual      Fitted                             00  01   03   04   06   07   09   10   12

Source: RBA, Bloomberg, Barclays Capital                                 Source: RBA, Bloomberg, Barclays Capital


9 March 2012                                                                                                                            41
Barclays Capital | Global Rates Weekly


JAPAN: RATES STRATEGY

                                            Market’s response function to investor sentiment
                    Chotaro Morita          JGB market sentiment peaked last December, but we have not seen the usual pattern, in
                   +81 3 4530 1717          which a peak is followed immediately by a bearish market. We attribute this largely to
      chotaro.morita@barcap.com             the impact of the BoJ’s latest easing. However, we should also recall the case of 2003,
                                            when sentiment eventually began to weaken with a significant lag after hitting its peak.
            Reiko Tokukatsu, CFA
                                            We think the recent diversion of EUR/USD OIS/OIS basis in a more negative direction does
                   +81 3 4530 1532
                                            not mean more negative JPY/USD basis. We also add a short JGB 2-5-10y position.
    reiko.tokukatsu@barcap.com
                                            We noted last week that although the expansion in the loan-deposit gap at Japanese banks
                     Noriatsu Tanji         halted last autumn, they have continued to boost their JGB holdings at a consistent pace.
                   +81 3 4530 1346          Deposit and loan data for February, released this week, show continued flat growth in the
       noriatsu.tanji@barcap.com            loan-deposit gap. That is, banks are accumulating JGBs at a faster pace than the growth in
                                            their surplus cash.

                                            Bank data is about the only balance sheet information available on a timely basis, but more
                                            general information on investor positions, gleaned from investor surveys, indicates that the
                                            overall bullish phase in the markets reached a peak in December. The domestic bond
                                            weighting in the QUICK survey serves as one indicator of market sentiment (Figure 1).

                                            We also look at US Treasury sentiment as reported in a JP Morgan survey. We note that the
                                            overall trend in both markets tends to move in the same direction, but fluctuations in sentiment
                                            differ in some cases and occasionally veer in completely different directions. Last December,
                                            while UST investor sentiment was rather weak, Japanese sentiment was hitting a peak.

                                            Japanese bond investor sentiment was at bullish levels in December, but as with the two
                                            previous occasions, suffered a relatively large correction immediately after it reached its high.
                                            In December 2008, when sentiment similarly peaked, yields touched their low point at the end
                                            of the month, followed by a bearish market through the following June. During another
                                            sentiment peak in October 2010, yields bottomed early in the month, and the markets then
                                            rose though April. At least in these two cases, market sentiment data functioned as a
                                            contrarian indicator.


Figure 1: UST and JGB positions                                            Figure 2: Oil prices and 3m-1y1y JGB (bp)

 60                                 Dec-08                         40        70                           y = 0.9765x - 116.19
                                                                                                                2
                                                                             60                                R = 0.7198
                                                            Dec-11 30            y = 0.5444x - 25.724
 55                                               Oct-10           20        50         2
       Apr-03                                                                         R = 0.6591 y = 0.1165x + 9.0461
                                                                             40
                                                                   10                                   2
                                                                                                       R = 0.0418
                                                                             30
 50                                                                0
                                                                             20
                                                                   -10       10
 45                                                                -20        0
                                             Bullish               -30      -10
 40                                                                -40      -20
                                                                   -50      -30
                                             Bearish                            60        80       100    120       140      160        180
 35                                                                -60
      03    04     05    06    07      08    09   10   11     12                 Jan-Oct 08                Oct-Dec 08       Dec 08-Jun 10
                 JGB positions (LHS)         UST net long (RHS)                  Jun 10-Oct 11             Oct 11-present   Present

Source: QSS, JP Morgan Chase                                               Source: Bloomberg, Barclays Capital


9 March 2012                                                                                                                                42
Barclays Capital | Global Rates Weekly


                                         This time, however, despite the fact that sentiment peaked in December, there has been no
                                         shift to a bearish market in the subsequent months. One factor is the unusually strong
                                         effect of monetary policy. In particular, we believe the low sensitivity of yields to the rise in
                                         commodity prices represents the growing impact of the BoJ’s easing.

                                         One element in common during the bear markets of December 2008-June 2009 and
                                         October 2010-April 2011 was the uptrend in oil prices. JGB markets are affected to a
                                         significant extent by commodity price rises, including an indirect impact via US and
                                         European bond markets. Figure 2 shows the strong correlation between oil prices and the
                                         short end of the JGB yield curve in January 2008-October 2008 and December 2008-June
                                         2009. The relation diminished markedly from June 2010. In contrast, UST yields and oil
                                         prices were clearly linked during June 2010-November 2011, but since then the correlation
                                         has weakened.

                                         However, from the standpoint of the impact of monetary easing, we should also recall the
                                         case of April 2003, another peak in sentiment point indicated in Figure 1. This represents the
                                         initial launch of the BoJ’s quantitative easing policy and policy duration effect, precisely the
                                         strategies the bank is pursuing at present. At that time, it took two months from the peak in
                                         sentiment until we entered a bear market. This is an example of how the widening impact of
                                         monetary policy measures does not necessarily guarantee a prolonged bullish bond market.


                                         Impact of the more negative EUR/USD basis on JPY/USD basis, rich 5y JGB
                                         Historically EUR/USD and JPY/USD cross-currency basis used to move in line when
                                         compared as OIS/OIS basis, given that OIS is much closer to actual funding rates. However,
                                         recently, EUR/USD OIS/OIS diverged significantly in the negative direction (Figure 3). We
                                         attribute this trend to ECB’s 3y LTROs, which supplied EUR529bn.

                                         This means that for cash-rich USD investors, it may be more attractive to invest in EUR
                                         instead of JPY. Since 2010, US banks have increased excess reserves at the BoJ to capture
                                         the spread between the effective JPY funding rate and IOER. However, as the JPY/USD basis
                                         returned to near flat, the spread has compressed and excess reserves were withdrawn
                                         (Figure 4). If such investors shift investment from the BoJ to the ECB, the JPY/USD basis may
                                         follow the negative move by EUR/USD.



Figure 3: Spot 3m OIS/OIS basis (bp)                                    Figure 4: Foreign banks’ excess reserves at BoJ (JPY trn) and
                                                                        implied JPY funding rate when USD is funded at OIS (%)

   -20                                                                             Jan-09          Jan-10        Jan-11             Jan-12
   -30                                                                             0                                                         0.2
   -40                                                                             1                                                         0.1

   -50                                                                             2                                                         0.0
                                                                                                                                spread
   -60                                                                                                                                       -0.1
                                                                                   3
                                                                          JPY tn




                                                                                                                                             -0.2
   -70                                                                             4
                                                                                                                                             -0.3
   -80                                                                             5
                                                                                                                                             -0.4
   -90                                                                             6                                                         -0.5
 -100
                                                                                   7                                                         -0.6
 -110                                                                                       Excess reserve by foreign banks (LHS)
                                                                                   8                                                         -0.7
   Aug-11              Oct-11        Dec-11         Feb-12                                  implied JPY funding rate (RHS)
                           EUR/USD        JPY/USD                                           IOER (RHS)
Source: Barclays Capital                                                Source: Barclays Capital


9 March 2012                                                                                                                                       43
Barclays Capital | Global Rates Weekly


Figure 5: Margin comparison at BoJ vs ECB (bp)                                         Figure 6: 25% risk reversal in EUR/USD, %

 120                                                                                      0.0
                                                                                                                                                             Vol low
 100                                                                                     -0.5
                                                                                                                                                           for Euro put
   80                                                                                    -1.0
   60                                                                                    -1.5
   40                                                                                    -2.0
   20                                                                                    -2.5
       0                                                                                 -3.0
  -20                                                                                                                                                        Vol high
                                                                                         -3.5
  -40                                                                                                                                                      for Euro put
                                                                                         -4.0
  -60
                                                                                         -4.5
  -80
                                                                                         -5.0
   Aug-11              Oct-11             Dec-11             Feb-12
                                                                                            Jun-10       Oct-10       Feb-11     Jun-11 Oct-11            Feb-12
                      Margin via BoJ             Margin via ECB                                                                   25%RR
Source: Barclays Capital, assuming investor can fund USD at OIS and either             Source: Barclays Capital, difference of implied volatility between EUR call and put
deposit at ECB or BoJ via reserve account                                              options of 25% delta.


                                                However, current pricing does not suggest that there is a compelling incentive to shift.
                                                Figure 5 shows that while the JPY’s advantage has been reduced relative to the EUR, both
                                                investments still earn a similar spread. Therefore, at this stage, we are comfortable with
                                                paying 1y1y JPY/USD cross-currency basis as a carry position.

                                                This week, the 5y JGB richened further, as there has been some speculation that the BoJ may
                                                ease again at next week’s MPM. First, we the fresh 5y positions face disappointment if
                                                easing does not materialize. In addition, during the past two years, we have seen 5y richness
                                                ahead of easing had retraced – even when the easing took place. Therefore, we recommend
                                                positions that are short 5y JGBs and add 2s5s10s short butterfly.

Figure 7: Recommendation updates (bp)
                                                            Year
                                                            end/       Current       Weekly        Risk      Target
                                                 Entry      Entry        (incl         P&L        (DV01,      (incl
                                                 date       level       carry)      (JPY mn)     JPY mn)     carry)      Stop      Horizon       Action
              JGB 10-30y flattener                                                                                                                New (per 30y auction
 JGB                                            06-Mar       97.0        96.8          2.0          10        93.0      101.0      medium
              (JB321/JX36)                                                                                                                         preview on Mar 5)
              JGB 2s5s10s short                                                                    20                               short-
                                                09-Mar       -55.0      -55.5         -5.0                   -50.0       -60.0                             New
              (JN314-JS100-JB321)                                                                (body)                            medium
                                                                                                                                  by March
 Swap         Tibor/Libor 5-10y steepener       09-Dec       -2.0        -1.2          0.0          10         2.0       -4.0                              Hold
                                                                                                                                     end
              10Y ASW (JB318)                   25-Nov        0.1        -3.0         15.0          10        -5.0        8.0        long                  Hold
 Swap         20Y ASW vs. 3month(JL129)          28-Oct      36.0        30.4         15.0          10        25.0       42.0        long                  Hold
 spread
                                                                                                                                                  Increase position by
              5Y ASW short (JS100)              02-Mar       -15.7      -16.0         -5.0          15       -13.0       -18.0     medium
                                                                                                                                                       JPY 5mm
                                                                                                                                                 Hold (CM=-63.5bp, the
              Pay 1y1y                          02-Dec       -92.0      -59.0         10.0          10       -50.0      -100.0     medium           difference owes
 Xccy basis                                                                                                                                             rolldown)
 swap
                                                                                                                                   medium-
              Rec 20yx10y                        27-Jan      38.0        41.5         -4.8          3         20.0       45.0                              Hold
                                                                                                                                    long
                                                                                                                                                   Hold with view to
              3mx10Y swaption long                                                               JPY10b
                                                 20-Jan      43.0        20.5          1.9                    90.0       20.0      till expiry   possible sell-off in early
              (K=1.12% )                                                                          n face
                                                                                                                                                           April
 Swaption
                                                                                                 JPY10b
              1mx10y-20y conditional bull
                                                 15-Feb      -5.0        4.7          -1.7        n face      35.0       -5.0      1 month                 Hold
              steepener
                                                                                                 for 10Y

Weekly P/L = 11.0; Total P/L since 2012: 537; Balance sheet 162.1; 1 day VaR (x2.33 std) 64.0.
Note: Current levels based on the absolute maturity to capture rolldown correctly; therefore, it is different from the constant-maturity spread. Source: Barclays Capital


9 March 2012                                                                                                                                                             44
Barclays Capital | Global Rates Weekly


GLOBAL TRADERS’ GUIDE

                                         Key data and events
                                         US
                                            We do not anticipate any major changes to the monetary policy stance at the next
                                             FOMC meeting (Tues). Although labor market conditions have improved, some data on
                                             activity have been mixed – factors that are likely to be reflected in the assessment of
                                             economic conditions.

                                            We look for a 0.5% m/m increase in the February CPI (Fri; consensus: 0.4%, last: 0.2%),
                                             driven by higher gasoline prices, and a 0.2% m/m increase in core CPI (consensus/ last:
                                             0.2%), reflecting our view that gains in core service prices are likely to persist. We and
                                             the consensus look for a 0.5% m/m increase in the February PPI (Thurs; last: 0.1%) and
                                             a 0.2% m/m increase in core PPI (last: 0.4%).

                                            February retail sales are expected to have increased 1.2% m/m (Tues; consensus: 1.0%, last:
                                             0.4%). We and the consensus are looking for a 0.4% m/m increase in industrial production
                                             (Fri; last: 0.0%). We expect the current account deficit to have widened modestly to
                                             $113.0bn in Q4 from $110.3bn in Q3 (Wed; consensus: $114.2bn).

                                         Europe
                                            The Eurogroup (Mon)/Ecofin (Tues) meetings are expected to review progress made on
                                             the proposal of a Financial Transaction tax, adopt conclusions on the Alert Mechanism
                                             Report and debrief the main outcomes of the G20 summit at the end of February.

                                            We and the consensus expect euro area final HICP inflation rate to be confirmed at 2.7% y/y
                                             (Wed; last: 2.6%), while we are below-consensus in forecasting an unchanged reading for
                                             core inflation (+1.5% y/y; consensus: 1.6%). We also look for the euro area HICPx index to
                                             have increased to 113.53 (last: 112.96). We expect E17 January industrial production to climb
                                             by 0.2% m/m, offsetting last month’s 1.2% m/m decline (Wed; consensus: 0.6%). We look
                                             for E17 employment to fall by 0.3% q/q in Q4 11 after -0.1% q/q in Q3 11 (Thurs). We
                                             expect the January E17 trade balance to remain in positive territory with a €6.5bn surplus (Fri;
                                             last: €7.5bn). We and the consensus expect the Norges Bank to keep the policy rate
                                             unchanged at 1.75% (Wed).

                                            In the UK, we expect the February RICS house price balance to fall to -17 from -16 (Tues;
                                             consensus: -14), the January goods trade balance to improve to -£7.0bn from -£7.1bn
                                             (Tues; consensus: -£7.9bn), average weakly earnings (January) to grow by 1.9% 3m/y
                                             (Wed; consensus 1.9%; last: 2.0%) core earnings growth of 2.0% 3m/y (consensus
                                             1.9%; last: 2.0%), ILO unemployment to remain at 8.4% (consensus: 8.4%) and
                                             claimant count unemployment (February) to grow by 4.9k (consensus: 4.9k; last: 6.9k).

                                         Japan
                                            We estimate that January core machinery orders increased 2.0% m/m (Sun; consensus:
                                             2.3%, last:-7.1%). Using our estimate and assuming flat m/m readings in February and
                                             March, orders will be up 1.6% q/q. For BoJ’s MPM (Tues), we do not expect any change
                                             to policy rates or the asset purchase program (APP).




9 March 2012                                                                                                                              45
Barclays Capital | Global Rates Weekly


GLOBAL WEEKLY CALENDAR
Saturday 10 March                                             Period            Prev 2                           Prev 1          Latest      Forecast Consensus
     -      Slovakia: Parliamentary elections
   11:30    E17: EU President Rompuy speaks at "European strategy forum" in Dubrovnik
     -      China: Exports, % y/y                             Feb                 13.8                              13.4           -0.5               -          31.1
     -      China: Imports, % y/y                             Feb                 22.1                              11.8          -15.3               -          31.8
     -      Egypt: CPI, % y/y                                 Feb                  9.1                               9.6            8.6             9.7             -

Sunday 11 March                                                             Period                Prev 2         Prev 1          Latest      Forecast Consensus
     -     Russia: Overnight deposit rate, % (to 15/03)                     Mar                     4.00           4.00            4.00          4.00      4.00
     -     Russia: Refinancing rate, % (to 15/03)                           Mar                     8.00           8.00            8.00          8.00      8.00
   23:50   Japan: Core machinery order, % m/m                               Jan                     -6.9           14.8            -7.1           2.0       2.3
   23:50   Japan: Corporate goods price index, % y/y                        Feb                      1.6            1.2             0.5           0.6       0.6

Monday 12 March                                             Period            Prev 2        Prev 1     Latest                                Forecast Consensus
    -     Greece: Private creditors' swap transactions
  11:45   Belgium: CB Governor Coene speaks on Belgium financial administration in Brussels
  16:00   E17: Eurogroup meeting
    -     Serbia: HICP, % y/y                               Feb                   8.1           7.0        5.6                                     4.5           -
  08:00   Romania: CPI, % y/y                               Feb                   3.4           3.1        2.7                                     2.8         2.4
  09:00   Bulgaria: CPI, % y/y                              Feb                   3.1           2.8        2.3                                       -           -
  09:00   Italy: Final GDP release, % q/q                   Q4                    0.3          -0.2     -0.7 P                                    -0.7        -0.7
  10:00   Portugal: HICP, % m/m (y/y)                       Feb            -0.1 (3.8)     0.1 (3.5)  0.3 (3.4)                              -0.3 (3.1)           -
  18:00   US: Treasury budget balance, $ bn                 Feb         -193.9 ('09) -220.9 ('10) -222.5 ('11)                                 -229.0       -229.4
  23:50   Japan: Index of tertiary industry activity, % m/m Jan                   0.8          -0.6        1.4                                     1.5         0.2
  02:30   Korea: 5y Bonds Auction                                                                                                                     KRW 2300 bn
  04:00   Malaysia: 128d/154d/210d Notes Auction                                                                                                        MYR 5.5 bn
  10:30   Germany: New 6m Bubill 12Sep 2012                                                                                                                 € 4 bn
  13:50   France: BTF auction                                                                                                                             € 7.5 bn
  14:45   UK: 3-7y Reverse Gilt Auctions                                                                                                                  £ 1.5 bn
  18:00   US: 3y Note Auction                                                                                                                              $ 32 bn

Tuesday 13 March                                              Period             Prev 2        Prev 1       Latest    Forecast Consensus
     -     Japan: BoJ Target rate, %                          Mar                   0.10          0.10        0.10          0.10      0.10
   08:00   E27: ECOFIN meeting
   10:45   Finland: PM Katainen and former ECB President Trichet speaks at a seminar on the "Future of Europe"
   11:30   E17: EU President Rompuy and EC Barroso speaks to the European Parliament about the last EU summit
   11:30   E17: ECB President Draghi speaks on "The challenges of competitiveness" in Paris
   14:00   Global: WTO Committee on budget, finance and administration
   15:00   Italy: PM Monti and German Chancellor Merkel to discuss latest developments in the eurozone debt crisis in Rome
   16:30   France: FM Baroin and German FM Schaeuble discuss on "How to exit the crisis & restore growth" in Paris
   18:15   US: FOMC rate decision                             Mar                   0.25          0.25        0.25          0.25      0.25
   00:01   UK: RICS house price balance                      Feb                  -17.0         -16.0        -16.0        -17.0     -14.0
   06:30   France: HICP, % m/m (y/y)                          Feb              0.3 (2.7)     0.4 (2.7)  -0.4 (2.6)     0.5 (2.6) 0.5 (2.6)
   06:30   France: CPI, % m/m (y/y)                           Feb              0.3 (2.5)     0.4 (2.5)  -0.4 (2.3)     0.5 (2.4) 0.4 (2.3)
   06:30   France: CPI ex tobacco index                      Feb                123.00        123.51        123.06       123.67    123.67
   08:00   Hungary: CPI, % y/y                               Feb                     4.3           4.1          5.5          5.5       5.5
   08:00   Spain: Final HICP, % m/m (y/y)                     Feb              0.0 (2.4)    -1.7 (2.0)   ...(1.9) P    0.0 (1.9) 0.1 (1.9)
   08:30   Sweden: CPI Level,                                 Feb                314.16        314.78       311.85       314.05    313.67
   08:30   Sweden: CPIF, % m/m (y/y)                          Feb              0.2 (1.1)     0.0 (0.5)  -0.7 (0.9)     0.7 (1.1) 0.6 (1.0)
   08:30   Sweden: CPI Headline, % m/m (y/y)                  Feb              0.2 (2.8)     0.2 (2.3)  -0.9 (1.9)     0.5 (2.0) 0.4 (1.7)
   09:00   Italy: Final HICP, % m/m (y/y)                     Feb              0.3 (3.7)    -1.8 (3.4) 0.2 (3.4) P     0.2 (3.4) 0.2 (3.4)
   09:00   Italy: Final CPI, % m/m (y/y)                      Feb              0.4 (3.3)     0.3 (3.2) 0.4 (3.3) P     0.4 (3.3) 0.4 (3.3)
Note: All times reported in GMT. Some data or events are boxed to indicate their importance to financial markets. Market events are highlighted in light blue.




9 March 2012                                                                                                                                                       46
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Tuesday 13 March                                                            Period                Prev 2         Prev 1          Latest      Forecast Consensus
   09:30   UK: Visible trade balance, £bn                                   Jan                     -8.1           -8.9            -7.1          -7.0         -7.9
   10:00   Germany: ZEW economic expectations index                         Mar                    -53.8          -21.6             5.4             -         10.0
   10:00   E17: ZEW economic sentiment index                                Mar                    -54.1          -32.5            -8.1             -            -
   12:30   US: Retail sales, % m/m                                          Feb                      0.3            0.0             0.4           1.2          1.0
   12:30   US: Retail sales ex autos, % m/m                                 Feb                      0.2           -0.5             0.7           0.8          0.7
   12:30   US: Core retail sales, % m/m                                     Feb                      0.3           -0.7             0.8           0.4            -
   13:00   Poland: CPI, % y/y                                               Feb                      4.8            4.6             4.1           4.1          4.2
   14:00   US: Business inventories, % m/m                                  Jan                      0.8            0.3             0.4           0.5          0.6
   19:00   Argentina: CPI, % m/m                                            Feb                     0.60           0.80            0.90           0.8            -
   09:00   Holland: 3y DSL Auction                                                                                                                          € 4 bn
   09:00   Indonesia: 5y/25y Sukuk Auction                                                                                                                       -
   09:00   Indonesia: 6m Bills Auction                                                                                                                           -
   10:00   Italy: 12M & 3M BOT's (14 Mar13)                                                                                                           € 8.5+3.5 bn
   10:30   Belgium: TC 14Jun12 & 14Mar13                                                                                                                    € 5 bn
   14:45   UK: 15y+ Reverse Gilt Auctions                                                                                                                 £ 1.5 bn
   18:00   US: 10y Note Auction                                                                                                                            $ 21 bn

Wednesday 14 March                                              Period            Prev 2       Prev 1        Latest  Forecast Consensus
  09:30   Portugal: FM Gaspar speaks on the third review of Portugal's financial aid program at Parliamentary Commission
  12:00   E17: ECB Executive board member Praet speaks at the “Collateral Solutions Conference” in Paris
  13:00   Norway: Interest rate announcement, %                 Mar                  1.75         1.75         1.75        1.75       1.75
  13:00   US: Fed President Bernanke (FOMC voter) speaks in Nashville
  17:00   Germany: Chancellor Merkel speaks on "German Economy" in Heidelberg
  07:00   Finland: HICP, % m/m (y/y)                            Feb             0.2 (3.2)    0.0 (2.6)    0.8 (3.0)   0.9 (3.1)          -
  08:00   Slovakia: HICP, % m/m ( y/y)                          Feb             0.5 (4.8)    0.1 (4.6)    1.5 (4.1)   0.0 (3.7)      (3.9)
  09:00   Austria: HICP, % m/m (y/y)                            Feb             0.1 (3.9)    0.2 (3.4)   -0.5 (2.9)   0.5 (2.6)          -
  09:00   Sweden: Unemployment rate (PES), %                    Feb                   4.4          4.7           4.8        4.8          -
  09:30   UK: Average weekly earnings, % 3m/y                   Jan                   2.1          2.0           2.0        1.9        1.9
  09:30   UK: Core average earnings, % 3m/y                     Jan                   1.8          1.9           2.0        2.0        1.9
  09:30   UK: ILO unemployment rate, %                          Jan                   8.3          8.4           8.4        8.4        8.4
  09:30   UK: Claimant count unemployment, k                    Feb                   0.2          1.9           6.9        4.9        5.0
  10:00   Croatia: CPI, % y/y                                   Feb                   2.6          2.1           1.2          -          -
  10:00   E17: Final HICP, % m/m (y/y)                          Feb             0.3 (2.7)   -0.8 (2.6)    ...(2.7) P  0.5 (2.7)  0.5 (2.7)
  10:00   E17: HICP ex tobacco, index (2005 = 100)              Feb               113.58      113.91         112.96    113.53            -
  10:00   E17: 'Eurostat' core (HICP x fd, alc, tob, ene), % m/mFeb            -0.1 (1.6)    0.4 (1.6)   -1.7 (1.5)   0.4 (1.5)      (1.6)
  10:00   E17: Industrial production, % m/m (y/y)               Jan             0.2 (1.0)   -0.3 (0.1) -1.2 (-2.0)   0.2 (-1.0) 0.6 (-0.8)
  12:30   US: Import prices, % m/m (y/y)                        Feb           0.7 (10.1)    -0.1 (8.5)    0.3 (7.1)   0.4 (5.7)  0.6 (5.6)
  12:30   US: Nonpetroleum import prices, % m/m (y/y)           Feb            -0.3 (3.3)    0.1 (2.5)    0.0 (1.7)   0.1 (1.9)          -
  12:30   US: Current account balance, $ bn                     Q4                -119.6       -124.7        -110.3     -113.0     -114.2
  14:30   Brazil: Economic activity index, % y/y                Feb                  0.69         0.79         1.47           -          -
  04:00   Malaysia: 15y Bonds Auction                                                                                           MYR 3 bn
  04:00   Malaysia: 126d/208d/306d Notes Auction                                                                                MYR 4 bn
  10:00   Italy: BTP Auction                                                                                                     € 6.5 bn
  14:45   UK: 7-15y Reverse Gilt Auctions                                                                                        £ 1.5 bn
  18:00   US: 30y Bond Auction                                                                                                    $ 13 bn

Thursday 15 March                                            Period             Prev 2      Prev 1                               Latest      Forecast Consensus
     -     Global: G20 Sherpas Meeting (to 16/03)
  06:30    India: RBI repo rate, %                           Mar                  8.50        8.50                                 8.50           8.50           8.50
  06:30    India: RBI reverse repo rate, %                   Mar                  7.50        7.50                                 7.50           7.50           7.50
  08:00    E17: Euromoney conference in Luxembourg
  08:30    Swi: Interest rate announcement, %                Mar            0.00-0.25    0.00-0.25                           0.00-0.25      0.00-0.25       0.00-0.25
  08:45    E17: ECB publishes monthly bulletin               Mar
  09:00    Finland: CB Governor Liikanen speaks on monetary policy and global economy in Helsinki
  13:00    Neth: CB Governor Knot speaks at VU Amsterdam university in Amsterdam
  18:30    Austria: CB Governor Nowotny speaks in Vienna
  22:00    Chile: Overnight rate target, %                   Mar                  5.25        5.00                                 5.00           5.00           5.00
Note: All times reported in GMT. Some data or events are boxed to indicate their importance to financial markets. Market events are highlighted in light blue.

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Thursday 15 March                                                           Period               Prev 2         Prev 1          Latest       Forecast Consensus
     -     Peru: Economic activity index, % y/y                             Jan                      5.3            5.1             6.0           5.65           -
  00:00    Australia: Inflation gauge , % m/m                               Mar                      2.4            2.8             2.5              -           -
  07:00    EU 27: New car registrations, % y/y                              Feb                     -3.5           -6.4            -7.1              -           -
  08:30    Sweden: Unemployment rate, %                                     Feb                      6.7            7.1             8.0              -         7.9
  10:00    E17: Eurozone employment, % q/q (y/y)                            Q4                 0.1 (0.3)      0.2 (0.4)      -0.1 (0.3)     -0.3 (0.0)           -
  10:00    E17: Labor cost, % y/y                                           Q4                       2.5            3.3             2.7              -         2.3
  11:00    Ireland: HICP, % m/m (y/y)                                       Feb                0.0 (1.7)     -0.1 (1.4)      -0.4 (1.3)      0.7 (1.1)           -
  11:00    Brazil: IGP-10 inflation, % m/m                                  Mar                     0.19           0.08            0.04              -        0.14
  12:30    US: PPI, % m/m (y/y)                                             Feb                0.2 (5.7)     -0.1 (4.8)       0.1 (4.1)      0.5 (3.3)   0.5 (3.1)
  12:30    US: Core PPI, % m/m (y/y)                                        Feb                0.1 (2.9)      0.3 (3.0)       0.4 (3.0)      0.2 (3.9)   0.2 (2.9)
  12:30    US: Initial jobless claims, k (4wma)                             10-Mar            353 (360)      354 (355)       362 (355)      365 (359)         355
  12:30    US: Empire State mfg, index                                      Mar                     8.19         13.48           19.53            22.0        17.4
  13:00    US: Net long-term TIC flows, $ bn                                Jan                      8.1           61.3            17.9              -           -
  14:00    US: Philadelphia Fed mfg, index                                  Mar                      6.8            7.3            10.2           11.5        11.0
  16:30    Israel: CPI, % y/y                                               Feb                      2.6            2.2             2.0            1.9         1.7
  03:00    Japan: 20y JGB Auction                                                                                                                      ¥ 1100 bn
  04:00    Malaysia: 182d Notes Auction                                                                                                                MYR 1 bn
  09:30    Spain: 3y, 4y & 6y SPGB Auction                                                                                                               € 4.5 bn
  09:50    France: 2y & 4y BTAN Auction                                                                                                                  € 8.5 bn
  10:30    UK: 2042 Gilt Auction                                                                                                                        £ 2.25 bn
  10:50    France: 7y OATi Auction                                                                                                                       € 0.6 bn
  10:50    France: 10y & 15y OATei Auction                                                                                                               € 1.6 bn

Friday 16 March                                                Period             Prev 2    Prev 1       Latest                              Forecast Consensus
     -      Peru: Central bank inflation report (to 23/03)     Q1
     -      UK: BoE interim FPC Meeting                        Q4
   10:00    E17: ECB Executive board member González-Páramo speaks at "Finance meeting" in Spain
   11:30    Germany: Chancellor Merkel speaks at a conference with German Industry Associations in Munich
   12:00    Finland: CB Governor Liikanen speaks on European integration in Helsinki
   15:00    France: CB Governor Noyer speaks at a central banking conference in Paris
   15:00    Mexico: Overnight rate, %                          Mar                   4.50      4.50         4.50                                   4.50           4.50
     -      Uruguay: GDP, % y/y                                Q4                     6.7       4.7          7.5                                    6.8            6.5
   10:00    E17: Trade balance, € bn (sa)                      Jan                    0.5       6.1          7.5                                    7.1              -
   12:30    US: CPI, % m/m (y/y)                               Feb              0.1 (3.4) 0.0 (3.0)    0.2 (2.9)                              0.5 (3.0)      0.4 (2.9)
   12:30    US: Core CPI, % m/m (y/y)                          Feb              0.2 (2.2) 0.2 (2.2)    0.2 (2.3)                              0.2 (2.3)      0.2 (2.2)
   12:30    US: CPI, NSA index                                 Feb              226.230   225.672      226.665                                   228.0               -
   13:15    US: Industrial production, % m/m                   Feb                    0.0       1.0          0.0                                    0.4            0.4
   13:15    US: Capacity utilization, %                        Feb                   77.9      78.6         78.6                                   78.9           78.8
   13:55    US: Michigan consumer sentiment- p, index          Mar                   69.9     75.0         75.3                                    74.0           75.6
Note: All times reported in GMT. Some data or events are boxed to indicate their importance to financial markets. Market events are highlighted in light blue.




9 March 2012                                                                                                                                                        48
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GLOBAL KEY EVENTS

                                 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12      Dec-12   Jan-13 Feb-13
Forthcoming central bank announcement dates
North America
FOMC meeting                       13   24-25     -    19-20   31      -     12   23-24      -        11       n/a    n/a
FOMC minutes                        -      2     16      -     11     21      -      3      14         -       n/a    n/a
Congressional testimony             -      -      -      -     Jul     -      -      -       -         -       n/a    n/a
Fed's Beige Book                    -     11      -      6     18     30      -     10      28         -       n/a    n/a
Bank of Canada                      8     17      -      5     17      -      5     23       -         4       n/a    n/a
Europe
ECB "policy" meeting                8      4      3      6      5      2      6      4       8         6       10      7
ECB monthly bulletin               15    11      10     13     12     9      13     11      15        13       17     14
ECB "non-policy" meeting           22     19     16     21     19      -     20     18      22        20       24     21
Bank of England                    7-8   4-5    9-10    6-7    4-5   1-2     5-6    3-4    7-8        5-6     11-12   8-9
BoE Inflation Report                -      -     16      -      -      8      -      -      14         -        -     15
BoE minutes                        21     18     23     20     18     15     19     17      21        19       25     22
Riksbank                            -     19     30      -      4      -      6     25      29        18       n/a    n/a
SNB                                15      -      -     14      -      -     13      -       -        13       n/a    n/a
Norges Bank                        14      -     10     20      -     29      -     31       -        19       n/a    n/a
Asia/RoW
Bank of Japan                    12-13 9-10,27 22-23   14-15 11-12   8-9    18-19 4-5, 30 19-20      19-20     n/a    n/a
BoJ minutes                        16     13    7, 28   20     18     14     24     11     2,28       26       n/a    n/a
Reserve Bank of Australia           6      3      1      5      3      7      4      2       6         4       n/a    n/a
RBNZ                                8      -      -     14      -      -     13      -       -         6        -      -
Key international meetings
ECOFIN                            13,31    -     15     22    n/a    n/a     n/a    n/a    n/a        n/a      n/a    n/a
G20                              15-16  19-20  10-11   15-17    -      -    13-14   n/a    n/a        n/a      n/a    n/a
Elections
Finland (Presidential)              -      -      -      -      -      -      -      -       -         -        -      -
Russia (Presidential)               4      -      -      -      -      -      -      -       -         -        -      -
Greece (Parliamentary)              -    Apr      -      -      -      -      -      -       -         -        -      -
France (Presidential)               -     22      6      -      -      -      -      -       -         -        -      -
France (Legislative)                -      -      -    10-17    -      -      -      -       -         -        -      -
India (Presidential)                -      -      -      -     Jul     -      -      -       -         -        -      -
Mexico (Presidential/Legislative    -      -      -      -      1      -      -      -       -         -        -      -
Hong-Kong (Legislative)             -      -      -      -      -      -     Sep     -       -         -        -      -
US (Presidential/Legislative)       -      -      -      -      -      -      -      -       6         -        -      -
Source: Central banks, IMF, European Commission, Reuters, Bloomberg, Market News, Barclays Capital




9 March 2012                                                                                                                49
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GLOBAL SUPPLY CALENDAR
                                                                                                     Spread to   3 mth Z                3 mth Z
                                                                                                      German     Score to   Spread to   Score to
              Country                       Bond                   Coupon   Maturity     Size - bn     Spline    Germany     Swaps       Swaps
  Euro Area
   Mar-12      Belgium              New 5y OBL Auction                                     5.00                   500.00                500.00
  13-Mar-12    Holland                 3y DSL Auction                       15-Apr-15      4.00                   500.00                500.00
  14-Mar-12       Italy             New 3yr BTP Auction                     01-Mar-15      4.00                   500.00                500.00
  14-Mar-12       Italy               2yr BTP Auction              4.00%    01-Apr-14      1.00       197.9        -1.65     102.6       -1.77
  14-Mar-12       Italy               15yr BTP Auction             4.50%    01-Mar-26      1.50       296.0        -1.67     245.7       -1.74
  14-Mar-12     Finland               5y RFGB Auction              1.875%   15-Apr-17      1.50                   500.00                500.00
  15-Mar-12      Spain                6y SPGB Auction               4.10%    30-Jul-18     1.50       297.6        -0.76     217.6       -0.82
  15-Mar-12      Spain                7y SPGB Auction               4.30%   30-Oct-19      1.50       304.9        -0.49     229.7       -0.55
  15-Mar-12      Spain               10y SPGB Auction               5.85%   31-Jan-22      1.50       330.2        -0.71     278.7       -0.76
  15-Mar-12     France          2yr BTAN (range €7.5-8.5bn)         4.00%   25-Apr-14      1.50        48.3        -1.18     -39.3       -1.83
  15-Mar-12     France          2yr BTAN (range €7.5-8.5bn)         4.00%   25-Oct-14      1.50        54.0        -1.34     -28.4       -1.98
  15-Mar-12     France          5yr BTAN (range €7.5-8.5bn)         2.25%   25-Feb-16      2.00        77.6        -1.40      -0.7       -1.71
  15-Mar-12     France          5yr BTAN (range €7.5-8.5bn)         1.75%   25-Feb-17      3.50        91.2        -0.68      16.1       -1.14
  15-Mar-12     France       7y OATi Auction (range €1.2-1.7bn)                            0.60
  15-Mar-12     France      10y OATei Auction (range €1.2-1.7bn)                           0.60
  15-Mar-12     France      15y OATei Auction (range €1.2-1.7bn)                           0.50                   500.00                500.00
  21-Mar-12    Germany               2y Schatz Auction             0.25%    14-Mar-14      5.00                   500.00                500.00
  26-Mar-12     Belgium              Auctions Cancelled ?                                  0.00                   500.00                500.00
  27-Mar-12       Italy                  CTZ Auction               0.00%    31-Jan-14      2.50                   500.00                500.00
  27-Mar-12       Italy              BTPei Linker Auction                                  1.00                   500.00                500.00
  29-Mar-12       Italy             CCT Auction Cancelled                                  0.00                   500.00                500.00
  29-Mar-12       Italy                5y BTP Auction              4.75%    01-May-17      2.50       299.6       -1.26      223.4       -1.32
  29-Mar-12       Italy                9y BTP Auction              3.75%    01-Mar-21      1.50       288.4       -1.83      215.7       -1.94
  29-Mar-12       Italy                10y BTP Auction             5.50%    01-Sep-22      2.50                   500.00                500.00
    Japan
  15-Mar-12      Japan                  20y JGB Auction                                   1100
  22-Mar-12      Japan          Liquidity Enhancement Auction                              300
  27-Mar-12      Japan          Liquidity Enhancement Auction                              300
  29-Mar-12      Japan                   2y JGB Auction                                   2700
      UK
  12-Mar-12       UK               3-7y Reverse Gilt Auctions                              1.50
  13-Mar-12       UK              15y+ Reverse Gilt Auctions                               1.50
  14-Mar-12       UK              7-15y Reverse Gilt Auctions                              1.50
  15-Mar-12       UK                   2042 Gilt Auction           4.50%    07-Dec-42      2.25
  19-Mar-12       UK               3-7y Reverse Gilt Auctions                              1.50
  20-Mar-12       UK              15y+ Reverse Gilt Auctions                               1.50
  21-Mar-12       UK              7-15y Reverse Gilt Auctions                              1.50
  22-Mar-12       UK                  2042 Linker Auction          0.625%   22-Nov-42      0.90
  26-Mar-12       UK               3-7y Reverse Gilt Auctions                              1.50
  27-Mar-12       UK              15y+ Reverse Gilt Auctions                               1.50
  28-Mar-12       UK              7-15y Reverse Gilt Auctions                              1.50
      US
  12-Mar-12         US                  3y Note Auction                                     32
  13-Mar-12         US                 10y Note Auction                                     21
  14-Mar-12         US                 30y Bond Auction                                     13
  22-Mar-12         US                 10y TIPs Auction                                     13
  27-Mar-12         US                  2y Note Auction                                     35
  28-Mar-12         US                  5y Note Auction                                     35
  29-Mar-12         US                  7y Note Auction                                     29
               Unconfirmed Barclays Capital Estimate
               Rich
               Cheap
Source: Barclays Capital




9 March 2012                                                                                                                                     50
Barclays Capital | Global Rates Weekly


GLOBAL BOND YIELD FORECASTS

                                             US Treasuries                                            US swap spreads

               Fed funds       3m Libor        2y        5y    10y      30y       10y RY             2y      5y     10y     30y
   Q1 12       0.00-0.25        0.65           0.25     1.00   2.25     3.25       0.00    Q1 12     50      45      15     -20
   Q2 12       0.00-0.25        0.65           0.25     0.75   2.00     3.25       -0.40   Q2 12     50      40      15     -30
   Q3 12       0.00-0.25        0.60           0.25     0.75   2.00     3.25       -0.25   Q3 12     40      30      10     -35
   Q4 12       0.00-0.25        0.40           0.25     0.75   2.00     3.40       -0.10   Q4 12     40      25         5   -40


                                          Euro government                                          Euro area swap spreads

                Refi rate        3m            2y        5y    10y      30y       10y RY             2y      5y     10y     30y
   Q1 12           0.5          0.90           0.35     1.00   2.00     2.70       0.05    Q1 12     70      60      45     0
   Q2 12           0.5          0.70           0.40     1.10   2.10     2.70       0.15    Q2 12     65      55      40     0
   Q3 12           0.5          0.70           0.45     1.20   2.20     2.80       0.15    Q3 12     60      50      35     -5
   Q4 12           0.5          0.70           0.50     1.25   2.25     2.90       0.20    Q4 12     60      50      35     -5


                                             UK government                                            UK swap spreads

                Bank rate        3m            2y        5y    10y      30y       10y RY             2y      5y     10y     30y
   Q1 12           0.5          1.00           0.40     1.15   2.40     3.30       -0.40   Q1 12     100     55      15     -15
   Q2 12           0.5          1.00           0.50     1.30   2.50     3.35       -0.60   Q2 12     100     55      15     -10
   Q3 12           0.5          1.00           0.60     1.60   2.75     3.45       -0.35   Q3 12     95      50      10     -5
   Q4 12           0.5          1.00           0.70     1.80   3.00     3.50       -0.10   Q4 12     90      45      10     -5


                                          Japan government                                          Japan swap spreads

               Official rate     3m            2y       5y     10y      30y       10y RY             2y      5y     10y     30y
   Q1 12          0.10          0. 20         0.10     0.35    1.15     2.05       0.95    Q1 12     15      15         5   0
   Q2 12          0.10          0. 20         0.10     0.40    1.20     2.10       0.85    Q2 12     15      15      10     0
   Q3 12          0.10          0. 20         0.10     0.35    1.15     2.05       0.85    Q3 12     15      15      10     0
   Q4 12          0.10          0. 20         0.10     0.35    1.10     2.00       0.85    Q4 12     15      15      10     0
   Q1 13          0.10          0. 20         0.10     0.35    1.00     2.00       0.85    Q1 13     15      15      10     0


                                        Australia government

               Official Rate            3y             5y         10y          AU-US 10y
Q1 12              4.25               3.85            4.05       4.25            2.00
Q2 12              3.75               3.95            4.05       4.15            2.15
Q3 12              3.75               4.15            4.20       4.25            2.25
Q4 12              3.75               3.95            4.05       4.15            2.15
Source: Barclays Capital




9 March 2012                                                                                                                      51
Barclays Capital | Global Rates Weekly


GLOBAL RATES RESEARCH


 US
 Ajay Rajadhyaksha                   Joseph Abate                       Piyush Goyal                       James Ma
 Head of US Fixed Income and         Fixed Income Strategy              Fixed Income Strategy              Fixed Income Strategy
 Securitised Products Strategy       +1 212 412 6810                    +1 212 412 6793                    +1 212 412 2563
 +1 212 412 7669                     joseph.abate@barcap.com            piyush.goyal@barcap.com            james.ma@barcap.com
 ajay.rajadhyaksha@barcap.com

 Chirag Mirani                       Amrut Nashikkar                    Michael Pond                       Anshul Pradhan
 Fixed Income Strategy               Fixed Income Strategy              Treasury and Inflation-linked      Treasury and Inflation-linked
 +1 212 412 6819                     +1 212 412 1848                    Strategy                           Strategy
 chirag.mirani@barcap.com            amrut.nashikkar@barcap.com         +1 212 412 5051                    +1 212 412 3681
                                                                        michael.pond@barcap.com            anshul.pradhan@barcap.com

 Rajiv Setia                         Vivek Shukla                       Igor Zoubarev
 Fixed Income Strategy               Fixed Income Strategy              Fixed Income Strategy
 +1 212 412 5507                     +1 212 412 2532                    +1 212 526 5518
 rajiv.setia@barcap.com              vivek.shukla@barcap.com            igor.zoubarev @barcap.com


 Europe
 Laurent Fransolet                   Alan James                         Cagdas Aksu                        Fritz Engelhard
 Head of European Fixed Income       Global Inflation-Linked Strategy   European Strategy                  German Head of Strategy
 Strategy                            +44 (0)20 7773 2238                +44 (0)20 7773 5788                +49 69-7161 1725
 +44 (0)20 7773 8385                 alan.james@barcap.com              cagdas.aksu@barcap.com             fritz.engelhard@barcap.com
 laurent.fransolet@barcap.com

 Jussi Harju                         Moyeen Islam                       Sreekala Kochugovindan             Giuseppe Maraffino
 European Strategy                   Fixed Income Strategy              Asset Allocation Strategy          Fixed Income Strategy
 +49 69 7161 1781                    +44 (0)20 777 34675                +44 (0)20 7773 2234                +44 (0)20 313 49938
 jussi.harju@barcap.com              moyeen.islam@barcap.com            sreekala.kochugovindan@barcap.co   giuseppe.maraffino@barcap.com
                                                                        m
 Mikael Nilsson                      Hitendra Rohra                     Michaela Seimen                    Henry Skeoch
 Fixed Income Strategy               Fixed Income Strategy              SSA & Covered Bond Strategy        Inflation-Linked Strategy
 +44 (0)20 7773 6057                 +44 (0)20 7773 4817                +44 (0) 20 3134 0134               +44 (0)20 777 37917
 mikael.nilsson@barcap.com           hitendra.rohra@barcap.com          michaela.seimen@barcap.com         henry.skeoch@barcap.com

 Khrishnamoorthy Sooben              Stuart Urquhart                    Marcus Widen                       Huw Worthington
 Inflation-Linked Strategy           European Strategy                  Fixed Income Strategy              European Strategy
 +44 (0)20 7773 7514                 +44 (0)20 7773 8410                +44 (0)20 3134 5632                +44 (0)20 7773 1307
 khrishnamoorthy.sooben@             stuart.urquhart@barcap.com         marcus.widen@barcap.com            huw.worthington@barcap.com
 barcap.com

 Asia Pacific
 Chotaro Morita                      Reiko Tokukatsu                    Rohit Arora                        Kumar Rachapudi
 Head of Fixed Income Strategy       Senior Fixed Income Strategist,    Fixed Income Strategist,           Fixed Income Strategist,
 Research, Japan                     Japan                              Emerging Asia                      Emerging Asia
 +81 3 4530 1717                     +81 3 4530 1532                    +65 6308 2092                      +65 6308 3383
 chotaro.morita@barcap.com           reiko.tokukatsu@barcap.com         rohit.arora3@barcap.com            kumar.rachapudi@barcap.com

 Ju Wang                             Gavin Stacey
 Fixed Income Strategist,            Fixed Income Strategist,
 Emerging Asia                       Australia and New Zealand
 +65 6308 2801                       +61 2 933 46128
 ju.wang@barcap.com                  gavin.stacey@barcap.com




9 March 2012                                                                                                                               52
Analyst Certification(s)
We, Vivek Shukla, Anshul Pradhan, James Ma, Rajiv Setia, Amrut Nashikkar, Joseph Abate, Chirag Mirani, Michael Pond, Piyush Goyal, Laurent Fransolet, Huw
Worthington, Giuseppe Maraffino, Cagdas Aksu, Moyeen Islam, Henry Skeoch, Khrishnamoorthy Sooben, Hitendra Rohra, Gavin Stacey, Chotaro Morita,
Noriatsu Tanji, Reiko Tokukatsu, CFA and Marion Laboure, hereby certify (1) that the views expressed in this research report accurately reflect our personal
views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or
indirectly related to the specific recommendations or views expressed in this research report.

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