US-Rates-Radar-wk-1-7 by stojeipatrze


									MGM Radar
Rates Mirage
Credit Research | United
Rates Strategy | AmericasStates

US Rates: 2Q11 Review and 3Q11 Outlook                                                           01 JULY 2011
Life in the UST market will go on after QE2 as displaced investors look for duration
Even though the Fed‘s daily presence in the Treasury markets may diminish, it is by no
means gone. We examine the recent sell-off, looking for clues to its longevity and to
what it implies for forward expectations. Our thesis of a Treasury rally has been based    Fixed Income Research
on the view that the Fed displaced other investors during QE2, pushing them into risk
assets. However, we believe these investors will return on a permanent basis to the
bond market to close their duration gaps in the months ahead. Despite the sell-off, we     Rates Strategy Feedback Mailbox
believe the US economy remains soft and bonds should not sustain a meaningful sell-        +1 212 667 2254
off unless market expectations for rate hikes are validated by a turn in the data. We
also believe that technicals support a bullish view as signs point to a long-term rally
                                                                                           Contributing Rates Strategists
even as the recent sell-off drives weak hands out of the market and resets overbought
indicators.                                                                                George Goncalves
                                                                                           Head of Rates Strategy – Americas
In this issue, we also provide a review of Q2 data and key drivers of the rates markets.
                                                                                           +1 212 667 2254
The Week Ahead Calendar                                                          
There is no UST supply in the coming week, but Thursday is the key day with the ECB        Aaron Kohli
and BoE Rate Announcements and the UST supply announcement for the 3yr, 10yr               +1 212 667 9889
and 30yr. Fedspeak is light for the upcoming holiday week, with only Hoenig speaking
on Thursday. Central Bank speak outside the US is also light with Trichet speaking on
                                                                                           Stanley Sun
Thursday and Bini Smaghi speaking on Friday. The big economic data point in the
                                                                                           +1 212 667 1236
upcoming week is NFP on Friday. We have also included the following week‘s
calendar as we will not be publishing a weekly during the holiday week.
Rates Trade Portfolio Update                                                               Marcus Phua
                                                                                           +1 212 667 9349
       As we wrap up the quarter, we have de-risked massively after the 30yr TIPS
        auction as multiple trades have been closed. We hit our revised stops on our
        TIPS trades, protecting the gains, and closed the second half of our 5y30y real    Ankit Sahni
        flattener after index extension.                                                   +1 212 667 1049
       We are back to a very slim portfolio as we look to start the new quarter with a
        clean slate. As we highlight our more balanced outlook and slight biases in our
        Cross Rate Table, we look to stay nimble and tactical at the start of Q3.          Matthew Bouchard
                                                                                           +1 212 667 9249
Market Focus
USTs: We maintain our buy-on-dips strategy for now as the weeks ahead
promise ―wei ji‖                                                                           This report can be accessed electronically
TIPS: When the end of QE2 TIPS buying by the Fed meets the mother of all                   via: or on
index extensions in July, overweight the 20yr sector                                       Bloomberg (NOMR)
Futures: While the on-going Eurozone crisis is unlikely to reach the depths of
2008 or 2010, asset managers‘ UST duration shorts in futures remain at risk
in the near-term
                                                                                           ** NOTE: Rates Radar will not be
Derivatives: We see moments where wider spreads and higher volatility may
                                                                                           published next week due to the
materialize in Q3 as portfolios readjust to a world without QE2 POMOs, but at
                                                                                           shortened holiday week. Publication
the same time we see these spikes to be short-lived as the existing stock of
                                                                                           will resume the following week.
liquidity acts as a dampener
Money Markets: The end of QE2 & debt ceiling resolution should see front-
end rates rise in Q3
US Rates Data Review
According to our weekly data, US Eurodollars Blues, UST 2s/7s/30s Butterflies, TIPS
BEI 5yr Spread and 3M1Y normal vol were the biggest weekly movers in the duration,
curve, spread and vol spaces (see the tables at the end of this report).
                                                                                              Nomura Securities International Inc.
         See Disclosure Appendix A1 for the Analyst Certification and Other Important Disclosures
Nomura | Rates Radar                                                                                                                           1 July 2011


US Rates Weekly Outlook
Cross Rates Analysis Summary ......................................................................................... 3
The Week Ahead Calendar: Key Events for Rates Investors.............................................. 4-5

Macro Topics
2Q11 Review and 3Q11 Outlook ........................................................................................ 6-10
2Q11 Trade Ideas Performance Review ............................................................................. 11
2Q11 Cross Market Total Return Analysis .......................................................................... 12-14
2Q11 Positioning Review – Fed Only Displaced Investors ................................................. 15-16

Market Focus
Treasuries ........................................................................................................................... 17-19
TIPS .................................................................................................................................... 20
Futures................................................................................................................................ 21
Derivatives .......................................................................................................................... 22
Money Markets ................................................................................................................... 23

Trade Recommendations
Rates Trade Portfolio……………………………………………………………………………. . 24
Historical Rates Trade Portfolio…………………………………………………………. ........... 25-26

US Rates Data Review
Duration Snapshot .............................................................................................................. 27
Curve Snapshot……………………………………………………………………….. ................ 28
Spreads Snapshot…………………………………………………………………….. ............... 29
Vol Snapshot…………………………………………………………………………… ............... 30

US and Canada Rates Forecast ......................................................................................... 31
Recent Rates Strategy Publications.................................................................................... 32

    1 July 2011                                                                                 2
Nomura | Rates Radar                                                                                                                                                        1 July 2011

US Rates Weekly Outlook
Figure 1. Cross-rates analysis summary as of 6/30/2011
                                                             Core View             Adjustment   10Y Target: 2.75%                               Core-view: Mildly Bullish
                                                                                      Add       • We were wrong on momentum carrying us through 2.75 but view the
                        DURATION                                                                pullback as an opportunity to reload. Will reassess if data improves.
                          Direction                Bearish               Bullish
                                                                                                • Still view that a new low is ahead as recent price action took place in
                                                                                                a vacuum of liquidity during the end of QE2 & quarter-end rebalancing

                                                             Core View             Adjustment   2s10s Range: 255 – 275 bps                      Core-view: Mildly Flatter
                          CURVE                                                       Add       • We shift up the range for the curve but would add to flatteners here
                             Call                  Steeper               Flatter
                                                                                                • The curve directionality continues with Fed on hold, keep tight stops

                                                             Core View             Adjustment   10Y Spreads Target: 15 bps                      Core-view: Slightly Wider

                         SPREADS                                                    Reduce      • Reduced near-term spread target as all the action is down SoS curve
                         Sentiment                 Tighter               Wider
                                                                                                • We still argue spreads of spreads (SoS) flattener is a hedge to Europe

                                                             Core View             Adjustment   1Y10Y Target: 115 bpv                          Core-view: Slightly Higher

                            VOL                                                     Reduce      • After a multi-week move, vols can decline before hitting our target
                            Views                  Lower                 Higher
                                                                                                • But the conclusion of QE2, Europe & debt ceiling will arrest declines

                                                             Core View             Adjustment   5Y Breakeven Range: 1.80 – 2.10%                       Core-view: Neutral

                        INFLATION                                                   Neutral     • We de-risked our TIPS trades after a strong 30-year TIPS auction
                          Insights                 Lower                 Higher
                                                                                                • Turning neutral in the near-term until a real direction is established

Core-view = Strategic view (up to 6 months)   Adjustment = Tactical view change
Source: Nomura

Nomura | Rates Radar                                                                                                                                    1 July 2011

The Week Ahead (July 4 – July 8): Key Events for Rates Investors

         SUPPLY: There is no UST supply in the coming week, but on Thursday there is an UST supply announcement for the 3yr, 10yr and 30yr. Outside
          the US, on Wednesday there is a 2yr auction in Germany and a 5yr auction in Canada and on Thursday there is a 5yr Spanish Auction and a
          French OAT auction.

         CENTRAL BANK NEWS & POLICY: Fedspeak is light for the upcoming holiday week, with only Hoenig speaking on Thursday. Central Bank
          speak outside the US is also light with Trichet speaking on Thursday and Bini Smaghi speaking on Friday. Also, the BoE and the ECB have rate
          announcements on Thursday where our Euro economists expect a rate hike by the ECB. The ECB Bond Purchase announcement is on Monday.

         ECONOMIC DATA: The big economic data point in the upcoming week is Unemployment on Friday. Other data points in the US and Canada
          include Factory Orders on Tuesday, MBA Purchase Applications, Challenger Job Cuts and ISM non-manufacturing composite on Wednesday,
          ADP Employment report, Jobless Claims, Treasury STRIPS, Fed Balance Sheet and Money Supply on Thursday and Canadian Unemployment,
          Payrolls, Average Hourly Earnings, Wholesale Inventories and Consumer Credit on Friday. In the Euro-zone there is PPI on Monday and PMI and
          Retail Sales on Tuesday.
                                                                                                                  Canadian Unemployment (7:00am)
                                                                 German 2yr Auction (5:15am)                     Payrolls (8:30am)
                                                                 MBA Purchase Applications (7:00am)              Average Hourly Earnings (8:30am)
                                                                 Challenger Job Cuts (7:30am)                    Unemployment (8:30am)
               US Market Closed                                 ISM Non-manf. Composite (10:00am)               Wholesale Inventories (10:00am)
               Euro-zone PPI (4:00am)                           Jan 14 – Jun 15 POMO (est. $2.5 – 3.5bn)        Bini Smaghi Speaks (1:30pm)
               ECB Bond Purchase Announcement (9:30am)          Canadian 5yr Auction (12:00pm)                  Consumer Credit (3:00pm)

                          Monday                  Tuesday                 Wednesday                   Thursday                   Friday
                           (7/4)                   (7/5)                    (7/6)                       (7/7)                     (7/8)

                                    Euro-zone PMI (4:00am)                                    Spanish 5yr Auction (4:30am)
                                                                                                                                                 Source: Nomura
                                    Euro-zone Retail Sales (5:00am)                           French OAT Auction (5:00am)
                                    Factory Orders (10:00am)                                  BoE Rate Announcement (7:00am)
                                                                                               ECB Rate Announcement (7:45am)
                                                                                               ADP Employment (8:15am)
                                                                                               Jobless Claims (8:30am)
                                                                                               Trichet Speaks (8:30am)
                                                                                               3, 10, 30yr UST Announcement (9:00am)
                                                                                               Hoenig Speaks (12:30pm)
                                                                                               Treasury STRIPS (3:00pm)
                                                                                               Fed Balance Sheet (4:30pm)
                                                                                               Money Supply (4:30pm)

Nomura | Rates Radar                                                                                                                                      1 July 2011

The Week Ahead (July 11 – July 15): Key Events for Rates Investors

         SUPPLY: There is $76bn of UST supply for the coming week in the form of 3yr ($32bn), 10yr ($21bn - reopening) and 30yr ($13bn - reopening)
          auctions on Tuesday, Wednesday and Thursday respectively. Outside the US, on Wednesday there is a 10yr auction in Germany and a 2yr auction
          in Canada and an auction in Italy on Thursday.

         CENTRAL BANK NEWS & POLICY: Fedspeak is centralized to Ben Bernanke‘s Humphrey-Hawkins testimony on Wednesday and the Minutes
          of the FOMC meeting on Tuesday. In the Euro-zone, the ECB releases its monthly report on Thursday.

         ECONOMIC DATA: The major economic data point in the upcoming week is the Consumer Price Index on Friday. Other data points in the US and
          Canada include the NFIB Small Business Optimism, Trade Balance and Canadian International Trade on Tuesday, MBA Purchase Applications,
          Import Price Index and the Treasury Budget on Wednesday, Producer Price Index, Retail Sales, Jobless Claims, Business Inventories, Fed
          Balance Sheet and Money Supply on Thursday and Canadian Manufacturing Sales, Capacity Utilization, Industrial Production, Consumer
          Confidence, and the Bank of Canada‘s Business Outlook and Senior Loan Officer Survey on Friday. In the Euro-zone there is Industrial Production
          on Wednesday, Consumer Price Index on Thursday and Trade Balance on Friday.

                                                             Euro-zone Industrial Production (5:00am)        Euro-zone Trade Balance (5:00am)
                                                             German 10yr Auction (5:15am)                    Consumer Price Index (8:30am)
                                                             MBA Purchase Applications (7:00am)              Canadian Manufacturing Sales (8:30am)
                                                             Import Price Index (8:30am)                     Capacity Utilization (9:15am)
                                                             Humphrey-Hawkins Testimony (10:00am)            Industrial Production (9:15am)
                                                             Canadian 2yr Auction (12:00pm)                  Consumer Confidence (9:55am)
                                                             UST 10yr Reopening ($21bn est.)                 BoC Business Outlook (10:30am)
            July 15 - Dec 16 POMO (est. $2.5 – 3.5bn)       Treasury Budget (2:00pm)                        BoC Senior Loan Officer Survey (10:30am)

                         Monday                    Tuesday                Wednesday                  Thursday                    Friday
                          (7/11)                    (7/12)                  (7/13)                    (7/14)                     (7/15)

                                     NFIB Small Business Optimism (7:30am)                   ECB Monthly Report (4:00am)
                                     Trade Balance (8:30am)                                  Euro-zone CPI (5:00am)
                                     Canada International Trade (8:30am)                     Italian Auction (5:00am)                            Source: Nomura

                                     UST 3yr Auction ($32bn est.)                            Producer Price Index (8:30am)
                                     Minutes of FOMC Meeting (2:00pm)                        Retail Sales (8:30am)
                                                                                              Jobless Claims (8:30am)
                                                                                              Business Inventories (10:00am)
                                                                                              UST 30yr Reopening ($13bn est.)
                                                                                              Fed Balance Sheet (4:30pm)
                                                                                              Money Supply (4:30pm)

Nomura | Rates Radar                                                                                                 1 July 2011

Macro Topics
  2Q11 Review & 3Q11 Outlook
  The past quarter marshaled in easing from many fronts which helped all assets             George Goncalves
  perform on balance. Broader markets were supported by a ton of liquidity stemming         +1 212 667 2254
  from three venues in our view. Obviously the Fed‘s QE2 bond buying was the main 
  vehicle of easing. However there were two other key drivers of easy money in the
  system. First, the “Fiscal debt ease” where the reduction in T-Bills outstanding (the
  Treasury shrunk its SFPs to help avoid crossing the debt ceiling) created a               Aaron Kohli
  supply/demand imbalance that pushed short-rates down near zero. The second                +1 212 667 9889
  was the “FDIC ease” which in conjunction with the excess reserves created by the
  Fed‘s QE2 program made it possible for short-term rates to stay floored – please
  see this report. We believe that some of the benefits of all this easing will start to    Ankit Sahni
  turn once we get a resolution on the debt ceiling, and in the meantime some of the
                                                                                            +1 212 667 1049
  QE2 impact will fade too.
  We have argued that the risk markets have been the biggest recipients of extra
  cash in the system and that a market where no new money is created will need to
  get its sea-legs after careful analysis of what is fair-value for stocks versus bonds
  and vice-versa with the Fed out of the picture. The latest sell-off aside (more on that
  later) the 2 quarter was actually favorable to the bond market. For example, yields
  on the 10-year entered a glide path lower into the last remaining days of QE2 Fed
  buying on the back of short-covering as most investors were not willing to chase the
  rally as they did in 2010. The bias of being underweight USTs by investors has
  been vindicated this past week as the market corrected to higher rates. That said
  we do not believe the rally is over. In the last quarter we moved from a neutral
  stance on duration to bullish and our rationale mostly remains intact because:
   1. QE2 Unwind: We expected investors to pull forward the end of QE2 rally
       (historically bonds have rallied at the end of Fed buying of assets as duration
       needs shift cash back to bonds from other assets). Our view that the Fed didn‘t
       replace investors but displaced them made us feel comfortable with a call for a
       rally ahead of QE2‘s completion. We also viewed hyper-inflation fears were
       over-rated as commodities rose partly because of QE2. The jury is still out how
       broader markets will behave as QE2 sets sail.
   2. The Data: In April our economists were benchmarking the impact of the
       Japanese earthquake on US data. Our initial analysis proved to be correct in
       that the supply disruptions from Japan would weaken the US economic data in
       Q2. At the time most economists were still calling for the 2 quarter to
       recuperate from the 1 quarter lull. Then our weak economic data call morphed
       into a view that the globe was indeed slowing as seen by PMIs. Until we see the
       ISMs consistently higher, we stand by our view that it‘s all about the
       fundamentals (see page 7).
   3. Sovereign Debt Crisis: The boiling pot of sovereign debt was still rising in
       temperature in Europe back in April and that, along with ongoing Greece
       funding concerns through June, suggested that US rates should head lower into
       the end of the quarter and not higher, as was priced in by the forwards. There
       seems to have been a temporary reprieve in concerns over Greece given the
       recent votes, although we still are a bit skeptical about the ability for some of
       the tough measures to stick and believe the summer weeks are key to watch.
  The view and rationale for why we went bullish (and remained constructive) on the
  bond market was virtually airtight up until the last few days of Q2. It‘s true that the
  recent spike in yields has taken us by surprise. Although we were able to de-risk our
  model portfolio somewhat last week (see page 11 for our 2Q performance), we were
  wrong in assuming that this past week‘s close of quarter would see momentum
  carrying us through to 2.75 on 10s. In the sections that follow in this report we
  expand upon the aforementioned rationale where we believe that until one of the
  following occurs: the Fed raises rates (or expectation come back into the market),
  the data turns higher on a consistent basis or technicals turn for good, we will
  continue to advocate buying dips as we look past the debt ceiling woes.

Nomura | Rates Radar                                                                                                                                                                                                                                           1 July 2011

  Economic Data Drive Rates in the Medium Term
  We have repeatedly mentioned weakness in economic data as one of the core
  reasons for our bullish tilt on rates – in this section we look at some of the data
  points in more detail and analyze why we don‘t think the economic surprise index
  will necessarily revert back from its extreme value in the near term.
  One of the high-frequency data points we look at (and has caught the market‘s
  attention recently) is the daily Federal tax withheld data. This offers insight into the
  overall employment and earnings situation in the economy and is a useful forward
  looking indicator for the overall economy. Figure 1 shows that this data is seasonal
  with a strong Q1 and Q4 and relatively weak mid-year.
  We find it interesting to compare 2011 with 2010 and the years before. As seen in
  Figure 1, there was a strong start to 2011 (the blue line), but the momentum has
  slowed recently. At this point of the year, we‘re at the same levels as 2010. The
  current market sentiment seems similar to 2010 as well, with the overall consensus
  for stronger growth in the H2 after some improvements in H1. We remain skeptical
  about this hypothesis as we are not sure if a big part of the economic weakness did
  come from transitory factors which may fade in H2. If the recovery is on track, we
  should see these indicators turn up, to a similar trajectory as the dotted line
  representing pre-crisis years and improve in H2.
  In Figure 2, we look at the manufacturing ISM data (due on Friday) along with the
  economic surprise index. In general, the economic surprise index is fairly mean-
  reverting as expectations tend to undershoot and then overshoot the actual
  recovery. Current levels are near all-time lows and if past patterns hold, we should
  see a correction and a corresponding improvement in the overall economic surprise.
  However, we‘re not sure this is likely to happen any time soon as the current
  situation is somewhat peculiar. Most economists have attributed the current data
  weakness almost entirely to one-off events (mainly the oil spike due to the MENA
  crisis and supply disruptions from the Japan earthquake). As a consequence,
  forecasts for H2 have been sticky at relatively high levels. For example, the Fed‘s
  forecast for 2011 growth stands at 2.7-2.9%, down only 0.4% since April. To put this
  in context, the final released estimate for Q1 growth was only 1.9% and Q2
  expectations are for about 2.0% growth. This means that H2 needs more than 3.5%
  growth to meet the Fed‘s target in a period where we will see the end of QE2
  implementation (we have had only six 3.5% plus growth quarters since 2000).
  We don‘t think an economic improvement of this magnitude is impossible, but it is
  unlikely and we wait for signs to see if this takes shape. We continue to monitor high
  frequency data including tax receipts and the ISM to gauge the speed of economic
  recovery and overall sentiment. If the data does point up, we will reconsider our
  hypothesis and potentially our rates view as well, but until then we remain skeptical.

Figure 1. Federal Income Tax Withheld – High                                Figure 2. Citi Economic Surprise Index and ISM
Frequency Indicator In Line Currently with 2010 –                           Manufacturing – Forecasts Have Been Sticky
Will it Recover in H2 as Economists Expect?                                 Implying Surprise Index May Not Revert
              2009      2010       2011      Average (03-07, RHS)                                              Citi Economic Suprise Index                                                     ISM Manufacturing

   85,000                                                                         80                                                                                                                                                                      65
   80,000                                                      70,000             40
                                                                                  20                                                                                                                                                                      55
   75,000                                                      67,500              0                                                                                                                                                                      50
                                                               65,000             -20
   70,000                                                                         -40                                                                                                                                                                     45
                                                               62,500             -60                                                                                                                                                                     40
                                                               60,000             -80
   60,000                                                      57,500            -120                                                                                                                                                                     30










   55,000                                                      55,000
            Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Source: Nomura Rates Strategy, US Treasury                                  Source: Nomura Rates Strategy, Bloomberg

Nomura | Rates Radar                                                                                                                                                                           1 July 2011

  Fed Expectations Drive Rates in the Long Term
   ―Don‘t fight the Fed‖ is an expression that has been the cornerstone of Treasury
  markets for many years now. The POMOs made the Fed‘s presence in the rates
  space even better appreciated as the near-daily rhythm of QE2 purchases
  punctuated the schedules of economic data, Fed speakers, and headlines. As we
  are now past the end of QE2 implementation, markets seem to have quickly lost
  sight of the fact that, ultimately, rates markets, especially at the short-end, are a
  reflection of the Fed‘s ability and desire to control rates. Figure 3 demonstrates the
  changes in expectations of Fed hiking that have persisted over the last six months.
  The graph shows the expected value of the Fed funds rate at future Fed meeting
  dates for the next year. What is clear is the extent to which underlying economic
  data has disappointed those expectations. This is not hard to understand given the
  anemic economic conditions, a potential Euro crisis and a Fed on near perma-hold.
  What is puzzling is how the recent rates moves higher seem to fly in the face of
  such weak expectations for the outlook. It is almost as if investors are treating the
  Fed‘s exit from the expansion of their portfolio as a hiking cycle or as a sign that
  forward expectations for Fed hikes have changed. Nomura‘s economists, led by
  David Resler have been fairly prescient in describing the endemic weakness
  plaguing the US economy and as such, they continue to expect no hike from the
  Fed till Q1 2013. They discuss this and other aspects of the economy in their recent
  note Downgraded Economic Conditions and Unchanged Policy. In addition, in our
  view that QE3 is off the table as discussed in this report (see link), so this further
  supports in our minds that the Fed will resort to keeping rates pinned instead of
  further easing policies which will help rolldown and carry trades.
  We continue to believe that one stronger-than-expected PMI print does not make for
  a sea change in economic conditions. The US economy remains structurally
  weakened by the recent recession and while a variety of indicators have improved
  from distressed levels, others have failed to do so. Primary among these is housing,
  which has not yet recovered to a significant extent and which at one time was
  considered a central driver for the US economy. With that pillar of support still weak,
  it‘s difficult to see where the impetus for a burst of economic growth will come from,
  especially given the recent talks about cutting government spending, which could
  easily act as a brake on the economy. Recent headlines about the Eurozone debt
  situation also reinforce the fragility of the global financial system and we still believe
  that the Fed will find little reason to hike rates before Q1 2013. The withdrawal of
  supportive measures should be just as gradual.
  This may keep front-end rates pinned, but how will it restrain longer rates? As long
  as the front end of the curve is at such low levels; financial institutions including
  banks will be incentivized to earn carry on the curve by borrowing at the front-end
  and investing in longer dated USTs. That potentially sets an upper bound on how far
  yields can climb given a floored front-end, still low fed-funds and a Fed on perma-
Figure 3. 5-day Average of Fed Funds Expectations                   Figure 4. Evolutions of Fed Hike Expectations over
in 2012 declines as Fed goes on “Perma” hold                        Q2 – Significant Flattening of FF Strip
                                                                        5-day moving average
                                                                                                                    4/11/2011                    6/30/2011
 1.2                                                                    1.6
 0.6                                                                    0.6

 0.2                                                                    0.0










   Jan-11      Feb-11   Mar-11   Apr-11   May-11     Jun-11

Source: Nomura Rates Strategy                                         Source: Nomura Rates Strategy

Nomura | Rates Radar                                                                          1 July 2011

  Technicals – A Review of Two-stage Rallies Over the Last 50 Years
  At some points of uncertainty in the market, participants turn to technical analysis as
  a method to help clarify short and long-term rates views. We have recently had
  some need to put the latest rally into context and to examine one particular indicator
  that has garnered some headlines – the venerable ―death cross‖ which is often
  applied to equity markets and gains its name from the decline of equity prices once
  the 50-day moving average crosses the 200-day moving average from above. In the
  case of 10yr yields, such an indication occurred on June 24 pointing to a further
  potential drop in yields. We take an in-depth look at what such indications have
  meant for 10yr yields in the past 50 years, starting with yield data in the 1960s.
  Our results were interesting in that the prevailing momentum of rates markets was
  significantly important in whether the indicator was accurate or a ―head fake.‖ In the
  last 50 years, 10yr rates have been through one very long bearish cycle,
  (culminating in the peak of 15.8% reached in 1981), followed by a sustained bull
  market. The peak in 1981 was at the end of the hiking cycles started by Paul
  Volcker and the rallies that followed were the work of his successors, Alan
  Greenspan and Ben Bernanke.
  Turning back to the results of our analysis regarding the ―death cross‖, we observed
  that in the case of 10yr yields, death crosses were more significant if they occurred
  in structurally bullish markets for rates rather than structurally bearish ones. During
  a bullish market, when the 50-day moving average (ma) crossed the 200-day ma, a
  rally could be expected to continue 76% of the time (compared to 50% of the time in
  a bearish market). We often found these rallies to have multiple legs or waves and
  significant pauses or selloffs to punctuate the broader moves as these presumably
  helped shake out low conviction players (weak hands) and clear overbought
  sentiment and momentum readings. In the case of bull markets, when these
  crosses were false indicators, losses were an average of 40bp, adjusted for rate
  levels (coincidentally, we have sold off almost 40bp already), while gains when they
  were proven correct were on average 108bp (adjusted for rate levels). This
  indicates that even when such crosses were proven false, the losses were more
  limited against the payoff from correct indicators. All this indicates a good
  risk/reward ratio and suggests somewhat limited potential for a sustained selloff,
  though such a move is still possible. Furthermore, in a bullish cycle, a rally lasts for
  six days on average after passing through a false indicator but continues for 221
  days when the cross is a valid indicator. In the current environment, this indicates to
  us that if rates rally strongly next week, there is a high likelihood that the rally will
Figure 5. Long Term Technical Analysis for 10yr Yields – L/T Bullish Trends Remains in Tact

Source: Nomura Rates Strategy, Bloomberg

Nomura | Rates Radar                                                                                                                            1 July 2011

  continue further and our bullish view will be vindicated.
  All this begs the question: Are we in a significant bearish or bullish cycle? In a
  bullish cycle, such indicators would signify a good opportunity while in a bearish
  market; they are more likely to be a red herring. As Figure 5 shows, in late 1993,
  markets began to get a better sense of the systemic underlying shift in rates to a
  bullish sentiment and established the first parts of a wide and downward sloping
  channel that has endured ever since. Many have referred to these times as the
  ―Greenspan Put‖ but rates markets began to sniff out such patterns in the early 90s.
  The channel established in 10yr rates has since been tested several times and held
  successfully with the current support and resistance for 10yr rates at 4.40% and
  1.32% respectively. The breadth of this channel indicates that it has less immediate
  trading significance, but much more tenacity over longer cycles. If, for instance, we
  were to witness a weekly close through 4.40% at some point in the next few months
  or year, we may then hew more bearishly towards 10yr yields as a rule going
  forward rather than accepting the current bullish lean as a ―default‖ position.
  Within this broader channel lies a line which establishes support for 10yr notes at
  3.52%, and indicates a more nearby pause for 10yr yields should they breakout to
  the upside. That still isn‘t our core view as we believe the recent move is a sideways
  chop to flatten momentum indications from overbought levels and to dampen
  sentiment indicators before fundamentals reassert themselves and the next leg of
  this rally begins. RSI and Stochastic indicators both seem to be pointing to stretched
  conditions for the 10yr as the current rally has soldiered on almost without cessation
  since April. That move has left sentiment distorted and indicators over-extended;
  both of which can be cured either with a mild backup or a stabilization in rate levels.
  The fact that we‘re in a bullish cycle indicates that the ‗death cross‘ has
  significance – as seen in Figure 6, statistics indicate that we have a 76% probability
  that this indicator points to further bullish moves ahead. While we would hesitate to
  use this indicator on its own, given the confluence of other factors and the recent
  backup in rates (which we believe is overdone), this helps us maintain our bullish
  view. We think the move this has been a breath for air as the recent move has
  pushed many technicals into overbought territory prompting participants to go short.
  We think fundamentals continue to point us lower in yields as all is still not well with
  the world (domestic economy and exogenous events) and we continue to look for
  the 2.75% target in 10yr yields.

Figure 6. Detailed Statistics For „Death Cross‟ Moves – We Think This Indicator is Useful in Current Bull Market
                                                        Rally - Start to Cross                        Rally - Cross to End             Total Rally
                                      Count    Average % of Total Average % of Total        Average     % of     Average % of Total Average Average
          Rally Regime       Count
                                   Distribution Days   Rally Days     ∆ bp     Rally ∆ bp    Days      Total       ∆ bp Rally ∆ bp Days       ∆ bp
                                                             All Markets (1962 - Now)                   Rally
        False Indicator       12       34%        91     103%          117        85%         -3        -3%           1      1%        88      138
    Rally time ≤ 200 days     11       31%        89      56%           72        58%         70        44%          52     42%       159      124
   Rally time 201 - 400 days   6       17%        86      34%           91        41%        169        66%         133     59%       255      224
    Rally time > 400 days      6       17%       112      22%           91        29%        405        78%         226     71%       517      317
            All Data          35      100%        93      44%           94        52%        119        56%          78     44%       212      179
                                                              Bear Market (1962 - 1981)
        False Indicator         7      50%        78       103%       129         83%         -8        -3%       -8       -5%        70     155
    Rally time ≤ 200 days       4      29%       114        68%        66         84%         55        32%       13       42%       169      79
   Rally time 201 - 400 days    3      21%        95        39%        53         31%        151        61%      119       69%       245     172
    Rally time > 400 days       0       0%         0        n/a         0          n/a         0        n/a        0       n/a         0       0
            All Data           14     100%        92        68%        95         52%         44        56%       25       44%       136     137
                                                              Bull Market (1981 - Now)
        False Indicator         5      24%       108       103%         99        88%          6        -3%       13       12%       114     113
    Rally time ≤ 200 days       7      33%        74        49%         76        51%         78        51%       74       42%       153     150
   Rally time 201 - 400 days    3      14%        78        29%        129        47%        187        71%      147       53%       265     276
    Rally time > 400 days       6      29%       112        22%         91        29%        405        78%      226       71%       517     317
            All Data           21     100%        94        36%         93        52%        170        56%      113       44%       264     207

Source: Nomura Rates Strategy, Bloomberg

Nomura | Rates Radar                                                                                                                                                                                            1 July 2011

Macro Topics
Q2 2011 Trade Ideas Performance Review
Our model portfolio had a strong Q2 as we changed our call to be bond bullish in mid-                                                                                              George Goncalves
April (see link) and expressed our long duration view via selling TIPS vs. USTs (we                                                                                                +1 212 667 2254
de-risked into quarter-end – see link). We have also stayed very nimble, where 75 bp                                                                                     
of the total 105 bp of outperformance in Q2 was tactical in nature (Figure 4). Below
we break down our recommendations over Q2 into basis point performance charts
and other metrics, with a summary for each category.                                                                                                                               Stanley Sun
                                                                                                                                                                                   +1 212 667 1236
      Duration in this bucket our actual trades underperformed on the quarter by 13
       bps even though we had a bullish call on 10s breaking thru 3% (which was
       realized). Where we miscalculated was in real rates however and not nominals.
       In April we put out a 1y1y real yield short that was stopped out. Granted we
       only had 3 pure duration (either outright in real rate or nominals) expressions.
      Curve is where we had the most tactical trades as we recommended relative
       value opportunities in a range-trading market. The only strategic curve trade
       was a long end BEI steepener (+7bps) and our 5s30s real flattener benefitted
       from the 30yr TIPS auction that just passed us (+16bp). With QE compressing
       yield spreads across the board, all the other curve trades only had small gains.
      Spreads have not really exhibited much volatility until the mid of June. We
       were able to position for front end spread widening as we wrote in this report at
       the end of May, we captured the blowout in 2yr spreads, driving P/L in spreads.
      Vol stayed low during Q2 and we were torn between wanting to be long vol (to
       hedge systemic blowouts) and staying on the sidelines (due to QE keeping vol
       lower). We had few vol trades and small loss (-2bp) over the quarter.
    Inflation was where we captured most of our gains as well as served to best
     express our duration view, leading to a short in 5yr TIPS BEI. Also in inflation,
     we benefited from trading forward BEIs via the monthly auction cycles in TIPS.
Figure 1. 2Q Historical type of trades open by style           Figure 2. Q2 Type of trades by sector in our portfolio
           Strategic Trades Open                          Tactical Trades Open                                  Duration Trades Open               Curve Trades Open                      Spread Trades Open
                                                                                                                Vol Trades Open                    Inflation Trades Open
   60%                                                                                                          60%
   40%                                                                                                          40%
   20%                                                                                                          20%
      0%                                                                                                         0%















Source: Nomura                                                                                               Source: Nomura
Figure 3. Return attribution by style (bp) in Q2                                                             Figure 4. Return Attribution (by bucket in bps) in Q2
                               P&L Breakdown                                                                                                  P&L Breakdown
                     Strategic Trades                    Tactical Trades                                                         Duration Trades                        Curve Trades
                                                                                                                                 Spread Trades                          Vol Trades
                                                                                                                                 Inflation Trades
                                                                                                                                                                        -13 bp
                                                                      30 bp

                                                                                                                                                                                          30 bp

                                                                                                                                76 bp
            75 bp
                                                                                                                                                                                   14 bp
                                                                                                                                                              -2 bp

Source: Nomura                                                                                               Source: Nomura

Nomura | Rates Radar                                                                                                                                                                           1 July 2011

Macro Topics

   2Q11 Cross Market Total Return Analysis
   As a follow-up to our Rates Radar Weekly on April 1 (see link for our original
                                                                                                                                                                       Ankit Sahni
   themes/total return analysis) in this section we review the relative performance of
                                   nd                                                                                                                                  +1 212 667 1049
   different asset classes in the 2 quarter using our heatmap methodology.
   In Figure 1 we list the returns of key cross market assets from left to right (in order
   of risk) on a total return basis which uses a historical z-score ranking system. The
   first row shows the full year 2010 returns for each asset class with a green cell
   indicating outperformance of that asset class relative to others in 2010. For 2011,
   we use rolling 6-month returns for the first 6 months to highlight the trend in
   performance for the asset classes listed where growing shades of green are signs
   of continued strength in that asset class relative to others and shades of red
   represent the opposite. Finally, in the last 2 rows we look at the overall Q1 and Q2
   returns for each asset class to show the quarterly overall performance.
   A quick glance of the data in our table highlights how just as the first quarter was
   driven by Fed induced activity, Q2 has seen the start of the unwind of many of those
   themes. As we have mentioned repeatedly, the key beneficiaries of Fed QE2 have
   been risk assets, i.e. equities and commodities along with high yield debt. The key
   loser from Fed easing has been the US dollar as well as low-risk assets such as US
   Treasuries. The unwind of that process has thus sent shocks through some of the
   markets that prospered the most when QE2 kicked off. A review of the quarter
   shows that breakeven inflation has tightened; though this is not entirely apparent in
   the table (TIPS have still outperformed nominals on a total return basis, partly
   attributable to their higher average duration and the prevailing bullish environment).
   The most extreme turn was seen in commodities and the S&P – both had strong Q1
   performance which has since evaporated with the former actually down YTD (June
   6m rolling return is the same as YTD). Not surprisingly, the dollar continued to
   underperform as the reserve creation by the Fed led to weakening the currency.
   High yield debt, another beneficiary of Fed QE2 also saw reduced returns as
   investors moved up the capital structure (for more on this see Positioning section on
   page 15) also helping investment grade debt to post a strong Q2 performance. Most
   low-risk assets (left side) performed well during May and June as a general risk-off
   theme pervaded markets amid continued debt concerns about the European
   periphery, though the last few days in the quarter saw some reversal of this trend.
   The key questions for the third quarter ahead may create some volatility for USTs
   as the debate surrounding the debt ceiling grows in intensity and a resolution still
   appears distant. To the extent that an agreement isn‘t forthcoming, we caution any
   uncertainty will add to the risk premium being built into UST markets but also into
   risk markets in general (a nowhere to run/hide mentality comes to mind for the worst
Figure 1. Macro Performance: Comparing Returns Across Asset Classes (6m Rolling Returns for Months)
                                 Mortgage        Supra       Agency       Tsy            TIPS     Commodities            Corp          DXY            EM              HY              SPX
                2010              5.58%          4.72%       5.73%       5.81%          6.46%        10.89%             9.13%         1.50%         12.01%          14.24%           12.78%
                                                                                            6m rolling
              Jan-11               0.28%         0.05%        0.41%      -0.68%         1.96%        16.94%              1.15%        -4.67%          1.57%          8.45%           16.75%
              Feb-11               0.30%        -1.10%       -0.73%      -2.69%         0.91%        23.68%             -0.31%        -7.59%         -0.62%          9.93%           26.48%
              Mar-11               0.90%        -1.32%       -0.73%      -2.75%         1.26%        18.46%             -0.80%        -3.64%         -0.95%          7.21%           16.18%
              Apr-11               0.91%        -0.20%       -0.46%      -1.48%         0.99%        17.82%              0.83%        -5.61%         -1.80%          6.11%           15.24%
              May-11               2.09%         1.46%        0.73%      0.71%          3.33%        11.07%              3.07%        -8.08%          2.87%          7.82%           13.95%
              Jun-11               3.65%         3.52%        2.52%      2.83%          6.00%        -1.28%              4.25%        -5.86%          6.01%          6.13%            5.01%

                 Q1                0.55%         0.63%       0.23%       -0.19%         2.03%            5.13%          0.82%         -4.01%         0.73%           3.95%            5.42%
                 Q2                3.08%         2.87%       2.28%       3.02%          3.89%            -6.10%         3.40%         -1.92%         5.24%           2.10%           -0.39%

     Best Month                     May           Apr          May         May           Apr               Mar            Apr           May            Jun            Jan              Feb
     Best Month Return             1.13%         1.15%        0.90%      1.52%          2.29%            3.21%           1.76%         2.34%          2.47%          2.22%            3.20%
     Worst Month                    Jan           Feb          Feb         Feb           Jan               May            Mar           Apr            Jan            Jun              Jun
     Worst Month Return            0.15%        -0.08%       -0.02%      -0.07%         0.02%            -5.47%         -0.08%        -3.85%         -0.60%          0.24%           -1.83%

Note: The heatmap represents 6m rolling returns across asset classes for H1. Comparisons are made across assets for the same period and a green cell indicates better performance (return) for that
asset class than those appearing yellow or red. The intensity of the shade represents the extent of outperformance. The lower table uses MoM returns to indicate best and worst months for each asset.
June represents the latest available data as of publication. The Q1 return represents returns during Jan – March and Q2 represents Apr – Jun.
Source: Nomura, Yield Book, Bloomberg

Nomura | Rates Radar                                                                                                                                                                           1 July 2011

   case scenario). A positive resolution along with spending cuts is likely to help USTs.
   The rest of the quarter, away from the debt-ceiling debate, should see a resumption
   of flows into USTs from other investors such as households and banks as the Fed‘s
   participation throttles back. And until we see a further strengthening of economic
   fundamentals and a concrete EU solution we believe that risk assets could falter or
   stagnate post Q2 wrap up driving some flows back to bonds again.
   US Treasuries
   It has been a fairly strong quarter for UST performance with a Q2 return of 3.02%.
   As expected, in a generally bullish environment longer maturities outperformed due
   to higher duration and carry. But it was also noticeable that the long-end (20yr+
   sector) lagged the rest of the curve. This was a consequence of the curve
   steepening we saw during the quarter. Fed statements (and comments) led the
   market to price out some rate hike expectations, and Greece-led flight-to-quality
   flows also found a home in the belly and front-end causing them to outperform.
  TIPS had another strong quarter, as the higher average duration (almost 3 years
  greater than the UST index) combined with a bullish environment, especially for
  long dated TIPS, saw another quarter of TIPS outperformance over USTs.
  Breakevens did tighten during the quarter led by the decline in commodities, but the
  performance seems to have been strong despite this. April was the best month for
  TIPS across sectors in terms of m-o-m performance as May saw the start of the
  decline in breakevens led by commodities hurting the performance of TIPS.
Figure 2. US Treasuries: Relative Performance by            Figure 3. US TIPS: Relative Performance by Sector –
Sector – Belly and Intermediates Leads the Way              April Performance Makes for a Strong Quarter
                      Tsy           Tsy 1-3y Tsy 3-7y Tsy 7-10y Tsy 10-20y Tsy 20+                                       US ILS Index US ILS 1-3 US ILS 3-5 US ILS 5-7 US ILS 7-10 US ILS 10+
         2010               5.81%       2.33%      6.57%  9.40%     9.80%      9.40%                        2010           6.46%       2.60%      4.53%      6.32%       7.42%       8.94%
                                          6m Rolling                                                                                        6m Rolling
       Jan-11             -0.68%        0.37%      0.14% -1.09%    -3.18%     -7.13%                       Jan-11          1.96%       1.97%      2.89%      3.42%       2.77%       0.27%
       Feb-11             -2.69%        0.09%     -1.73% -4.52%    -7.44%    -12.89%                       Feb-11          0.91%       2.88%      3.22%      2.77%       1.76%      -2.68%
       Mar-11             -2.75%       -0.12%     -2.30% -4.54%    -6.84%    -10.72%                       Mar-11          1.26%       3.28%      3.08%      2.39%       0.83%      -1.15%
       Apr-11             -1.48%        0.08%     -1.50% -2.96%    -3.75%     -4.56%
                                                                                                           Apr-11          0.99%       3.60%      3.72%      2.78%       1.12%      -2.61%
       May-11              0.71%        0.60%      0.94%  0.40%     0.57%      0.26%
                                                                                                           May-11          3.33%       3.80%      4.54%      4.08%       3.39%       2.00%
       Jun-11              2.83%        1.78%      3.43%  3.95%     4.54%      4.00%
                                                                                                           Jun-11          6.00%       3.98%      5.99%      7.16%       7.12%       5.71%
          Q1              -0.19%       0.02%       -0.06%      -0.28%     -0.26%      -1.58%
          Q2               3.02%       1.76%        3.49%       4.24%      4.81%       5.67%                 Q1             2.03%         2.26%       2.51%         2.45%      1.98%        1.41%
                                                                                                             Q2             3.89%         1.68%       3.40%         4.60%      5.05%        4.24%

 Best Month               May          Jun          May         May       May         May         Best Month                  Apr          Apr          Apr           Apr       Apr           Apr
 Best Month Return       1.52%        0.99%        1.58%       2.59%     3.07%       3.68%        Best Month Return         2.29%        0.98%        2.06%         2.40%      2.60%        2.94%
 Worst Month              Feb          Feb          Feb         Feb       Jan         Jan         Worst Month                Jan           May         May           Feb        Jan           Jan
 Worst Month Return     -0.07%       -0.09%       -0.46%      -0.20%    -0.90%      -3.09%        Worst Month Return        0.02%        -0.16%       0.15%         0.17%      0.57%        -2.13%

Note: The heatmap represents 6m rolling returns across asset classes for H1. Comparisons are made across assets for the same period and a green cell indicates better performance (return) for that
asset class than those appearing yellow or red. The intensity of the shade represents the extent of outperformance. The lower table uses MoM returns to indicate best and worst months for each asset.
June represents the latest available data as of publication. The Q1 return represents returns during Jan – March and Q2 represents Apr – Jun.
Source: Nomura, Yield Book, Bloomberg

   US Agencies
   Agency debt continues to perform well as a dry-up in issuance ensures that supply-
   demand dynamics favor tight spreads. But the outperformance relative to USTs has
   slowed indicating that we could be approaching the point where liquidity concerns
   offset lower supply, as we had mentioned in our 2011 Outlook (see link).

Figure 4. Agency Debt Performance: Liquidity Concerns Offset Lower Supply
                                     Agency          Agency 1-3     Agency 3-7         Agency 7-10         Agency 10+                Agency           Agency Callable Agency Bullet
                      2010               5.73%           2.42%          6.24%             13.51%              14.07%                     5.73%            2.01%           6.16%
                                                             6m Rolling                                                                                 6m Rolling
                     Jan-11              0.41%           0.49%          0.06%                3.07%            -1.48%                      0.41%           0.06%           0.44%
                     Feb-11              -0.73%          0.20%          -1.22%               0.71%            -5.07%                      -0.73%          -0.19%          -0.77%
                     Mar-11              -0.73%          0.06%          -1.38%               0.82%            -3.70%                      -0.73%          -0.17%          -0.77%
                     Apr-11              -0.46%          0.18%          -0.99%               0.72%            -2.55%                      -0.46%          0.32%           -0.52%
                     May-11              0.73%           0.80%          1.30%                0.02%            -0.07%                      0.73%           0.76%           0.71%
                     Jun-11              2.52%           1.96%          3.65%                2.60%            3.39%                       2.52%           2.06%           2.54%

                       Q1                0.23%              0.14%          0.26%             0.20%             1.02%                      0.23%            0.03%            0.09%
                       Q2                2.28%              1.82%          3.38%             2.39%             2.34%                      2.28%            1.95%            2.29%

                Best Month                 May                Jun            Apr               May              May                         May              Jun             May
                Best Month Return        0.90%              0.99%          1.36%             1.96%            2.53%                       0.90%            0.98%            0.92%
                Worst Month                Feb                Feb            Feb               Feb              Jan                         Feb              Feb             Feb
                Worst Month Return       -0.07%             -0.09%         -0.46%            -0.20%           -0.90%                      -0.07%           -3.09%           1.00%

Note: The heatmap represents 6m rolling returns across asset classes for H1. Comparisons are made across assets for the same period and a green cell indicates better performance (return) for that
asset class than those appearing yellow or red. The intensity of the shade represents the extent of outperformance. The lower table uses MoM returns to indicate best and worst months for each asset.
June represents the latest available data as of publication. The Q1 return represents returns during Jan – March and Q2 represents Apr – Jun.
Source: Nomura, Yield Book, Bloomberg
Nomura | Rates Radar                                                                                                                                                                               1 July 2011

   Suprasovereign (SSAs) debt denominated in USD trades very similar to Agency
   debt as it is an alternative liquid rates product. April is generally a high issuance
   month from a seasonal perspective for supra-sovereign borrowers – the fact that
   supras performed strongly after this (May and June) indicates that this growing
   market is finding its feet and seeing increased investor interest. Any concerns from
   the Eurozone may widen spreads in the future while additional supply from any
   potential comprehensive package for the Eurozone could materialize later this year
   or early next year.
   The overall story for Canadian rates has been very similar to the US rates market
   As with the US, the belly and front end have seen the bulk of the outperformance as
   the combined effect of duration and curve moves affect the total return heatmap. On
   a total return basis, in fact Canadian debt has outperformed USTs by a slight margin
   (which is impressive given that their central bank expectations have been on
   balance higher than the US as inflation worries up North linger).

Figure 5. US Supras: Relative Performance by
                                                                                                 Figure 6. Canadian Debt: Similar Story to US Treasuries
Sector – Long End outperformance
                     Supranational    Supra 1-3      Supra 3-7      Supra 7-10      Supra 10+                          Canada Total   Canada 1-3    Canada 3-5   Canada 5-7   Canada 7-10   Canada 10+
       2010             4.72%          2.61%          6.26%           7.47%          9.66%               2010               6.18%         1.85%         4.20%       5.79%         7.45%        12.46%
                                           6m Rolling                                                                                              6m Rolling
      Jan-11            0.05%          0.46%          0.22%           -2.81%         -3.75%            Jan-11               0.69%         0.61%         0.84%        0.80%        0.42%         0.95%
      Feb-11            -1.10%         0.07%          -1.48%          -5.53%         -7.01%            Feb-11               -1.46%       -0.15%        -1.15%       -1.77%       -2.43%         -2.60%
      Mar-11            -1.32%         -0.04%         -1.88%          -5.81%         -6.15%            Mar-11               -1.67%        0.26%        -1.06%       -1.86%       -2.64%         -3.87%
      Apr-11            -0.20%         0.39%          -0.52%          -2.84%         -2.04%            Apr-11               -0.87%        0.44%        -0.60%       -1.11%       -1.40%         -2.28%
      May-11            1.46%          1.14%          1.59%           1.00%          1.69%             May-11               1.75%         1.14%         1.49%        1.84%        2.22%         2.50%
      Jun-11            3.52%          2.36%          3.95%           4.79%          6.05%             Jun-11               2.37%         2.31%         2.63%        2.63%        2.55%         2.54%

        Q1              0.63%          0.40%           0.72%          1.09%           1.83%              Q1                 -0.58%        0.17%        -0.28%       -0.47%       -0.69%         -1.69%
        Q2              2.87%          1.95%           3.21%          3.66%           4.15%              Q2                 2.95%         1.93%         2.80%        3.06%        3.37%         4.52%

   Best Month             Apr           Jun             Apr             May            May           Best Month               May          Jun           Jun          May          May            May
Best Month Return       1.15%          0.94%          1.45%           2.24%          2.09%        Best Month Return         1.57%         1.20%         1.08%        1.37%        1.74%         3.46%
  Worst Month             Feb           Feb             Feb             Jun            Jan          Worst Month               Jan          Feb           Feb          Feb          Jan            Jan
Worst Month Return      -0.08%         0.00%          -0.24%          -0.48%         -0.41%       Worst Month Return        -0.64%       -0.13%        -0.32%       -0.26%       -0.91%         -2.27%

Note: The heatmap represents 6m rolling returns across asset classes for H1. Comparisons are made across assets for the same period and a green cell indicates better performance (return) for that
asset class than those appearing yellow or red. The intensity of the shade represents the extent of outperformance. The lower table uses MoM returns to indicate best and worst months for each asset.
June represents the latest available data as of publication. The Q1 return represents returns during Jan – March and Q2 represents Apr – Jun.
Source: Nomura, Yield Book, Bloomberg

Nomura | Rates Radar                                                                                                                                                                                                        1 July 2011

Macro Topics
  2Q11 Positioning Review – Fed Only Displaced Investors
  Following fairly lackluster demand for Treasury securities in Q1 2011, the second
                                                                                                                                                                                             Marcus Phua
  quarter of the year saw markedly improved buying appetite among market
                                                                                                                                                                                             +1 212 667 9349
  participants. Not withstanding the last days of Q2, risk assets fell out of favor during
  most of the quarter by investors after a strong performance earlier in the first quarter.
  Some of the reduction in risk appetite ended up with bond mutual funds. Meanwhile
  heavy Fed buying of USTs in the last stage of QE2 implementation nearly                                                                                                                    Matthew Bouchard
  outstripped net supply change for bonds leaving many fund managers underweight                                                                                                             +1 212 667 9249
  duration (although recently they are trying to close it) as the UST market rallied.                                                                                              

Figure 1: Quarter-on-Quarter US Rates Positioning and Flows Update

                             CFTC Aggregate Specs      Primary Dealer  Bond Mutual Funds Foreign Central Banks    Japanese Investment in        Large Commercial
                              UST Net Positions (in UST Net Positions Quarterly Cumulative Quarterly Cumulative Foreign Securities Quarterly Banks Treasury/Agency Federal Reserve
                             10yr equivalents., $bn) (face value, $bn)  Net Flow s ($bn)    Net Flow s ($bn)    Cumulative Net Flow s ($bn) Security Holdings ($bn) Treasury Holdings
      Q4 2010                        -14.89                 -0.91             11.56              132.50                    11.98                     260.48             1,010.29
      Q1 2011                         5.43                 -43.28             19.79               30.00                    48.59                     262.33             1,323.23
      Q2 2011                         20.41                -50.10             44.23               81.00                   -17.32                     246.07             1,589.17

Source: CFTC, Federal Reserve, ICI, MOF Japan, Nomura
  Primary Dealers
  According to Fed data, primary dealers had extended their net shorts on USTs by
  nearly $7 bn in the second quarter, led by positions in the belly/intermediate sector.
  As mentioned before in our earlier reports (see RPI link), this could have been
  caused by facilitation of client longs during the bond rally. However dealers‘ long
  hedges in futures were relatively light compared to cash, it‘s likely the short-bias
  was a combination of Fed buying & dealers remaining short as an end of QE2 trade.
  Bond mutual fund flows and duration bias
  Bond mutual fund inflows improved by $24.4 bn on the quarter, at the expense of
  withdrawals from domestic equity funds as bonds outperformed stocks. Taxable
  funds accounted for nearly all net new money received by bond funds, while flows
  into municipal funds were muted following large withdrawals seen at end-2010 and
  in Q1 2011. Within taxable funds itself, high yield debt funds have been
  experiencing large outflows in June and the long-standing inflows into loan funds
  seem to be grinding to a halt. We believe flows will continue to roll up the capital
  structure as the Greek debt situation continues to be debated and as the uncertainty
  over the US economy persists. We surmise that these withdrawals are likely to be
  reallocated into other bond funds geared towards safer assets such as USTs and IG
  debt. The dichotomy of sentiment between ailing developed economies and more
  robust emerging economies might have also triggered outflows towards emerging
  market funds (see Macro Daily – link).
  Flush with cash, bond funds have been reducing their underweight duration bias
  relative to UST benchmarks as rates rallied (see Rates Radar Weekly - link). We
  expect funds to see continued inflows and their duration bias to turn more bullish in
  the coming weeks, should economic data fail to improve and Europe flareup.
Figure 2. Primary dealers remain substantially net               Figure 3. US bond funds continued to see strong
short in the UST belly despite a strong rally in rates           inflows as investors withdraw from equities
    Amt                      PDP UST 6-11y Position                                                       1M Rolling                                   ICI Equity Mutual Fund Net Flows
   ($bn)                     Dealers TY Futures Position (10y cash note equiv. risk)                      Flow ($bn)
                                                                                                                                                       ICI Bond Mutual Fund Flows
              20                                                                                                        25
                                                                                                          Inflow >>

              10                                                                                                        20
              -10                                                                                                        5
              -20                                                                                                        0

                                                                                                          << Outflow

              -50                                                                                                      -20








Source: Federal Reserve, Nomura                                                                       Source: ICI, Nomura

Nomura | Rates Radar                                                                                                                                                                                             1 July 2011

  Non-commercial futures traders
  CFTC data shows that large speculators have increased their overall net longs on
  UST futures appreciably by nearly $15 bn (in 10-yr note equivalent risk) on the
  quarter. This surge in bullish bias was spearheaded by the steady build-up of net
  longs on 5-year note futures to the highest levels since May 2008 (nearly $21 bn in
  10-yr note equivalent risk). In light of the momentum trading style which is
  characteristic of large speculators, we expect overall net long positions on Treasury
  futures to increase further in the near to medium term if bonds continue their
  outperformance over riskier assets on a worsening economic/macro outlook.
  Large commercial banks
  Fed H.8 data reveals that large commercial banks have been net sellers of
  Treasury/Agency debt by about $16 bn in Q2 2011. This reflects a gradual move by
  these investors away from Treasuries into other products such as MBS (and some
  marginal C&I loan growth) in an effort to boost profitability, as bank revenues have
  been on a considerable decline since 2008. Nonetheless we expect banks to start
  buying UST/Agency debt (and MBS) in favor of other riskier investments in Q3 given
  the recent rate backup. Also there is still an onus to hold USTs to comply with
  increased minimum tier-1 capital ratios proposed under Basel III rules.
  Japanese investments in foreign bonds
  Japanese investors turned net sellers of foreign bonds by $17 bn in the second
  quarter, in stark contrast to net buying to the tune of over $48 bn in Q1 2011. This
  was due to 1) heightened caution among Japanese investors following the
  earthquake in March; and 2) Japanese financial institutions shifting away from last
  year‘s momentum investing to more tactical trading. According to anecdotal
  evidence, some Japanese insurers became long USD as barrier options knocked in
  at the 80-handle on March 17, and bought USTs when 10yr yields ranged from
  3.5% to 3.6%. These investors would thus have less incentive to chase rallies.
  Hence we feel that recovery in Japanese investors‘ appetite for USTs is likely to be
  carry oriented as well as display a ―buy on dips‖ strategy in 2H 2011.
  Foreign central banks
  Foreign central banks increased their total Treasury security purchases to over $80
  bn in Q2 2011, after a first quarter of comparatively muted buying. This might reflect
  in part, a renewed inclination by some foreign central banks to engage in traditional
  FX intervention to stem currency appreciation against the dollar versus other macro
  prudential policies such as capital controls. With emerging markets still leading
  world growth and the USD still subject to a secular trend of depreciation, we expect
  increased UST purchases by foreign official accounts in the coming months.
  With the Fed ending its Treasury buy operations for QE2, market participants have
  been fretting over whether there would be sufficient appetite for USTs from non-
  public investors. We are sanguine on the demand picture, and expect foreign
  central banks, underweight bond funds and the short-base in dealers to more than
  adequately fill this gap in buying.
Figure 4. Non-commercials added to UST net longs                  Figure 5. Foreign central bank UST buying increased
     Amt                             Agg. Spec UST Fut Net Risk (10y note equiv.)                                           UST 10-yr          Quarterly       Foreign Central Banks' Quarterly UST          UST
    ($bn)                            UST 10yr Yield (RHS, Inverse)                                                          Yield (%)          Purchase        Net Purchase                                Holdings
                                                                                                                                                 ($bn)         Foreign Central Banks' UST Holdings
        25                                                                                                                       2.8                                                                        ($bn)
              20                                                                                                                 2.9

                                                                                                                                                250                                                            2,800
              15                                                                                                                 3.0                                                                           2,700
              10                                                                                                                 3.1            200                                                            2,600
                                                                                                                                 3.2                                                                           2,500
                                                                                                                                 3.3            150                                                            2,400
                                                                                                                                 3.4                                                                           2,300
               -5                                                                                                                3.5

                                                                                                                                                100                                                            2,200
              -10                                                                                                                3.6
              -15                                                                                                                3.7
                                                                                                                                                 50                                                            2,000
              -20                                                                                                                3.8







                                                                                                                                                  0                                                            1,800
                                                                                                                                                      Jun-09   Dec-09        Jun-10       Dec-10      Jun-11

Source: CFTC, Nomura                                                                                                                         Source: Federal Reserve, Nomura

Nomura | Rates Radar                                                                                                                                                                                                                                                                1 July 2011

Market Focus
Treasuries: Fed Departure May Bring in Other Buyers
  We maintain our buy-on-dips strategy for now as the weeks ahead promise “wei ji”                                                                                                                              Aaron Kohli
                                                                                                                                                                                                                +1 212 667 9889
  One question we often face from clients now that the Fed is stepping back a bit is:
  In the absence of the Fed, who will buy Treasuries? Some market participant voice
  the concern that the Fed has been the omnipresent buyer of Treasuries for the last
  couple of years and it is difficult to imagine the market without it, especially in a                                                                                                                         Ankit Sahni
  period with large deficits.                                                                                                                                                                                   +1 212 667 1049
  Our answer comes partly from the prevailing patterns of purchases occurring                                                                                                                         
  before the central bank entered the markets and how Fed purchasing affected
  those. The remaining part is based on our view on current economic fundamentals
  as outlined in the Macro section on page 6.
  First, we focus on the effect Fed purchases actually had on other demand source
  and market dynamics. We believe the Fed‘s buying took most of the duration supply
  out of the market (they bought almost all net issuance of USTs even as ABS and
  MBS issuance slows), displacing other investors who would have purchased
  Treasuries and forced cash into riskier markets. This was also facilitated by the
  improvement seen in the economy and the return of general optimism. This duration
  buying also led some investors to take the other side of the trade, selling to the Fed
  by establishing short positions.
  In the past few weeks, as the market began pricing in the end of QE buying, the
  unwind of the risk trade brought buyers rapidly back into USTs with some closing
  shorts and others attempting to avoid the pain of dropping risk markets. We expect
  the return to treasuries to continue as investors move toward a more neutral
  position over time along with those who had been displaced into other asset
  classes – in effect, we think the partial unwind of the benefits from portfolio
  rebalance will have a beneficial impact for USTs as we have mentioned in the past.
  The catalysts for such a return to USTs at the cost of risk assets have been, in our
  view, the continued soft economic picture, the changing demographics of the US,
  and the continued issues and concerns in Europe. Specifically, we believe that
  several investor classes reduced their holdings of USTs as the Fed added and they
  were displaced into other assets. These are the investors most likely to return to
  Treasuries once the Fed steps away, as buying on dips resumes. Households and
  hedge funds reduced their holdings from $1.12trn at the end of the third quarter to
  $0.96trn at the end of the first quarter. This decrease was matched by an increase
  in several asset classes, that largest of which were corporate equities, which saw an
  increase of $552bn (for more discussion see Rates Radar Weekly, page 7). We
  expect some unwind of this dynamic as the Fed steps away. Figure 1 shows the
  allocation to treasuries by households and hedge funds over the past few decades.
  Household holdings of USTs are still relatively weak compared with long-term

Figure 1. US Households/Hedge Funds Shifting                                                                                             Figure 2. JGB Yield Responses to S&P Rating Cut –
Assets From USTs to Equities During QE                                                                                                   Yields Actually Rallied in the Immediate Aftermath
                                                Equities                        USTs
  35%                                                                                                                        5.0%
  30%                                                                                                                                        1.3
  25%                                                                                                                                       1.25
  20%                                                                                                                        3.0%
  15%                                                                                                                        2.0%
  10%                                                                                                                                       1.15
   5%                                                                                                                                        1.1
   0%                                                                                                                        0.0%           1.05







Source: Nomura, Federal Reserve                                                                                                          Source: Nomura, Bloomberg

Nomura | Rates Radar                                                                        1 July 2011

  averages and we believe recent trends will correct as demographics and weak risk
  markets force realignment.
  Meanwhile, commercial banks reduced their allocation to bank credit while
  increasing their reserves at the Fed sharply while keeping their Treasury positions
  virtually unchanged over the last quarter (although they fell from the prior peak). In
  sum, the flow of funds to a large extent confirms our hypothesis that there has been
  a continued displacement of investors out of USTs which could reverse course
  should risk markets fail to hold its ground of late.
  Another issue likely to dominate the coming quarter is uncertainty surrounding the
  debt ceiling. To a large extent, this has thus far been ignored by the market as the
  CDS which recently spiked to higher levels has since retraced at least some of
  those gains. The debt ceiling remains a salient issue in the near term with a
  resolution likely to appear only at the 11 hour. A default would have a severe
  impact on worldwide markets, as treasuries serve as the risk free rate for markets
  worldwide. This could cause a systemic shock to borrowing rates across various
  markets and local dislocation on the curve as well as a prolonged shutdown of
  government services that may actually bring yields down once the markets have
  absorbed the initial selloff. Although, there may not be much of a yield selloff if the
  Japanese example of downgrades is a relevant guide (Figure 2), though a default is
  definitely more significant than a rating cut. We believe that any missed payments
  by the US would represent a truly monumental event for investors and could
  especially affect the psychology of the markets which have come to view USTs as a
  safe, liquid instrument in which to park assets. Although the lack of alternatives may
  give us some maneuvering room, a default would very likely significantly damage
  the borrowing ability of the US in the long run. Much of the debate surrounding the
  debt ceiling revolves around the extent of the intended spending cuts. Republicans
  are likely to push for cuts that include discretionary, mandatory and entitlement
  spending, with caps on total spending as well that could last from a few years to a
  decade. We believe a final compromise will likely cut several trillion dollars over 10
  Broadly, there are 4 scenarios we expect will play out over the next several weeks.
  1) The first scenario is one where the debt ceiling is raised by $1.5trn-$1.75trn,
     which, at its current UST net issue rate of nearly $125bn/month, will likely push
     the problem into the middle of 2012. This scenario is problematic in that it
     removes the immediate impetus for a concern, but could cause a more
     significant problem next year as the debt will be reached again just ahead of a
     major election. An even bigger impasse would then be more likely next year
     with yields much more volatile in that period than right now.
  2) In the second scenario, a face-saving compromise is made at the last minute in
     an effort to ―kick the can down the road‖ for a few more weeks or potentially a
     month to avoid default while further negotiations take place. This seems a
     somewhat likely outcome since it would allow time for better negotiations while
     avoiding default. It‘s not clear whether rating agencies would abstain from taking
     some negative action against the US if no fundamental compromise is reached
     on deficit spending. Moody‘s has already voiced concerns in early June over a
     potential inability to reach a compromise. Yields should do little here unless
     there is mention of a ratings downgrade or a negative creditwatch.
  3) In the third scenario, significant spending compromise is worked out and a full
     extension of the debt ceiling is made to potentially $2.5trn, allowing the debt
     ceiling issue to extend beyond the 2012 elections, insulating the decision from
     undue political interference. Under this scenario, the Treasury will likely need
     another extension at the end of 2012, but as this will occur after the elections.
  4) In the final scenario, there is no attempt made to raise the debt ceiling and the
     government continues past the August 2 deadline with little accomplished in the
     way of an agreement. We consider this the ―outside‖ scenario with a very small
     probability of occurring, and assign it a less than a 1% chance. Under this
     outcome, the U.S. Treasury secretary would likely prioritize interest and
     principal payments but would lose the ability to manage cash flows and would
     engage in a very severe attempt to balance the budget by cutting spending
Nomura | Rates Radar                                                                                                                                                                                                                                         1 July 2011

     indiscriminately. A default could happen on any day when estimated tax
     payments, withholdings and revenues fail to meet the amount needed to pay
     the interest and principal on debt. It‘s not entirely clear whether ratings agencies
     would consider defaulting on non-treasury payments an act of default, which
     might make the exercise of payment prioritization futile. Further, the damage to
     the US economy as the Treasury fails to make payments would be significant.
  Considering the demand for USTs over the last few quarters and the implications for
  demand in the coming quarters, the end of QE2 buying has seen an increase in
  dealer participation at auctions and a drop off in non-dealer participation. We do not
  believe this reflects a systemic lack of customer demand for USTs, but rather a bit
  of sticker-shock at the levels where supply was being brought to market. USTs will
  be the largest supply sector in fixed income markets and we expect investors to
  return in the next quarter. Of course, the question is almost never one of whether
  investors will return, but at what price. As the Fed‘s role in the Treasury market
  diminishes with the ending of the QE2 expansion phase, we are likely to see
  continued investor demand, especially if risk markets again start to decline, as we
  expect they might.
  Things Ahead to Watch
  The Chinese word for opportunity and crisis (wei ji) represents the advantage that is
  almost always present with any dramatic shift. The sudden sell-off in rates at the
  end of QE2, in our view, holds promise and peril for investors as the weeks ahead
  cover a slew of economic data. The coming days hold several valuable data points:
  NFP, the minutes from the June meeting, and the Humphrey Hawkins testimony
  stand out among the most important. For NFP, our economists currently expect a
  print of 150k for the headline along with the unemployment rate of 9.0%. Not much
  is likely to change in the Fed minutes with exit strategy already discussed, though
  there may be some talk about the Greece situation and concerns about growth and
  longer-lived factors impacting the economy. In his semi-annual testimony to
  Congress, Bernanke is likely to use the opportunity to encourage a debt ceiling
  compromise if one has not been obtained at that point along with the normal political
  jousting that accompanies such an event. There will also be an auction for 3s
  ($32bn) as well as a second reopening for 10s ($21bn) and bonds ($13bn). Overall,
  we expect rates to stay in a new range, with 10yr yields capped by 2.75% on the
  bottom and 3.25% at the top. We continue to expect rates to drift lower in the
  coming days although there are likely to be some bumps along the way. The
  economic data, if it inspires selloffs, should be viewed as another opportunity to add
  to positions.

Figure 3. Auction Results Over the last quarter –                   Figure 4. Fed Bought Almost All of UST Net
Non-dealer Demand Decreasing But We Think it‟s                      Issuance Over QE2 – The Coming Months Will See
Because of Yield Levels                                             the Fed Step Away But Supply Remain High
                                                                                                                                                 Net Issuance                   POMOs
               Q1       Q2      Apr       May     June

    2s        42.1%    45.7%   51.2%     50.4%    35.5%                         200

    3s        46.6%    45.2%   42.6%     48.1%    44.8%                         150

    5s        50.0%    51.7%   51.2%     56.0%    47.9%                         100

    7s        56.7%    50.5%   47.0%     60.6%    43.9%                          50

    10s       64.3%    54.3%   48.3%     55.6%    59.0%











    30s       49.4%    49.2%   58.0%     41.8%    47.7%

Source: Nomura, US Treasury                                         Source: Nomura, NY Fed

Nomura | Rates Radar                                                                                                                                                                                                                                                                                                                                                 1 July 2011

        When the end of QE2 TIPS buying by the Fed meets the mother of all index
                                                                                                                                                                                                                                                                                                                                 Stanley Sun
        extensions in July, overweight the 20yr sector
                                                                                                                                                                                                                                                                                                                                 +1 212 667 1236
        We have pared down TIPS risks in our model portfolio and are currently neutral on                                                                                                                                                                                                                              
        breakevens for the near term. With QE2 coming to an end and potentially a new
        trading regime starting, we will look for tactical expressions and focus more on
        curve relative value than outright direction. As shown in Figure 1, the Fed‘s QE2 has                                                                                                                                                                                                                                    Matthew Bouchard
        been mostly supporting the current 10yr and 30yr TIPS. Granted, the Fed should                                                                                                                                                                                                                                           +1 212 667 9249
        still be buying TIPS albeit in less frequency and smaller sizes, likely back to the                                                                                                                                                                                                                            
        purchase pattern of QE-lite as MBS prepays get reinvested. However, it‘s worth
        noting that during QE-lite on the run TIPS were never the favorites mostly because,
        in our view, the much smaller purchase amount could be filled in an off the run issue
        (for the same reason, Nominal purchases were also concentrated in on the run
        issues during QE2). Hence the Fed could rely more on rich/cheap in terms of which
        issue to purchase and as we head into July, we could see the 10yr and 30yr points
        of the TIPS curve under some pressure without the Fed‘s support.
        The 10yr TIPS supply in July could also require some cheapening on the curve,
        especially from these levels where 5y5y BE is about 20bps higher than before the
        30yr TIPS auction. Given that the issue settles on July 29th, cutting close to the
        debt ceiling deadline, we could see some concerns from foreign investors, leading
        to a poor showing from indirects (which in our view partially contributed to three
        auction tails in a row for the 2s, 5s, and 7s auctions). The 30yr TIPS had a great
        auction and again outperformed on index extension date. But one key driver of the
        successful 30yr TIPS auction in our view was positioning established before the
        auction (driving Feb41 overnight repo to as low as -20bps, which is very unusual for
        a TIPS). The last time TIPS traded so special was the Jan21 back in March, also
        resulting in a strong auction. As the extra $7bn Feb41 settle, removing the repo bid,
        we have the risk of running some supply overhang, just like last summer.
        Given we believe both the 10yr and 30yr could underperform in July, we like to
        overweight the 20yr sector, which is now trading cheap both on the fly and using
        forwards (Figure 2). In addition, the month of July will give us the mother of all index
        extensions, an unprecedented 0.38 years (by our preliminary estimate) for the TIPS
        index, as July 12 rolls out and July 21 (penciled at $13bn) rolls in. The indexer
        community will need to buy every single TIPS and we believe the 20yr sector will
        stand to benefit as the paper may be harder to come by, compared to the more
        liquid 10s and 30s.

Figure 1. Fed's TIPS purchases during QE2 by                                                                                                                                                                                                       Figure 2. 20yr TIPS looks cheap both on the fly and
maturity                                                                                                                                                                                                                                           in forwards
                                                                                                                                                                                                                                                                               10s20s30s TIPS                    5y5y-10y10y TIP Spd (RHS)
              4,000                                                                                                                                                                                                                                 70                                                                                                               100
              3,500                                                                                                                                                                                                                                 65
              3,000                                                                                                                                                                                                                                 60
                                                                                                                                                                                                                                                    55                                                                                                               80
 $ millions

                                                                                                                                                                                                                                                    50                                                                                                               70
              2,000                                                                                                                                                                                                                                 45
              1,500                                                                                                                                                                                                                                 40                                                                                                               60

              1,000                                                                                                                                                                                                                                 35                                                                                                               50
               500                                                                                                                                                                                                                                                                                                                                                   40
                 0                                                                                                                                                                                                                                  20                                                                                                               30







Source: Fed                                                                                                                                                                                                                                        Source: Nomura

Nomura | Rates Radar                                                                                                                                                 1 July 2011

  While the on-going Eurozone crisis is unlikely to reach the heights of 2008 or 2010,                                                  Marcus Phua
  asset managers’ UST duration shorts in futures remain at risk in the near-term                                                        +1 212 667 9349
  The escalating uncertainty over the Euro zone‘s fiscal woes for the past month has                                          
  led to renewed concerns over some European banks‘ exposure to periphery debt
  and doubts over their ability to fund themselves in dollars. Wary of a possible repeat
  of a LIBOR blow-out similar to last summer‘s, some market participants have pre-
  emptively entered into hedges in the Eurodollar futures and options space in the
  form of short outright positions and put spreads (in the OTC space, we also
  recommended entering into front-end swap spread wideners in Rates Radar Weekly,
  May 27 – see link).
  Although the situation has since stabilized with the passing of the austerity votes at
  the end of the quarter, the sharp sell-off in EDU1 on 15 & 16 June served as a stern
  warning to investors holding a benign view on Europe. The current dire picture has
  even led to speculation of a Lehman-like sovereign debt contagion by extreme
  pessimists. At this juncture, we feel that it is important to put the prevailing situation
  in perspective by drawing references to similar LIBOR funding crises in the past.
  If investors were to use the ubiquitous LIBOR-OIS spread alone as a gauge of
  funding stress, the more stable, tighter spreads of today and 2010 betray little hint of
  any liquidity issues. However this tightness was largely caused by a shift to a new
  rate regime where ample QE liquidity has removed much of the bank credit risk
  component while provided excess cash at the same time – see link.
  In the current regime, it might be better to use indicators based on traded
  instruments such as FRA-OIS or Eurodollar options. Figure 1 show FRA-OIS
  spreads pre-emptively widening more than the spot LIBOR-OIS spread for the
  current bout of funding stress and also for 2010, compared to 2008. It is evident that
  market determined levels such as FRA-OIS, along with Eurodollar put-call ratios are
  more indicative of brewing funding stress in the current QE-dominated rate regime
  than the traditional LIBOR-OIS spread (which is being artificially suppressed).
  Taken as a whole, we would surmise that the market is still concerned over a
  potential repeat of dollar liquidity stress, but the existing ―wall‖ of QE liquidity built up
  from successive rounds of Fed buybacks should likely dampen any ensuing shocks
  and prevent a full blown crisis à la 2008. That said we nevertheless feel that it would
  be prudent to maintain existing hedges through the summer as a safeguard.
  Given that the current state of risk markets like equities still resembles more of a
  correction than a total risk meltdown, asset managers still hold substantial net
  shorts on Treasury futures, most notably on 2-yr (TU) and 5-yr (FV) notes as
  positioning for a back-up in rates (see Figure 2). We however feel that holding large
  shorts in UST futures while there is still continuing uncertainty over a second bailout
  package for Greece is akin to ―running the gauntlet‖. In the event of deterioration in
  the current situation, these short positions might have to be covered rapidly.
Figure 1. FRA-OIS, LIBOR-OIS and ED put-call ratio
                                                                     Figure 2. Asset Managers UST Futures Positioning
approx. 1 month before height of past crises
 1st FRA-OIS-                                                    Put-Call           Net OI                       Asset Manager Net Futures Position
                       1st FRA-OIS - LIBOR-OIS spread
  3M LIBOR-            1st ED Put-Call Ratio (RHS)                Ratio
  OIS Spread
                                                                                   Long >>

    14                                                                2.5                     200,000

    12                                                                                        100,000
                                                                      2.0                           0
     8                                                                1.5
                                                                                   << Short

     6                                                                1.0                     -300,000
     4                                                                                        -400,000
     2                                                                                        -500,000

     0                                                                0.0                     -600,000
         Sep-08 (pre-Lehman) May-10 (2010 debt   Jun-11 (2011 Greek                                      2-yr (TU)   5-yr (FV)   10-yr (TY)    Classic  Ultra Bond
                                   crisis)          debt rollover)                                                                            Bond (US)    (WN)

Source: Bloomberg, Nomura                                                        Source: CFTC, Nomura

Nomura | Rates Radar                                                                                                                                                                                                                                                 1 July 2011

  We see moments where wider spreads and higher vol can materialize in Q3 as                                                                                                                                              Marcus Phua
  portfolios readjust to a world without QE2 POMOs, but at the same time we see                                                                                                                                           +1 212 667 9349
  these spikes to be short-lived as the existing stock of liquidity acts as a dampener                                                                                                                          
  The widening move in spreads began in late April/early May, driven largely by a rally
  in Treasuries (particularly in the 5-year point of the UST curve) while corporate
  supply gradually eased into a summer lull as issuers increasingly stayed on the
  sidelines in light of growing uncertainty over the economy and Europe. Front-end
  spreads widened even further out in mid-June on dollar funding worries in the wake
  of adverse headlines on Greece. As the agreement by the EU/ECB/IMF triumvirate
  to a second bailout package will try to get resolved by mid-July, we continue to hold
  a tactical widening bias on spreads. With US debt ceiling discussions set to take
  center stage in July too, we expect the spread curve to experience some flattening
  on anxiety linked to both near-term LIBOR risk and the US fiscal conundrum.
  Over the longer term, we still hold a slight widening bias on spreads as we feel that
  successive injections of liquidity via Fed buybacks has had an effect of keeping
  spreads artificially tighter than they would be in a world without buybacks. With time,
  the market is likely to price in slightly more LIBOR risk into spreads. That said, the
  existing stock of liquidity should keep credit risk premiums reined in somewhat and
  limit spreads from widening out too much. As for spread curves, we also believe
  they should remain fairly flat as any debt ceiling concerns should drive hedging
  flows towards Eurodollars contracts, widening out front end spreads and flattening
  spread curves. Additionally, we see an opportunity for forward swap curve
  steepeners as we feel that forward curves are still pricing in an early Fed exit too
  Volatility continued to exhibit broad directionality with rates for most of the second
  quarter as with Q1 2011, selling off alongside the UST rally which was largely of a
  ―slow, grinding‖ variety. Realized vols thus stayed depressed until June, and
  exerted a significant drag on gamma. As QE2 implementation ends however, we
  expect portfolio rebalancing across asset markets to induce some volatility. On-
  going uncertainty over Greece would also support higher vols in the near-term. We
  are hence tactically constructive on vols.
  Realized volatility has also bottomed recently and its likely recovery should bring
  about higher implied vols over the longer-term. As with spreads however, the wall
  of liquidity already built up in the markets after successive rounds of Treasury
  buybacks would act as a long-term dampener on volatility in general, especially
  with the Fed committing to keep rates on hold for longer. Hence any rally in vols
  would be kept somewhat in check by this structural ―stabilizing force‖, in our view,
  unless bonds sell off harder alongside a broad recovery in risk sentiment. We thus
  maintain a mildly bullish view on volatility.
                                                                   Figure 2. Implied volatility has largely trended lower
Figure 1. Swap spread curves set to flatten further
                                                                   with lower rates in Q2 2011 but has recovered on
on the burgeoning US fiscal deficit
                                                                   renewed uncertainty over the EU periphery in June
 2s10s                                              2s10s Spread Curve                                                      5s30s
                                                                                                                                          Implied                                                     1y10y Implied Vol
 Curve                                              5s30s Spread Curve (RHS)                                                Curve         Vol (bpv)
 (bps)                                                                                                                      (bps)
    0                                                                                                                        -40
                                                                                                                             -45           116
   -6                                                                                                                        -50
   -8                                                                                                                        -55           110
                                                                                                                             -60           108
  -14                                                                                                                        -65           104
                                                                                                                             -70           102
  -20                                                                                                                        -75














Source: Bloomberg, Nomura                                                                                                                Source: Bloomberg, Nomura

Nomura | Rates Radar                                                                                                                                                                                                                                                                                                                                                                                                            1 July 2011

Money Markets
  The end of QE2 & debt ceiling resolution should see front-end rates rise in Q3                                                                                                                                                                                                                                                                                                           George Goncalves
  In this section we summarize a recently published report on The Fed, Europe and                                                                                                                                                                                                                                                                                                          +1 212 667 2254
  Money Fund Conundrum. In short, as the diagram (Figure 1) shows, the process of                                                                                                                                                                                                                                                                                                
  QE2 Fed purchases of USTs along with FDIC rule changes resulted in unintended
  consequences in the front-end. Please click the link to read the full story.
                                                                                                                                                                                                                                                                                                                                                                                           Stanley Sun
Figure 1. QE2 and Regulation Changes Shift USD to Foreign Banks                                                                                                                                                                                                                                                                                                                            +1 212 667 1236

Source: Nomura Rates Strategy, Federal Reserve H.15

  In our view the conclusion of the Fed‘s QE2 purchases, concerns over Europe
  bank funding and debt ceiling resolution could result in higher short rates:
  1.) For LIBOR: The end of the QE2 period as related to foreign bank accumulation
      of excess dollar reserves (Figure 2) equals less POMO money going overseas,
      meanwhile prime funds reducing Europe bank CD/CP will depress foreign bank
      holdings of USDs sitting at the Fed pushing up S/T bank funding spreads.
  2.) For T-BILLs: In the quarter ahead, as mentioned in the Treasury section on
      page 17, we expect a resolution of the debt ceiling which should also result in
      more short-term T-Bill issuance by the summer‘s end pushing up bill rates.
  3.) In Repo: The Fed will still be buying USTs in QE-lite (re-investing of MBS
      proceeds) but at a much smaller scale (~25 bn versus ~100 bn a month). This
      will allow more new UST collateral to stay in the system with primary dealers.
      As dealers cover their shorts and UST holding rise, so should GC (Figure 3).
Figure 2. US vs. Foreign Bank Cash Reserves                      Figure 3. Dealer Holdings of Treasuries versus GC
  $bns                                                                           Domestic bank cash reserves                                       Foreign bank cash reserves                                                                                                                                                                         GC                        PD Holdings
                                                                                                                                                                                                                                                                                              0.30                                                                                                                              95
                                                                                                                                                                                                                                                                                                                                                                                 QE2 Start                        End of
                                                                                                                                    QE1 Buying Ends                                                                                                   FDIC Fee                                                                               End MBS QE1
                                                                                                                                                                                                            QE2 Starts                                                                                                                                                                                            QE2 UST
                                                                                                                                                                                                                                                                                              0.25                                                                                                                              75

 1500                                                                                                                                                                                                                                                                                         0.20                      End of US QE1

 1300                                                                                                                                                                                                                                                                                         0.15

 1100                                                                                                                                                                                                                                                                                         0.10

  900                                                                                                                                                                                                                                                                                         0.05

                                                                                                                                                                                                                                                                                              0.00                                                                                                                              -45

                                                                                                                                                                                                                                                                                              -0.05                                                                                                                             -65
































Source: Nomura, US Treasury                                                                                                                                                                                                                                                                  Source: Nomura, US Treasury

Nomura | Rates Radar                                                                                                                                                    1 July 2011

Rates Trade Portfolio
                 Trade                      Type      Portfolio   Publication     Entry       Stop-Loss                        Target         Status        Current     Performance
                                                                                                                                               Closed                        18 bp
                                                                  Rates Trade      227bp
5s30s Real Yield Flattener (half risk)      Curve      Tactical                                 241bp                          190bp         (6/23/11 &      209bp      (9bp from half-
                                                                     Idea       (6/20/2011)
                                                                                                                                              6/30/11)                  close at 209bp)

                                                                  Rates Trade      2.8bp
         Sell Aug 18s vs OTR 7s            Curve RV    Tactical                                 4.3bp           -1bp            -5bp           NEW           2.8bp            0 bp
                                                                     Idea       (6/21/2011)

                                                                  Rates Trade                                                                 Stopout
Long 7s in 3s7s30s Trsy fly (half risk)     Curve      Tactical                    -36bp        -25bp           -65bp          -55bp                         -22bp            -5 bp
                                                                     Idea                                                                    (6/30/11)

Rates Trade Portfolio Review:

          As we wrap up the quarter, we have de-risked massively after the 30yr TIPS auction as multiple trades have been
           closed. We hit our revised stops on our TIPS trades, protecting the gains, and closed the second half of our 5y30y
           real flattener after index extension.

          We are back to a very slim portfolio as we look to start the new quarter with a clean slate. As we highlight our more
           balanced outlook and slight biases in our Cross Rate Table, we look to stay nimble and tactical at the start of Q3.

                                                                                                  Tactical = Short-term view           Strategic = Long-term view (up to 6 months)
                                                                                                                                                                 Source: Nomura

 Nomura | Rates Radar                                                                                                                                                 1 July 2011

 Historical Rates Trade Portfolio
                                                                                                   Initial        Re-
                   Trade                    Type       Portfolio                       Entry       Stop-        Assess        Target         Status        Performance
                                                                                                    Loss         Point

                                                                                       18 bpv                                                 Closed
Buy 6m2y vs 1y2y ATM straddle, vega-wgt      Vol       Strategic   Rates Radar                     21 bpv                      10 bpv                         1 bpv
                                                                                      (4/14/11)                                              (6/29/11)

                                                                                                  Initial 250                              Closed & Hit
                                                                                       224 bp          bp                                    new stop
         Short 5y TIPS Breakeven           Inflation   Strategic   Rates Radar                                  Target at      175 bp                         38 bp
                                                                                      (5/12/11)    Now 190                                  (6/23/11 &
                                                                                                                 175 bp
                                                                                                       bp                                    6/29/11)

                                                                                        16 bp                                              New stop hit
Receive 2y3y forward swap in USD vs. CAD   Duration    Strategic   Rates Radar                      2 bp        Stop to 18     44 bp                           2 bp
                                                                                      (5/26/11)                                             (6/28/11)

                                                                   Rates Trade         -7 bp                                                  Closed
   Sell 4/16 TIPS vs 4/15 and 7/17 TIPS    Curve RV    Tactical                                    -13 bp                       4 bp                           9 bp
                                                                      Idea            (6/8/11)                                              (6/23/2011)

                                                                                       139 bp                                  1st 156,       Closed
 Buy 3m5y 25bp wide strangle (half risk)     Vol       Tactical    Rates Radar                     133 bp        156 bp                                       -3 bp
                                                                                      (6/17/11)                              then 170 bp   (Stopped out)

                                                                                       18.5 bp                                              Target Hit
         2y Swap Spread Widener            Spreads     Tactical    Rates Radar                      12 bp                      30 bp                          12 bp
                                                                                      (5/26/11)                                             (06/16/11)

                                           Curve /                 Rates Trade         -39 bp                                                Stop-out
  Long 7s in 3s7s30s UST fly (half risk)               Tactical                                    -29 bp                      -58 bp                         -5 bp
                                           Duration                   Idea            (6/8/11)                                               (6/14/11)

                                                                   Rates Trade                                                                Closed
       1yr fwd 5s10s TIPS flattener         Curve      Tactical                        107 bp      115 bp                      90 bp                           0 bp
                                                                      Idea                                                                   (5/26/11)

                                                                   UST Futures                                                                Closed
        TYM1-TYU1 calendar short            Curve      Tactical                        1-133/4      1-15                        1-08                         2.75 tick
                                                                      Roll                                                                   (5/26/11)

                                                                   Rates Trade                                                                Closed
  Jan19Jan25 BE steepener (double risk)     Curve      Strategic                        -1 bp       -9 bp           -          15 bp                           7 bp
                                                                      Idea                                                                   (5/19/11)

                                                                                                                New stop                      Closed
        Sell the belly in 2s3s7s Tsy        Curve      Tactical    Rates Radar        -128.0 bp   -133.5 bp                   -100 bp                          3 bp
                                                                                                                 -125 bp                     (5/16/11)

    TYM1/CT10 spread curve flattener       Spread      Tactical    Rates Radar          -7 bp       -5 bp                      -13 bp                          2 bp

  Nomura | Rates Radar                                                                                                                                             1 July 2011

                                                                                                        Initial      Re-
                    Trade                         Type       Portfolio                       Entry      Stop-      Assess        Target     Status      Performance
                                                                                                         Loss       Point

                                                                                                                  New stop                  Closed
Short 1y1y TIPS yield (Jul12Jul13) (half risk)   Duration    Strategic   Rates Radar         -84 bp     -115 bp                  -24 bp                    -18 bp
                                                                                                                   -120 bp                  5/3/11

                                                                           Inflation                                                        Closed
Short 5y5y TIPS BE (Apr16Jan21 at auction)       Inflation   Tactical                        291 bp     303 bp     stop 281      258 bp                    23 bp
                                                                           Monitor                                                          5/3/11

       Long FFU2 vs. FFU1 (half risk)             Curve      Tactical    Rates Radar         93 bp      105 bp                   60 bp                     13 bp

                                                                                             104 bp                                          Closed
Short GT2 & 70% Dv01 5y TIPS BE (half risk)      Duration    Tactical    Rates Radar                    118 bp    stop to 98     70 bp                     3 bp
                                                                                            (3/18/11)                                       (4/8/11)

                                                                         Rates Trade                              First target             Stop Out
             2y5y UST flattener                   Curve      Tactical                        141 bp     150 bp                   120 bp                    -9 bp
                                                                            Idea                                    134 bp                 (4/8/11)

                                                                         Rates Trade                                                       Target Hit
Jan16Jan21 TIPS BE long at 10y TIPS auction      Inflation   Tactical                        252 bp     237 bp                   267 bp                    15 bp
                                                                            Idea                                                            (4/4/11)

                                                                         Rates Trade                              First target              Stopout
            5s30s UST steepener                   Curve      Tactical                        229 bp     224 bp                   255 bp                    -5 bp
                                                                            Idea                                    241 bp                  (4/5/11)

                                                                                               6 bp                                        Stop Out
               0EM1 99.25 Call                   Duration    Tactical    Rates Daily        (3/17/11)
                                                                                                         2 bp          -         18 bp
                                                                                                                                                           -4 bp

                                                                                               0 bp                                          Close
     3M 2s5s conditional bear flattener          Curve/Vol   Strategic   Rates Daily                     -5 bp         -         10 bp                     2 bp
                                                                                            (3/14/11)                                      (03/24/11)

  Sell 11/17 10s to buy 2/18 10s & OTR 7s         Curve      Tactical    Trade Flash        12.8 bp     13.6 bp        -         9.25 bp                   1 bp

                                                                                             247 bp                                        Target Hit
   Long Jan16Jan21 fwd TIPS (half risk)          Duration    Strategic   Rates Radar                    265 bp      Stop:        200 bp                   23.5 bp
                                                                                            (2/10/11)                                      (3/16/11)

                                                                                           0 bp                                              Close
    3M 2s10s conditional bear flattener          Curve/Vol   Strategic   Rates Radar                     -7 bp         -         14 bp                     1 bp
                                                                                        (2/3/2011)                                         (3/14/11)

                                                 Duration/               Rates Trade
      3m5y 25bps higher payer spread                         Tactical                        45 bp      35 bp                    65 bp      Stopout       -10 bps
                                                   Vol                      Idea

Nomura | Rates Radar                                                                                                                                                                           1 July 2011

 Weekly Data Review

 Duration Snapshot
  Week on Week Changes

   Figure 1. Top 5 weekly duration movers (bp)                     Figure 2. Top weekly mover US Eurodollars Blues

         US Forward Swap Rates
                2Y10Y                                                  3.9
         US Eurodollars GOLDS                                                                                                                                                                           38.0 bp
                                                                       3.5                                                                                                                              change
        US Eurodollars GREENS
         US Forward Swap Rates
                 2Y2Y                                                  2.7














          US Eurodollars BLUES

                                   0     10    20     30     40

   Source: Nomura, Bloomberg                                       Source: Nomura, Bloomberg

     Figure 3. Duration Grid

                          US Treasuries                         Agencies*                    US LIBOR / Swap Rates
                Tenor       Yield    Wkly Chg (bp)   Tenor     Rate     Wkly Chg (bp)  Tenor       Rate Wkly Chg (bp)
                 1M          0.01          0.0        1M       0.02          0.5         1M        0.19          0.0
                 3M          0.02          1.0        3M       0.05          0.5         3M        0.25         -0.1
                 6M          0.09          2.0        6M       0.13          1.5         6M        0.40          0.2
                 12M         0.19          5.1        12M      0.21          2.0        12M        0.73          0.6
                 2Yr         0.46         10.1        2Yr      0.51          8.8         2Yr       0.70          8.1
                 3Yr         0.79         18.1        3Yr      0.86          14.2        3Yr       1.14         18.3
                 5Yr         1.76         26.1        5Yr      1.63          16.4        5Yr       2.04         25.7
                 7Yr         2.50         28.3        7Yr      2.32          16.4        7Yr       2.69         25.6
                 10Yr        3.16         25.0        10Yr     2.82          17.1       10Yr       3.28         24.1
                 30Yr        4.38         21.1        30Yr     4.53          19.3       30Yr       4.08         20.0
                        US TIPS Real Rates                      US Futures                  US Forward Swap Rates
                Tenor       Yield    Wkly Chg (bp)   Tenor     Price Wkly Chg (32nds) Tenor        Rate Wkly Chg (bp)
                 2Yr        -1.09          3.2        2Yr     109.67         -6.5       1Y1Y       1.01         19.8
                 5Yr        -0.37          6.0        3Yr     112.44         0.0       1Y10Y       3.75         27.9
                 10Yr        0.70          4.7        5Yr     119.20        -39.8       2Y2Y       2.51         37.7
                 20Yr        1.54          7.3        10Yr    122.33        -64.5      2Y10Y       4.22         31.7
                 30Yr        1.74          6.1        30Yr    123.03       -109.0       5Y5Y       4.77         24.8
                                                     Ultra    126.25       -147.0     10Y10Y       5.01         20.1
                         US OIS Rates                           US TLGP**                        US Eurodollars
                Tenor     Yield    Wkly Chg (bp)     Tenor     Yield    Wkly Chg (bp)  Tenor       Rate Wkly Chg (bp)
                 3M        0.12         0.6           1Yr      0.35          6.3      WHITES       0.47         -1.7
                 6M        0.14         0.8           2Yr      0.64          12.7      REDS        1.22         22.8
                 1Yr       0.19         2.8                                           GREENS       2.27         37.0
                 2Yr       0.46        12.8                                            BLUES       3.26         38.0
                 5Yr       1.75        25.1                                           GOLDS        4.06         34.1
                 10Yr      3.03        22.6
              * Based on Average GSE Rates                   ** Based on Original Issue Date                                      As of Friday, 06/30/2011
     Source: Nomura, Bloomberg
Nomura | Rates Radar                                                                                                                                                                                          1 July 2011

Curve Snapshot
Week on Week Changes

   Figure 1. Top 5 weekly curve movers (bp)                                 Figure 2. Top weekly mover, UST Butterflies 2s/7s/30s

          US Treasury Butterflies
                2s/5s/30s                                                         3.4
          US Treasury Butterflies                                                                                                                                                                             25.4 bp
                2s/7s/10s                                                          3
             US Swap Butterflies
                 2s/5s/30s                                                        2.6
             US Swap Butterflies
                 2s/7s/30s                                                        2.2

          US Treasury Butterflies                                                  2















                                    0       10        20         30

   Source: Nomura, Bloomberg                                                Source: Nomura, Bloomberg

     Figure 3. Curve Grid
                               US Treasury Curves                      US Swap Curves                                     Spread of Spread Curves
                        Curve       Level   Wkly Chg (bp)     Tenor       Level  Wkly Chg (bp)                        Tenor       Level   Wkly Chg (bp)
                        2s/3s        33.26        8.0         2s/3s       44.55        9.8                            2s/3s        11.29        1.8
                        2s/5s       130.00       16.0         2s/5s      133.60       16.66                           2s/5s        3.60         0.7
                        2s/7s       203.89       18.2         2s/7s      198.70       16.70                           2s/7s        -5.19       -1.5
                        2s/10s      270.12       14.9        2s/10s      258.20       15.15                           2s/10s      -11.92        0.2
                        2s/30s      391.84       11.0        2s/30s      338.05       11.65                           2s/30s      -53.79        0.6
                        3s/5s        96.74        8.0         3s/5s       89.05       6.86                            3s/5s        -7.69       -1.2
                        3s/7s       170.63       10.3         3s/7s      154.15       6.90                            3s/7s       -16.48       -3.4
                        3s/10s      236.86        6.9         3s10s      213.65       5.35                            3s10s       -23.21       -1.6
                        3/30s       358.57        3.1        3s/30s      293.50       1.85                            3/30s       -65.07       -1.2
                        5s/7s        73.89        2.2         5s/7s       65.10       0.04                            5s/7s        -8.79       -2.2
                        5s/10s      140.12       -1.1        5s/10s      124.60       -1.51                           5s/10s      -15.52       -0.4
                        5s/30s      261.83       -5.0        5s/30s      204.45       -5.01                           5s/30s      -57.38        0.0
                        7s/10s       66.23       -3.3        7s/10s       59.50       -1.55                           7s/10s       -6.73        1.8
                        7s/30s      187.95       -7.2        7s/30s      139.35       -5.25                           7s/30s      -48.60        2.0
                       10s/30s      121.72       -3.9        10s/30s      79.85       -3.70                          10s/30s      -41.87        0.2

                         US Treasury Butterflies                    US Swap Butterflies                              US TIPS Real Rate and BEI Curves
                     Curve      Level   Wkly Chg (bp)          Tenor     Level   Wkly Chg (bp)                        Curve      Level    Wkly Chg (bp)
                    2s/3s/5s    -63.47        -0.1           2s/3s/5s    -44.50        2.9                         2s/5s Real     72.72         2.8
                    2s/3s/7s   -137.25        -2.3           2s/3s/7s   -109.60        2.9                         5s/10s Real   106.36        -1.3
                   2s/3s/10s   -203.57         1.0           2s/3s/10s -169.10         4.5                         5s/20s Real   190.80         1.3
                   2s/3s/30s   -325.33         4.9           2s/3s/30s -248.95         8.0                         5s/30s Real   210.96         0.1
                    2s/5s/7s     56.33        13.8           2s/5s/7s     68.50       16.6                        10s/20s Real    84.44         2.6
                   2s/5s/10s     -9.99        17.1           2s/5s/10s    9.00        18.2                        10s/30s Real 104.60           1.4
                   2s/5s/30s   -131.75        21.0           2s/5s/30s   -70.85       21.7                          2s/5s BEI     54.26        14.2
                   2s/7s/10s   137.58         21.6           2s/7s/10s  139.20        18.3                          5s/10s BEI    34.83        -1.0
                   2s/7s/30s     15.82        25.4           2s/7s/30s    59.35       21.8                          5s/20s BEI    54.06        -2.0
                   2s/10s/30s 148.46          18.8          2s/10s/30s 178.35         18.7                          5s/30s BEI    58.09        -4.9
                    3s/5s/7s     23.01         5.8           3s/5s/7s     23.95        6.8                         10s/20s BEI    19.23        -1.0
                   3s/5s/10s    -43.32         9.1           3s/5s/10s   -35.55        8.4                         10s/30s BEI    23.26        -3.9
                   3s/5s/30s   -165.08        13.0           3s/5s/30s -115.40        11.9
                   3s/7s/10s   104.25         13.6           3s/7s/10s    94.65        8.5
                   3s/7s/30s    -17.51        17.5           3s/7s/30s    14.80       12.0
                   3s/10s/30s 115.14          10.8          3s/10s/30s 133.80          9.0
                   5s/7s/10s     7.46          5.6           5s/7s/10s    5.60         1.6
                   5s/7s/30s   -114.30         9.4           5s/7s/30s   -74.25        5.3
                   5s/10s/30s    18.34         2.8          5s/10s/30s    44.75        2.0                                                     As of Friday, 06/30/2011

     Source: Nomura, Bloomberg

Nomura | Rates Radar                                                                                                                                                                          1 July 2011

Spreads Snapshot
Week on Week Changes

   Figure 1. Top 5 weekly spread movers (bp)                     Figure 2. Top weekly mover, TIPS BEI Spread 5Yr

       TIPS Breakeven Inflation                                   2.6
              Sprd 30Yr                                           2.5
       TIPS Breakeven Inflation                                   2.4
                                                                                                                                                                                             20.3 bp
             Sprd 5Y5Y                                            2.3                                                                                                                        change
       TIPS Breakeven Inflation
              Sprd 20Yr                                           2.1
       TIPS Breakeven Inflation
              Sprd 10Yr                                           1.9
       TIPS Breakeven Inflation













              Sprd 5Yr

                                  0   5   10   15   20   25

   Source: Nomura, Bloomberg                                     Source: Nomura, Bloomberg

     Figure 3. Spreads Grid

                US Swap Spreads                       US Swap vs OIS Spread                                            US OIS vs UST Spread
          Tenor     Sprd    Wkly Chg (bp)       Tenor      Sprd      Wkly Chg (bp)                               Tenor       Sprd       Wkly Chg (bp)
           2Yr      23.88       -1.8              2Yr      24.04          -4.4                                     2Yr       -0.16           2.6
           3Yr      35.16        0.3              3Yr      27.48          -1.2                                     3Yr       7.68            1.5
           5Yr      26.88       -1.1              5Yr      27.79          0.0                                      5Yr       -0.91          -1.1
           7Yr      18.44        3.8              7Yr        -              -                                      7Yr         -              -
           10Yr     11.63       -1.1             10Yr      25.01          1.3                                     10Yr      -13.38          -2.4
           30Yr    -30.13       -1.3

            TIPS Breakeven Inflation Sprd          US Forward Swap Spreads                                          Muni Ratios to Swaps
          Tenor     BEI Sprd Wkly Chg (bp)      Tenor     Sprd    Wkly Chg (bp)                              Tenor       Ratio      Wkly Chg (ratios)
           2Yr        1.49           6.2        1Y1Y      26.65        1.0                                     2Yr       78.00            -1.1
           5Yr        2.04          20.3       1Y10Y      13.94        -2.6                                    5Yr       79.88            -0.5
           10Yr       2.38          19.3        2Y2Y      38.54        -2.0                                   10Yr       81.00            -0.6
           20Yr       2.58          18.3       2Y10Y      22.08        -0.3                                   20Yr       83.88            -0.6
           30Yr       2.62          15.4        5Y5Y     -14.04        -3.7                                   30Yr       86.75            -0.5
          5Y5Y        2.73          18.3       10Y10Y     28.86        -2.7                               SIFMA/LIBOR    65.01            -2.9

                  Agency Spreads*                Agency Callable Spreads (Euro)*                                  Agency Callable Spreads (Berms)*
         Tenor        Sprd    Wkly Chg (bp)     Tenor      Sprd      Wkly Chg (bp)                               Tenor        Sprd        Wkly Chg (bp)
       2Yr vs UST     4.74        -1.3          2NC6       18.02          12.0                                   2NC6         20.90            4.7
       3Yr vs UST     6.37        -3.9          2NC1       18.51          11.0                                   2NC1         19.22            6.6
       5Yr vs UST    -13.28       -9.8          3NC6       38.58           4.1                                   3NC6         45.65            0.6
      10Yr vs UST     -0.34       -1.0          3NC1       38.27           3.6                                   3NC1         41.95            1.8
      2Yr vs Swp -19.20            0.7          3NC2       31.29           3.5                                   3NC2         32.65            3.8
      3Yr vs Swp -28.80           -4.1          5NC6       51.02           2.2                                   5NC6         63.19            1.4
      5Yr vs Swp -40.70           -9.3          5NC1       52.88           2.7                                   5NC1         58.73            2.1
      10Yr vs Swp -46.35          -6.9          5NC2       44.75           3.4                                   5NC2         47.63            3.0
                                                5NC3       37.56           3.0                                   5NC3         38.68            2.8
      * Based on Average GSE Spreads                                                                                            As of Friday, 06/30/2011
     Source: Nomura

Nomura | Rates Radar                                                                                                                                                                                                        1 July 2011

Vol Snapshot
Week on Week Changes

Figure 1. Swaption implied vol term structure (bp)                                Figure 2. Eurodollar ATM implied volatility (bp)

                       2y tenor          5y tenor        10y tenor                      Implied Vol.                                              Spot                        1 Week Ago
            120                                                                           120
            110                                                                          100

             70                                                                              40
             60                                                                              20
                                                                                                      EDU1 EDZ1 EDH2 EDM2 EDU2 EDZ2 EDH3 EDM3
                        1m              3m Time 6m               2y

Figure 3. Top 5 weekly normal vol movers (bp)                                    Figure 4. Top normal vol mover, Normal Vol 3M1Y (bp)

            Normal Vol 3M10Y
                                                                                        48                                                                                                                                     7.1 bp
                Normal Vol 1Y5Y                                                                                                                                                                                               change
                Normal Vol 1Y1Y

             Normal Vol 3M5Y                                                            33

             Normal Vol 3M1Y












                                    0        2       4       6        8

  Source: Nomura, Bloomberg                                                      Source: Nomura, Bloomberg

     Figure 5. Vol Grid
                                         Swaption Vol                          Normal Vol                                                Swaption Premium
                            Tenor        Vol (%)    Wkly Chg (%)       Tenor   Bp Vol   Wkly Chg (bp)                     Tenor               Prem      Wkly Chg (bp)
                            3M1Y          86.63         16.5           3M1Y    43.20         7.1                          3M1Y               17.10            1.0
                            3M2Y          63.33         -6.3           3M2Y    54.00         3.0                          3M2Y               42.70            -0.5
                            3M5Y          45.33         -2.3           3M5Y    100.17        6.9                          3M5Y               193.72           5.1
                           3M10Y          30.50         -0.8          3M10Y    104.00        4.6                         3M10Y               365.90           9.8
                            6M1Y          78.86          7.6           6M1Y    47.90         3.3                          6M1Y               26.75            1.8
                            6M2Y          62.59         -9.3           6M2Y    66.80         3.0                          6M2Y               74.20            0.3
                            6M5Y          43.67         -2.1           6M5Y    101.90        4.1                          6M5Y               274.38           0.9
                           6M10Y          30.27         -1.3          6M10Y    107.91        3.1                         6M10Y               525.80           7.0
                            1Y1Y          72.53         -8.4           1Y1Y    73.40         5.1                          1Y1Y               56.50            3.0
                            1Y2Y          59.35         -9.4           1Y2Y    89.70         3.3                          1Y2Y               138.28           3.1
                            1Y5Y          38.52         -3.2           1Y5Y    108.00        4.9                          1Y5Y               404.00          10.5
                           1Y10Y          29.22         -1.5          1Y10Y    111.13        2.0                         1Y10Y               749.71           -5.7
                            2Y2Y          43.75         -5.5           2Y2Y    110.00        1.3                          2Y2Y               236.56           6.1
                            2Y5Y          31.98         -2.8           2Y5Y    114.14        1.6                          2Y5Y               578.72          -15.0
                           2Y10Y          26.39         -1.3          2Y10Y    112.00        0.6                         2Y10Y              1023.12           -5.7
                            5Y5Y          23.39         -1.3           5Y5Y    113.07       -2.2                          5Y5Y               801.00          -12.0
                           5Y10Y          21.81         -1.0          5Y10Y    109.09       -0.9                         5Y10Y              1364.91          -17.4
                           10Y10Y         18.61         -1.0          10Y10Y   94.50        -1.4                         10Y10Y             1294.10          -42.4
                                                 CBOT Vol                                                                                Eurodollar Vol
                                          Bp Vol    1 wk Chg (bp)                                                                            Bp Vol     1 Wk Chg (bp)
                             TUH1         50.90         -4.3                                                               EDM1              53.70            9.4
                             FVH1          103          -2.7                                                               EDU1              50.40            7.6
                             TYH1         116.50        -1.1                                                               EDZ1              49.40            4.7
                             USH1         111.30        -0.2                                                               EDH2              52.70            -3.0
                                                                                                                                             As of Friday, 06/30/2011
     Source: Nomura, Bloomberg
Nomura | Rates Radar                                                                                                                                        1 July 2011


Nomura US and Canada Rates Forecasts versus Forward Yields

                                     3Q2011                           4Q2011                                1Q2012                           2Q2012
                  Spot      NMR      Forward                 NMR      Forward                      NMR      Forward                 NMR      Forward
                                               Diff (bp)                             Diff (bp)                        Diff (bp)                          Diff (bp)
                  Rates   Forecast    Yield                Forecast    Yield                     Forecast     Yield               Forecast     Yield
 3m LIBOR         0.246    0.400      0.351        5        0.350      0.427            -8        0.500       0.496       0        0.500       0.633        -13
  2yr UST         0.458    0.650      0.609        4        0.850      0.768             8        0.800       0.945     -15        1.000       1.152        -15
  3yr UST         0.796    1.000      1.029       -3        1.200      1.228            -3        1.100       1.436     -34        1.300       1.658        -36
  5yr UST         1.761    1.650      1.931      -28        1.850      2.130           -28        1.750       2.326     -58        1.900       2.528        -63
  7yr UST         2.496    2.400      2.647      -25        2.500      2.822           -32        2.450       2.994     -54        2.600       3.169        -57
 10yr UST         3.160    3.050      3.397      -35        3.150      3.539           -39        3.050       3.678     -63        3.200       3.818        -62
 30yr UST         4.371    4.100      4.457      -36        4.200      4.524           -32        4.100       4.590     -49        4.250       4.657        -41
  3m GOC          0.900    1.200      1.182        2        1.800      1.362            44        2.300       1.526      77        2.700       1.677       102
  2yr GOC         1.594    2.000      1.730       27        2.300      1.878            42        2.700       2.015      68        3.000       2.152         85
  5yr GOC         2.332    2.700      2.486       21        3.000      2.612            39        3.200       2.729      47        3.400       2.843         56
 10yr GOC         3.110    3.300      3.210        9        3.500      3.292            21        3.700       3.367      33        3.800       3.439         36
                                                                                                                                                  As of 6/30/2011

                                                                                                                                                 Source: Nomura

Nomura | Rates Radar                                                                                                                                                                       1 July 2011

Recent Rate Strategy Publications
Rates Radar

      Date                                       Title                             Link                                              Summary
   6/24/2011                    The Beginning of the End of the Rally?             File      Although it is closing time for Fed balance sheet expansion, there are other buyers of USTs
   6/17/2011                  Markets Send a Shot Across the Risk Bow              File       Yet a few down days still embolden bears, but shallow sell-offs leave them gasping for air
   6/10/2011                          A Transitory Rally, Really?                  File              The market trend and weak data still suggest lower rates from these levels

Rates Positioning Index

      Date                                       Title                             Link                                              Summary
   6/24/2011                    Withdrawals from equity funds continue             File                Non-commercials increased their net longs to 364k on 5-yr note futures
   6/17/2011             Treasury buying continues as UST rally remains alive      File               Non-commercials added 34k lots to their net longs on a 5-yr note futures
   6/10/2011           Positioning data shows continued paring of shorts in USTs   File       Non-commercials were substantial net buyers of 10-yr note futures to the tune of over 60k

Rates Insights

      Date                                       Title                             Link                                              Summary
   6/30/2011                The Fed, Europe and Money Fund Conundrum               File             Review of funds during QE2 as related to foreign bank excess dollar reserves
   6/13/2011                   QE Thoughts: 2‘s Company, 3‘s a Crowd               File                                Thoughts on Market Chatter about QE3
   6/10/2011                    Fed QE2 Pomo Round 7 Observations                  File                We review the progress of Fed purchases of USTs & discuss key trends

Rates Daily Call

      Date                                       Title                             Link                                              Summary
    7/1/2011               It‘s 11 AM – Do you know where your bonds are?          File                          The recent spike in yields has taken us by surprise
   6/30/2011            Holding the Support Line Tests ―Buy-on-Dips Strategy‘      File   We maintain our modestly bullish view on rates as we have yet to see much economic improvement
   6/29/2011                   7yr Auction Preview – Greece is the Word            File       Markets are likely to be swayed by the setup for the 7yr auction and Greece austerity vote

Treasury Auction Monitors

      Date                                       Title                             Link                                              Summary
   6/29/2011                              7yr Auction Monitor                      File                                          Strategy Grade: C-
   6/28/2011                              5yr Auction Monitor                      File                                          Strategy Grade: C
   6/28/2011                       4wk/52wk T-Bill Auction Monitor                 File              Stopout yields came in at 0.005% and 0.2% for 4wk and 52wk respectively

Rates Trade Ideas

      Date                                       Title                             Link                                              Summary
   6/29/2011                            Long 7s in 3s7s30s Fly                     File                      Recommend long the belly given the recent backup in rates
   6/21/2011                            UST Tactical RV Trade                      File                                 Sell Aug 18s vs. Neighboring Issues
   6/20/2011                            Trade Idea – 30yr TIPS                     File                         30yr TIPS is cheap on the curve, use auction to add

Nomura | Rates Radar                                                                                                                          July 1, 2011

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Nomura | Rates Radar                                                                                                                       July 1, 2011

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