[deutsche bank] inflation - hedging it and trading it.pdf

8/10/2019 [Deutsche Bank] Inflation - Hedging It and Trading It.pdf

1/48

Deutsche BankCorporate and Investment Bank

InationHedging it & Trading it


2/48

This advertisement has been approved and/or communicated by Deutsche Bank AG London. The services described in this advertisement are provided by Deutsche Bank AG or by its subsidiaries and/or affiliates in accordance with appropriate local legislation and regulation.Deutsche Bank AG is authorised under German Banking Law (competent authority: BaFin Federal Financial Supervising Authority) and regulated by the Financial Services Authority for the conduct of UK business. Securities and investment banking activities in the United Statesare performed by Deutsche Bank Securities Inc., member NYSE, FINRA and SIPC, and its broker-dealer affiliates. Lending and other commercial banking activities in the United States are performed by Deutsche Bank AG, and its banking affiliates. Copyright Deutsche Bank 2011.

Deutsche BankCorporate & Investment Bank

Winning for our clients:Ination Derivatives House of the Year.

At Deutsche Bank, we are dedicated to setting the

stage so that our clients can perform at their best.

We appreciate winning awards that recognize thequality of service that we deliver.


3/48

InationHedging it & Trading it Deutsche Bank

Introduction Why ination, why now?

1.0 Deutsche Banks capabilities and credentials in this market1.1 How Deutsche Banks ination oering diers from

competitors

2.0 Market Overview the rise and rise of ination volatility2.1 Components of Ination indices

3.0 Ination Linked Bonds3.1 Ination Linked Bonds3.2 Real Yield and Breakeven Ination and Ination Protection 3.3 Indexation and Breakeven Ination3.4 Risk Measures, EM Sovereign Linkers, Seasonality,

and US TIPS3.5 UK Index Linked Gilts, EUR Sovereign Linkers, and other

Important Markets3.6 ILB coupon frequency and settlement characteristics

4.0 Ination Swaps4.1 ILS Swaps and Markets4.2 UK Swaps, Corporate Linkers, and US Swaps 4.3 ILS Indexation4.4 ILS Pension Fund demand

5.0 Assessing Relative Value

5.1 Linker Asset Swaps and the Leverage Eect5.2 5 sources of Asset Swap Dierence5.3 What is the Fair Price for Ination Protection?5.4 Fair Credit Spread of Ination Linked Bonds5.5 Hedge with Bonds or Swaps5.6 Summary

6.0 Ination Options6.1 Ination Options6.2 Who are the major players in the options market? 6.3 Option Products6.4 What are the trading opportunities?6.5 Option Strategies6.6 Creating Optimal Hedges

7.0 Deation tail risk7.1 Deation Tail Risk: DB 5 Year Note

8.0 Case Study Zero-Coupon Option Trade

9.0 Further Reading9.1 Ination Hedging for Institutional Investors

10.0 Contacts10.1 Deutsche Bank Global Ination Team

Contents

Contents


4/48


There has never been a bettertime to talk about ination

Ination looks set to be volatile

for the next 5 to 10 years Any client with a bond portfolio

is exposed to ination risk Clients with revenues or

liabilities indexed to ination

are especially vulnerable.

Deutsche Bank is very stronglypositioned to advise clients onwhat to do

We were recently voted theBest Ination Derivatives housein the industry by Risk magazine

We have a large global inationderivatives trading andstructuring team

We have extensive experienceof helping clients nd inationsolutions

The Deutsche Bank inationteam has developed this briengdocument to:

Set out the challengesand opportunities faced byclients

Explain the products andstrategies we have developed.

The Deutsche Bank GlobalInation team can help

IntroductionWhy ination, why now? Ination Derivatives

House of the Year

Contents


5/48


1Deutsche Banks credentials andcapabilities in the Ination marketHow Deutsche Banks ination oerings dier fromcompetitors

ContentsContents


6/48


We oer a full range ofination servicesOur primary capabilities aredemonstrated by our leading positionin the league tables; weve also playedan important role in maintaining orderin the secondary markets, distributingand recycling bonds and swaps acrossthe world. DB is the global leader inination-linked bond syndication.

Date DealNo.

LeadsDB UBS RBS Barc HSBC GS JPM Nomura BNPP SG Calyon MPS

24 Sep 09 UKTI50 4 1 1 1 1

29 Sep 09 ACGBi25 3 1 1 1

21 Oct 09 BTPei41 4 1 1 1 1

27 Jan 10 UKTI40 4 1 1 1 1

21 Apr 10 BTPei21 5 1 1 1 1 1

11 May 10 UKRAIL47 2 1 1

26 May 10 UKTI50 4 1 1 1 1

27 Jul 10 UKTI40 4 1 1 1 1

14 Sep 10 ACGBi30 3 1 1 1

01 Feb 11 NZGBi25 1 1

Total number 7 6 5 3 3 3 2 1 1 1 1 1

Issuing long dated ination in largesizes can be dicult to manage; debtmanagers turn to the strongest bankswho have the best track record forrisk management and distribution Deutsche Bank leads in this space

Lead syndication mandates awarded to market counterparties*between September 2009 and February 2011 Source: Bloomberg, Deutsche Bank

Deutsche Banks credentials and capabilitiesin the Ination Market

1.0Deutsche Banks credentials andcapabilities in the Ination Market

Contents


7/48


We are outperforming the competitionaround the worldDeutsche Bank is:

No 1 in ICAP market share for EUR Ination/Asset Swaps (2009, 2010)

No 3 in ICAP market share forUKRPI Ination/Asset Swaps(2009, 2010)

No 1 in BGC market share for all USproducts (Ination, Asset Swaps,Options) 2010

Fig.1:Global Linker Syndications as LeadManagerSource: Bloomberg, Deutsche Bank

Deutsche BankCompetitors

Fig. 2:Total Syndication Size for GlobalLinkers (mm)Source: Bloomberg, Deutsche Bank


Fig. 3:USD Ination Market by Volume 2010Source: Bloomberg, Deutsche Bank


DB

UBS

RBS

Barc

HSBC

GS

JPMC

Nomura

SocGen

BNPP

ML

MS

RBC

Calyon

ANZ

MPS

4

3

2

1

0

5

6

7

8 Number of

Syndications

0

7,000

6,000

5,000

4,000

3,000

2,000

1,000

DB

UBS

RBS

Barc

HSBC

GS

JPMC

Nomura

SocGen

BNPP

ML

MS

RBC

Calyon

ANZ

MPS

Total Syndication

Size

0

12,000

10,000

8,000

6,000

4,000

2,000


Expand Expand Expand

Contents


8/48


We are outperforming the competitionin the UK

Fig. 1:UK Linkers Syndications as LeadManagerSource: Bloomberg, Deutsche Bank


Fig. 2:UK Linkers and Nominals Syndicationsas Lead ManagerSource: Bloomberg, Deutsche Bank


Fig. 3:UK Linkers Total Syndication Size (mm)Source: Bloomberg, Deutsche Bank


Fig. 4:UK Linkers and Nominals Syndicationsas Lead ManagerSource: Bloomberg, Deutsche Bank


DB UBS RBS Barc HSBC GS JPM Nomura

0

3.5

3

2.5

2

1.5

1

0.5


4,000

3,500

3,000

2,500

2,000

1,500

1,000

500

0


0

3,000

2,500

2,000

1,500

1,000

500

0

3.5

3

2.5

2

1.5

1

0.5



Expand

Expand

Expand

Expand

Contents


9/48


Integrated trading, structuringand researchUnlike some of our competitors,Deutsche Banks ination trading,structuring and research professionalswork closely together, combiningstrategic and technical expertisewith the macro-economic insights soimportant to this oering.

BloombergForecasts, ination linked bonds,ination swaps and ination linkedoptions. US options will be addedsoon (gure 1)

The market is pricing much moreupside risk than downside risk contrary to what we see in othermarkets

Trade FinderCurrently being upgraded, it will sooninclude additional functionality: e.g.forward matrices ve year forwardon Eurozone or ve year to 25 yearforward. In Frankfurt and Mumbai,real live zero coupon lives and forwardmatrices and cross market indicatorswill soon be added (gure 2)

Fig. 1:Our ination page on Bloomberg DBII

Fig. 2:Ination on Trade Finder newimprovements coming soon


Expand

Expand

How Deutsche Banks ination oering diersfrom competitors

Contents


10/48


2Market Overview

Components of Ination indices

ContentsContents


11/48


All G7 nations issue ination-linkedbonds

MarketsUS TIPS the US Sovereign linkermarket is the largest globally with atotal market value of over USD700bnbut less liquid than EUR

UK IL Gilts rst issuance 1981; totalmarket value exceeds GBP270bn

EUR sovereign linkers- expandingrapidly; total market value exceedingEUR320bn as of now; France, Italy,Germany & Greece issue ILBs. Italian,German and Greek ILBs are linkedto euro area ination; France issuesbonds linked to EUR ination andbonds linked to FRF ination

Industrial country sovereign linkermarkets Other important marketsinclude Australia, Canada and Sweden.AUD: govt suspended issuance in2003, started again in 2009. Sweden:linkers account for almost 30% of totalgovt bond market, higher share than inany other industrial market

EM sovereign linker markets- mostLatAm ination markets have longhistories; Brazil is the largest market,suppression of investment restrictionsin 2006 spurred international demand.Chile, Colombia & Uruguay also issueILB. Israel is big (USD27bn marketvalue). More recently: South Africa,Poland, Turkey (2007) and South Korea(2007)

Fig. 1:A Fast Growing Asset ClassSource: Deutsche Bank

US ITLUK DEMJPY GrFRF SEKCAD AUD

2.0Market Overview the rise and rise ofmarket volatility

97 98 99 00 09 1001 02 03 04 05 06 07 08

0

1,600 total outstanding, $ bn

1,200

1,400

1,000

800

600

400

200

Expand

The rise and rise of ination

Contents


12/48


97 98 99 00 09 1001 02 03 04 05 06 07 08

0

1,600

1,200

1,400

1,000

800

600

400

200

%

Food and beverages

Housing

Apparel

Transportation

Medical Care

Recreation

Other

Education and

Communication

15

42

3

4

17

7

6

6

97 98 99 00 09 1001 02 03 04 05 06 07 08

0

1,600

1,200

1,400

1,000

800

600

400

200

Food and catering

Alcohol and tobacco

Housing and

household expenditure

Personal expenditure

Travel and leisure88

408

82

257

165

%

Food & beverages

Clothing & footwear

Furniture & household goods

Health

Alcohol & tobacco

Housing & household services

Recreation & culture

EducationRestaurants & hotels

Other goods & services

TransportCommunication

16

7

7

4

3

4

15

16

10

19

9

2.1Market Overview the rise and rise ofmarket volatility

Fig. 3:Weights in the EURSource: Deutsche Bank

Fig. 1:Weights in the US CPISource: Deutsche Bank

Fig. 2:Weights in the UK RPISource: Deutsche Bank

Components of Ination Indices

Expand Expand

Expand

Contents


13/48


3Ination Linked Bonds

Ination Linked BondsReal Yield and Breakeven Ination and Ination ProtectionIndexation and Breakeven InationRisk Measures, EM Sovereign Linkers, Seasonality and US TIPSUK Index Linked Gilts, EUR Sovereign and other Important Markets

ILB coupon frequency and settlement characteristics

ContentsContents


14/48


Ination Bonds LinkersInation Linked Bonds (also known asination indexed bonds) or Linkers.

These are Treasury bonds designedto cancel the capital eroding eectsof ination. Called TIPS (TreasuryInation Protection Securities) in theUS, their interest rate remains xed butthe principal is adjusted to matchchanges in a price index.

For example:A vanilla xed rate bond pays a xedcoupon and redeems at 100

Interest Paid = Fixed Rate *Constant

Notional (e.g. 5% * 100 = 5) Redemption = Constant Notional

(e.g. 100)

A Canadian style Linker pays a realcoupon and redeems at 100 in realterms

Index Ratio = CPI Index onPayment Date / CPI Index onIssue Date

Interest Paid = Fixed Rate * InatedNotional

= Fixed Rate * Notional * IndexRatio (e.g. 2% * 100 * 1.5 = 3)

Redemption = 100 * Index Ratio

(e.g. 100 * 1.5 = 150)

Some ILBs (like US TIPS or OATei/i)have a deation oor, meaning aprincipal repayment of minimum par isguaranteed by the issuer

Fig. 1:Vanilla Fixed Rate Bond versus InationLinked BondSource: Deutsche Bank

RealNominal

3.1Ination Linked Bonds

1 2 3 4 5 6 7 9 10

6%

5%

4%

3%

2%

1%

0%

Year

7%

8%

9%

10% Coupon Principal

80%

60%

40%

20%

0

100%

120%

140%

160%

Expand

Infation Linked Bonds

Contents


15/48


Real Yield and Breakeven InationComponents of nominal interest rate:

Real yield Expected Ination Risk Premium Liquidity Premium

Issuing nominals means investors needcompensation for ination uncertainty.

Linkers save issuers the risk premiumby providing certainty about real cashows in the future i.e. their increasein purchasing power is locked in.(gure 1)

Fig. 1:Components of Nominal YieldSource: Deutsche Bank

Ination ProtectionWith positive ination, the ILBs cashows will increase over time to securethe investors purchasing power.

Compared to a nominal bond earlycoupon payments will tend to be lower,and the nal repayment will tend to behigher.

The examples below assume an annualcoupon and ination at 2%. (gures 2and 3)

Fig. 2:Nominal cash owsSource: Deutsche Bank

Coupon Linker (2%) Notional Conventional (rhs)Coupon Conventional Bond (4%) Notional Linker (rhs)

Fig. 3:Real cash ows (purchasing powerof the CFs)Source: Deutsche Bank

Coupon Linker (2%) Notional Conventional (rhs)Coupon Conventional Bond (4%) Notional Linker (rhs)

1 2 3 4 5 6 7 9 10

6%

5%

4%

3%

2%

1%

0%

7%

8%

9%

Nominal Yield

Breakeven RateIndex Linked Bond

Real YieldInflation

ExpectationsRisk

PremiumLiquidityPremium

1 2 3 4 5 6 7 8 9 notl10

60

40

20

0

80

100

120

140

6

4

2

0

8

10

12

14

1 2 3 4 5 6 7 8 9 notl10

60

40

20

0

80

100

120

6

4

2

0

8

10

12


Real Yield and Breakeven Infation and

Infation Protection

ExpandExpandExpand

Contents


16/48


IndexationTo oer ination protection you needto: (i) choose a price index, (ii) deneprecise linking rules.

Price index: typically a non-seasonallyadjusted, ocial consumer price index

Indexation: the Canadian model isnow the benchmark, adopted amongothers by TIPS, EUR ILBs and newUKTi (gure 1) Problem: CPI only monthly and

published with a delay The price factor used to ination

adjust cash ows, the DailyInation Reference (DIR), is a linearinterpolation ofthe two monthly values of the ocialprice index three months earlier andtwo months earlier, e.g.:

The DIR for 1 June is theocial CPI March (releasedmid-April)

The DIR for 1 July is theocial CPI April (releasedmid-May)

The DIR for 23 June is: CPI(Mar) + 22/30 *[CPI(Apr) CPI(Mar)]

Breakeven InationCanadian style linkers are quoted inreal terms and the real price (P) - realyield (r) relationship is equivalent tothat of a conventional bond (c: coupon):

ILBs value is often expressed in termsof ination rather than in terms of realyields by considering the dierence inyield between nominal and real bonds.

BEI (Breakeven Ination) is the inationrate that equates the expectedreturn of an ILB and a comparablenominal bond; i.e. if actual inationuntil maturity exceeds BEI, linkersoutperform nominals.

In practice, the market looks at simpleyield spreads (gure 2).

Fig. 1:IndexationSource: Deutsche Bank

Fig. 2:BEI nominal yield real yieldSource: Deutsche Bank

Real YieldNominal Yield

Jan 04 Jun 04 Nov 04 Apr 05 Sep 05 Feb 06 Jul 06

100

99

98

97

96

101

102

103

BTPe

i08

BTANe

i10

BTPe

i10

OATe

i12

BTPe

i12

OBLe

i13

BTPe

i14

OATe

i15

DBRe

i16

BTPe

i17

OATe

i20

BTPe

i23

GGBe

i25

OATe

i32

BTPe

i35

OATe

i40

Breakeven Inflation

%

4.5

4.0

3.5

3.0

2.5

1.5

2.0

1.0

5.0

5.5

6.0


Expand

Expand

Indexation and Breakeven Infation

Contents


17/48


Risk Measures The concepts of duration and

convexity can be applied to linkersin the same way as for conventionalbonds

But in the case of linkers, durationdescribes the sensitivity of the priceto a change in the real rate

Linkers have a higher duration thansame maturity conventionals

Convexity rises exponentially withduration, for the same maturity ILBshave a higher convexity thannominals

EM Sovereign Linker Markets Most Latin American ination

markets have long histories; Brazil isby far the largest market, suppressionof investment restrictions in 2006spurred international demand

Chile, Colombia & Uruguay alsoissue ILB

Israel has a large linker market(USD27bn market value) More recently South Africa, Poland,

Turkey (2007) and South Korea (2007)

Seasonality Seasonal movements in price indices

mean that ination accrual is notlinear

Quoted real yields of ILB adjust to thechanging ination uplift

real yields & BEI exhibitseasonal patterns

detecting the seasonalpattern in prices is importantfor valuing ILBs

Estimation of seasonal factors is notwithout diculties, especially in theeuro area where there is instability

There is no consensus on theirprecise value

US TIPS The US sovereign linker market is the

largest globally with total marketvalue in excess of USD700bn (gure 1)

TIPS were rst issued in 1997; inrecent years, there have been two

5y, two 20y and four 10y auctions peryear; in February 2010 30y TIPS werereintroduced, replacing the 20y

Maturities range from 1y to 30y

Fig. 1:US TIPS total outstanding market valueSource: US Treasury


2 00 1 2 00 2 2 00 3 2 00 4 2 00 5 2 00 6 2 00 7 2 00 8 2 00 9 2 01 12010

300

200

100

0

400

500

600

700 US Db n

Expand

Risk Measures, EM Sovereign Linkers,Seasonality and US TIPS

Contents


18/48


UK Index Linked Gilts The UK linker market is the oldest in

Europe (rst issuance 1981) Total market value exceeds

GBP270bn and more than 20% ofsovereign debt is linked to ination

Traditionally bonds have an 8Mindexation lag, but since Sep 2005 allnew issues follow the 3M lag model;UKTi have no deation oor

Issuance has been weighted towardsthe long end

Maturities range from 1Y to 50Y,with issues available on all maincurve points (gure 1)

Fig. 1:UK Total Outstanding Market ValueSource: UK DMO

EUR Sovereign Linkers Euro area sovereign ination-linked

bond (ILB) markets are expandingrapidly with the total market valueexceeding EUR320bn today

France, Italy, Germany & Greeceissue ILBs

Italian, German and Greek ILBs arelinked to euro area ination; Franceissues both bonds linked to EURination and bonds linked to FRFination

Maturities range from 1Y to 32Y, withissues available on all main points onthe curve (gures 2 and 3)

Fig. 2:EUR Sovereign Linker IssuanceSource: National Treasury

FR DEIT GREUR (rhs)

Other important markets includeAustralia, Canada and Sweden AUD: govt suspended issuance in

2003, but started again in 2009.Strong liability related demand fromPF and insurance companies

Sweden: linkers account for almost30% of the total government bondmarket, a higher share than in anyother industrial market

Fig. 3:Sovereign Linkers, Outstanding VolumeSource: National Treasury

Germany Fr (FRCPIxt)France ItalyGreece

2 00 1 2 00 2 2 00 3 2 00 4 2 00 5 2 00 6 2 00 7 2 00 8 2 00 9 2 01 0

110

60

160

210

260

310 US Db n

20102009200820072006200520042003

5

10

15

0

20

25

30

35

50

100

150

0

200

250

300

350Linker Issuance

EURbn

Total Outstanding

EURbn

2011

2013

2015

2017

2019

2021

2023

2025

2027

2029

2031

2033

2035

2037

2039

2041

5

10

15

0

20

25

30

35

4 0 E UR bn


UK Index Linked Gilts, EUR Sovereign Linkers,and other Important Markets

ExpandExpandExpand

Contents


19/48


Price index BBG Index lag Deation oor Coupon

US CPI-U CPURNSA 3M YES semi-ann

UK RPI UKRPI 8M/3M NO semi-ann

FRCPI x tob, FR FRCPXTOB 3M YES annual

HICP x tob, EMU CPTFEMU 3M YES annual

IT HICP x tob, EMU CPTFEMU 3M YES semi-ann

JP CPI x fresh food JCPNJGBI 3M NO semi-ann

SE CPI SWCPI 3M YES (new ILB) annual

CA CPI CACPI 3M NO semi-ann

GR HICP x tob, EMU CPTFEMU 3M YES annual

DE HICP x tob, EMU CPTFEMU 3M YES annual

AU CPI quarterly ACIF 6M YES quarterly


Most ILBs have coupon frequency and settlement characteristics in line withthe nominal market

ILB coupon frequency and settlementcharacteristics

Contents


20/48


4Ination Swaps

ILS Swaps and MarketsUK Swaps, Corporate Linkers and US SwapsILS IndexationILS Pension Fund Demand

ContentsContents


21/48


Ination Linked Swaps (ILS) a pureination product as opposed to a realrate product

What is an Ination Swap?The cash-ows Receive Compounded Ination from

Start to Maturity: pay one cash-ow CPIt/CPI0 -1 Pay a known Fixed cash-ow at

Maturity (1 + X%)^t

What is the break-even rate? Receive Compounded Ination from

Start to Maturity: pay one cash-ow CPIt/CPI0 -1 Pay a known Fixed cash-ow at

Maturity (1 + X%)^t

ILS MarketsThe most liquid ILS are typically thoselinked to the same price index as theination-linked government bonds ofthe corresponding market (US CPI-U,EUR HICP ex-tobacco, French CPI extobacco, UK RPI).

For the major markets, ZC ILS areusually quoted for tenors out to 30years, sometimes 50 years.

Fig. 1:Ination Swaps

(1+BEI)N1

Fixed

Floating

Client

CPI(N)

CPI(0)1

4.1Ination Swaps

ILS Swaps

Expand

Contents


22/48


UK Swaps and Corporate LinkersNon-sovereign ination supply in bonds& swaps has grown rapidly in the UK inparticular 2006 and H107

MarketPriceIndex

Lag CPI Fixing

US CPI-U 3M Interpolated

Euro areaHICP extobacco

3M Straight

FranceCPI ex

tobacco3M Interpolated

UK RPI 2M Straight

US SwapsThe ination swap market hasdeveloped rapidly from 2004, butremains less liquid than its Europeancounterparts

A lack of natural ination swap supplytranslates into structural richness inswap BEI vs bond BEI and wide linkerASW discounts

Fig. 1:Bond Breakevens vs Swap BreakevensSource: Deutsche Bank

USCPI ZC swap ratesTIPS-implied ZC B/E

Fig. 2:Measures of Relative Value: ASWSpread and Z-spreadSource: Deutsche Bank

US Linker Z-spread discountUS Linker ASW discount

4.2Ination Swaps

0 5 10 15 20 3025

2.5

2.3

2.1

1.9

2.7

2.9

3.1 %

TIIApr13

TIIJ

ul13

TIIJa

n14

TIIApr14

TIIJ

ul14

TIIJa

n15

TIIApr15

TIIJ

ul15

TIIJa

n16

TIIJ

ul16

TIIJa

n17

TIIJ

ul17

30

25

20

15

5

10

0

35

TIIJa

n18

TIIJ

ul18

TIIJa

n19

TIIJ

ul19

TIIJa

n20

TIIJ

ul20

TIIJa

n21

TIIJa

n25

TIIJa

n26

TIIJa

n27

TIIJa

n28

TIIApr28

TIIJa

n29

TIIApr29

TIIApr32

TIIFe

b40

TIIFe

b41

ExpandExpand

UK Swaps, Corporate Linkers and US Swaps

Contents


23/48


ILS IndexationFor FRCPIxt & US CPI, the indexationlag convention is the same as for thecorresponding ination-linked bondmarkets Strong demand has led to a low

level of real interest rates, lock inlow nancing costs

PFI projects with ination component(usually bonds, but typicallytransformed into ASW)

Credit wrapping allowed corporatesto issue highly rated debt whichis more appealing to institutionalinvestors

But has fallen signicantly during thecredit crisis

Main sources: regulated utilities, PFIs,property leases, railway companies,retailers, supranationals

Alternative supply has led to two-wayswap market and narrow swap-bondB/E spread, but swap richness hasincreased again during the crisis

4.3Ination Swaps

ILS Indexation

Contents


24/48


ILS Pension Fund demand In the UK, pension indexation to RPI

(LPI) is more explicit than elsewhereand the pension industry is largerthan in other European countries

Accounting rules (FinancialReporting Standard 17) haveencouraged pension funds to matchtheir indexed liabilities more closely

As a result, demand growth frompension funds and life insurers hasoutstripped supply leading to lowreal yields and expensive BEI at thelong-end of the curve But has fallensignicantly during the credit crisis

Long-term investors own themajority of ILB as a hedge fortheir real liabilities

All public and part of private sectorpension liabilities will be linked to CPI(instead of RPI) from scal year2011/12 future issuance of CPIlinked Gilts looks possible

Fig. 1:Real YieldsSource: Deutsche Bank

USUKFRF

Fig. 2:UK Non-sovereign Ination SupplySource: Deutsche Bank

UK Non-sovereign ination supply

Fig. 3:UK Non-sovereign Ination SupplySource: Deutsche Bank

OtherRailUtility

4.4Ination Swaps

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0

0.5

1.0

1.5

2.0

2.5

2058

Maturity

Real Yields

205020422034202520172009 Q310Q305 Q306 Q307 Q308 Q309

500

1,000

1,500

0

2,000

2,500

3,000

3,500

4,000 GBPm

2 00 1 2 00 2 2 00 3 2 00 4 2 00 5 2 00 6 2 00 7 2 00 8 2 00 9 2 01 0

6,000

5,000

4,000

3,000

2,000

1,000

0

7,000

8,000

9,000

10,000 Issuance

GBPm

Expand

Expand Expand

ILS Pensions Fund Demand

Contents


25/48


5Assessing Relative Value

Linker Asset Swap and the Leverage Eect5 Sources of Asset Swap DierenceWhat is the Fair Price for Ination Protection?Fair Credit Spread of Ination Linked BondsHedge with Bonds or SwapsSummary

ContentsContents


26/48


Linker Asset Swap Investor buys an Ination Bond Investor agrees to pay away all the

cash-ows (P+I) from the bond Investor receives in return Libor +

x% until maturity as well as aprincipal payment

The Leverage EectSophisticated investors may notbe able to borrow to buy additionalnominal bonds due to constraints,hence are willing to give up some oftheir excess return

Some investors just like the pick-upover equivalent tenor nominal bondson asset swap (gure 2)

For example

This is how we expect a Linker toincrease in the Eurozone over time

Why is this important?Sovereign default is currently very realpossibility like for like exposuresneed to be carefully assessed for fairvalue some investors have increasedcredit risk for very little reward

Fig. 1:Linker Asset SwapSource: Deutsche Bank

Fig. 2:The Leverage EectSource: Deutsche Bank

InationLibor

5.1Assessing Relative Value

Libor + X

Inflated Notional Inflated Notional

Notional

InvestorLinker

CPICPI

0 5 10 15 20 25

Constant Swap Notional

Increasing Credit Exposure

30 35 40Years 45 50

150

100

50

0

200

250

300

350 Notiona l

The increasing credit exposure,and thereby return, on a linkerasset swap generates signicant

outperformance Daragh McDevitt,Global Head of Ination Structuring

Expand

Expand

Linker Asset Swaps and the Leverage Efect

Contents


27/48


5 Sources of Asset Swap Dierence

PV01 dierence Linkers have a higher duration

Swap richness The spread between ination-linked

swaps and implied bond break-evensgives rise to dierent asset swaplevels for linkers and nominals

It also usually tells the story of swapsupply and demand

Seasonality See the section on page 3.4

Credit / Liquidity Mis-priced credit cost leading to

value for issuers

Tax Favourable deferrals for issuers

encourage supply

The dierence between a nominalasset swap and a Linker Asset Swapof the same maturity is a function ofthe larger credit exposure, the termstructure of credit and the swaprichness

For example20 bps richness results in an additional28 bps on asset swap a 40% increase

Fig. 1:

Measures of Relative ValueSource: Deutsche Bank

Adjusts forDirty Price

Accounts

for CashowPattern

Accounts forTerm Structure

of Credit

Fair ValueDiscounting

Par par ASW

Net ProceedsASW

Z spread

Richness


Of these comparative measuresrichness is the true measure

Stephane Salas,Global Head of Ination Trading

5 Sources of Asset Swap Dierence

Contents


28/48


What is the Fair Price for InationProtection?

Ination Breakeven is not equal tomarket ination expectations but is afactor of Ination expectations Risk Premium Liquidity Premium

Ination expectations over the verylong run are hard to judge but tend to

be based on current economic policy ECB target rate is under, but close

to 2%

Risk Premium includes Potential change in monetary policy

target (e.g. 4% plus or minus 1%instead of under 2%)

Abandonment of monetary policyin favour of employment orcurrency board

EUR breakup, expansion orsuccession

Asymmetric elasticity of ination:wages are easier to raise than to cut

Liquidity premium includes Relative demand and supply for

ination bonds v nominal bonds Balance sheet costs of holding

ination bonds to recycle ination Opportunity cost of capital for cash

used to hedge ination


The biggest mistake people makewith ination-linked bonds isthinking that the breakeven inationis the markets expected inationrate. It is not and should not be.The breakeven includes what themarket expects ination to beand the major portion of the riskpremium that you should nd inthe nominal market, and theliquidity premium

Markus Heider,Global Head of Ination Research

What is the Fair Price for Ination Protection?

Contents


29/48


Fair Credit Spread of InationLinked BondsIssuing Linkers equates to borrowingmore over time in nominal terms i.e. itcan be thought of as a set of forwardstarting bonds

Forward starting bonds = greatercredit risk

Two components to fair price: The issuers current credit spread for

the maturity of the bond Forward credit spreads for each of

the forward starting borrowings i.e.forward credit spreads

A simple point, but investors may notrecognise and price this correctly

Fig. 1:Linker as a Series of ForwardStarting BondsSource: Deutsche Bank

Initial Principal Amount Fwd Borrowing Year 1Fwd Borrowing Year 2 Fwd Borrowing Year 3Fwd Borrowing Year 4 Fwd Borrowing Year 5Fwd Borrowing Year 6 Fwd Borrowing Year 7Fwd Borrowing Year 8 Fwd Borrowing Year 9

Fig. 2:Creating a synthetic 30-year oldNominal BondSource: Deutsche Bank


0 1 2 3 4 5 6 7 8Years 9 10

60

40

20

0

80

100

120

140 Borrowed Amount

=

EUR 100mm

EUR 25mm

EUR 25mm

EUR 50mm

20y @ 130bp

10y @ 100bp30y accreting @ 175bp

30y @ 150bp

Expand

Fair Credit Spread of Ination Linked Bonds

Expand

Contents


30/48


The Question isHedge with Bonds or SwapsTraditionally, many investors haveprimarily considered ination-linkedbonds to hedge exposure

However, a more modern approach is: Bonds can be cheaper or more

expensive than swaps Buy the cheapest asset Hedge the ination with swaps Opportunistically switch

between assets

This also gives a lot more exibility tohedge the desired cash ows, since atthe long-end there are only relativelyfew bonds outstanding (and liquiditycan be better as well)

Fig. 1:Swap Ination Price Bond Ination PriceSource: Deutsche BankPast performance is not a reliable indicator of future performance

UK ItalyFrance (French CPI) GermanyFrance (Euro CPI)

The Bond UniverseValue within the UK for exampleFigures 3 and 4 on the right depict thevalue that can be created by switchingbetween similar maturity nominal andination linked bonds.

Figure 2 below depicts the value inswitching between short and longmaturity linkers.

In terms of trading capability, howdoes this work?We should always be free to switchbetween UK Bonds and UK Linkers

Fig. 2 :PV Gain of UKTi40 over the UKTi27Source: Deutsche BankPast performance is not a reliable indicator of future performance

Switch inSwitch out

Fig. 3:PV Gain of UKTi27 over the UKT27Source: Deutsche BankPast performance is not a reliable indicator of future performance

Switch inSwitch out

Fig. 4:PV Gain of UKTi40 over the UKT40Source: Deutsche BankPast performance is not a reliable indicator of future performance

Switch inSwitch out


2 0 10 2 0 16 2 0 21 2 0 27 2 0 32 2 0 38 2 0 43 2 0 49 2 0 54 2 0 60

10

0

-10

-20

20

30

40

50

01/ 10 03/ 10 05/ 10 07/ 10 09/ 10 11/ 10 01/ 11 03/ 11

2

0

4

6

8

10 PV Gain (%)

01/ 10 03/ 10 05/ 10 07/ 10 09/ 10 11/ 10 01/ 11 03/ 11

2

0

4

6

8

10 PV Gain (%)

01/ 10 03/ 10 05/ 10 07/ 10 09/ 10 11/ 10 01/ 11 03/ 11

2

0

4

6

8 P V Gai n ( %)

Expand

ExpandExpandExpand

Hedge with Bonds or Swaps

Contents


31/48


To sum up Given the displacement between

ination and nominal markets, thereare opportunities for arbitrage

Asset swap spreads on linkersrepresent a premium for credit thatis hard to price, and when coupledwith demand/supply imbalances andhigher duration, they oer a pickupto nominals for the same underlyingissuer

Switching between equivalent risk

sovereigns/supra sovereigns canoften, driven by dynamics of thecross currency swaps market,provide additional yield pick-ups

These displacements can beassessed by a variety of metrics

The value of switching is evidentfrom the incremental excess pickupthat is generated by selling thecostlier asset to buy the cheapestasset from time to time

Used as a systematic strategythis can yield substantial returnsover medium term horizons

These represent incredible

opportunities for asset-heavyinvestors, and the markets willlikely normalize with time, henceit is important to act quickly


There isnt one risk free curve,there are 100, 150, 200 the key iswhen do you pick the fruit, whenis the bond cheap enough?

Daragh McDevitt,Global Head of Ination Structuring

there are incredible opportunitiesfor asset-heavy investorsit isimportant to act quickly

Haroon Sana,Global Head of Rates Sales

Summary

Contents


32/48


6Ination Options

Ination OptionsWho are the major players in the options market?Option ProductsWhat are the trading opportunities?Option StrategiesCreating Optimal Hedges

ContentsContents


33/48


A relatively new market, inationoptions traded between Europe andthe US have doubled every year sincetrading started in ination swaps in2002/2003. 2010 saw a particulargrowth spurt.

Long term growth looks set tocontinue at this explosive rate, whichis clearly indicative of its importanceto clients and represents a substantialopportunity to DB as intermediary

between buyers and sellers of ination.

Interbank volumes reached 50bn in2010, up from 13bn in 2009, and just1bn in 2005.

Fig. 1:London Options VolumesSource: Tullett Prebon

Fig. 2:NY Options VolumesSource: Tullett Prebon

6.1Ination Options

01/09

03/09

05/09

07/09

09/09

11/09

01/10

03/10

05/10

07/10

09/10

11/10

01/11

03/11

400

200

600

0

800

1,200

1,400

1,600

1,800 Volumes

(millions)

01/09

03/09

05/09

07/09

09/09

11/09

01/10

03/10

05/10

07/10

09/10

11/10

01/11

03/11

1,000

2,000

0

3,000

4,000

5,000

6,000

7,000 Volumes

(millions)

ExpandExpand

Infation Options

Contents

6 2


34/48


The market is becoming more andmore complex as sophisticated newplayers such as hedge funds, liabilitydriven investors, and non-life insurancepractitioners are added to the mix.

Any client: holding a bond portfolio subject to tail ination high or low who has revenues or liabilities that

are indexed to inationis exposed to ination risk

6.2Ination Options

Hedge Fund Real Estate Investor

Asset Manager

Inflation Options

MarketInsurance Company Pension Fund

Directional/RV TradesHedge LPIRevenues

Hedge LPI

Liabilities

Buy Deflation

Protection

Monetize

Embedded

Floors

Expand

Who are the major players in the Options market?

Contents

6 3


35/48


Year on Year cap/oor YoY oorlet : Max [ K - YoY

t, 0 ]

With YoYt= I

t/I

t-1- 1

A 5 year 0% YoY oor costs 80cor 18bp p.a.

Demand from retail notes >> Supplyfrom premium sellers

Zero Coupon cap/oor ZC oor: Max [ (1+K)^t - I

t/I

0, 0 ]

A 10 year 0% ZC oor costs 55c Supply from linkers and asset swaps

>> Demand from deation hedgers

Limited Price Index (LPI) LPI

t= LPI

t-1* { 1 + max [ min [ YoY

t,

5% ] , 0% ] } Ination observed annually, collared,

compounded and paid at maturity Demand from LDI funds >> Supply

from real estate investors

Fig. 1:5y 0% YoY oor HICPxTSource: Deutsche BankPast performance is not a reliable indicator of future performance

Fig. 2:10y 0% ZC oor HICPxTSource: Deutsche BankPast performance is not a reliable indicator of future performance

Fig. 3:Limited Price Index (LPI)Source: Deutsche Bank

Fig. 4:DB Ination pages: DBII

6.3Ination Options

04/09 10/09 04/10 10/10 04/11

40

20

60

80

0

100

120

140

160

-2%YoY Inflation -1% 0 % 1 % 2 % 3 % 4% 5% 6% 7%

1.0

2.0

0

3.0

4.0

5.0

6. 0 %

0 8/ 06 0 5/ 07 02/ 08 11 /0 8 08 /0 9 0 5/ 10 0 2/ 11

100

50

150

200

0

250

300

350

400 Price (bps)

Expand

Expand

Expand

Options products

Expand

Contents

6 4


36/48


LPI Collars represents a great ination-hedging alternativeInation risk for Pension funds andother liability-driven investors is big,20 30% of scheme risk.

Breakevens are deemed expensive: if,for example, breakeven is 3.7% andthe scheme expected ination of 2.8%,hedging loses value (gure 1).

Whats the solution?

Cover ination risk by creating anination collar Pay LPI Receive RPI

Expert historical perspectiveMarkus Heider, responsible forEuropean ination research at DBGlobal Markets Research, providesa useful long term perspective: thisgraph shows how the volatility we haveseen in the last three years is nothingcompared to the last 200 years. In thelong run, ination is a very volatileentity, which means risk and therefore,opportunity.

The relative stability weve seen in thelast 20 years can very quickly change

Signicant risk factors currently includegovernments with unsustainabledecits and globalisation; the needto hedge ination risk is becomingincreasingly relevant

Fig. 1:Assumed Constant Year on YearInation ReturnSource: Deutsche Bank

RPI ZC Swap100% LPI Collar

Fig. 2:Consumer price ination, y/y%, 11-yr MASource: EH Net

UKUS

1. US war of Independence2. Napoleonic Wars decit monetised3. 1st Industrial Revolution: productivity- led deation4. US Civil War5. 2nd Industrial Revolution: productivity rebounds; gold nds6. Fiscal monetisation during WWI7. Great Depression8. Fiscal monetisation during WWII9. Fiscal monetisation during Vietnam War; oil shocks10. Volcker clamps down on ination

6.4Ination Options

-2%-3%-4% -1% 0% 1% 2% 3% 4% 5% 6% 7% 8%-30

40

30

20

10

0

-10

-20

Payoff

30y Breakeven3.63%

180017751 75 0 1 82 5 1 85 0 1 87 5 1 90 0 1 92 5 1 95 0 1 97 5 2 00 0

-10

15

10

5

0

-5

2

3

4

5

6

7

8

9

10

1

The catalyst that makes this tradework is ination at above 5% this5% strike is currently lower thanspot ination a change from thelast ve years

Nicolas Tabardel,Global Head of Ination Volatility

and Exotics

Expand

Expand

What are the trading opportunities?

Contents

6 4


37/48


Market vs Economist ExpectationsUK RPI future ination: the marketin the long term is pricing muchmore downside risk than upsiderisk. In the UK, the risks of inationovershooting are much higher thanthem undershooting. This is contrary towhat we see in other markets.

In Europe and the US, there is morebalance; caps are becoming moremuch more expensive than oors.

Consensus economist predictionsindicate that market implied volatilityis too high; tails are too fat and theskew is too deep. Caps have no naturalsupply in Europe or the US so the tailrisk is always expensive (gure 1).

In Europe, volatility is too high, tails aretoo fat, and the skew is too steep.

What does this mean?Selling volatility now is a good idea

The skew was pricing oors higherthan caps; the skew is now symmetric(gure 2).

Fig. 1:Skew prices oors higher than capsSource: Deutsche Bank

SPF prob distribution for 5y in forecastMarket Implied Probability from EUR YoY caps/oors

1. Deation risk is overpriced2. Consensus economist predictions imply market implied volatility is too high3. Fat Tails

Fig. 2:Ratio of market implied probability vs.Economist ExpectationsSource: Deutsche Bank

6.4Ination Options

0

0.4

0.3

0.2

0.1

4

%

1

2

3

0

40

30

20

10

4

Value in selling wingsdistribution i.e. far out of

the money caps and floor

We expect this trend to continue,

so that by the end of 2011, capsbecome more expensive than oors,better reecting fundamentals

Stephane Salas,Global Head of Ination Trading

Expand

Expand

Contents

6 5


38/48


Collars (gure 1) Sell Floor Buy Cap

Strangles (gure 2) Sell OTM Floor Sell OTM Cap

Straddles Sell Floor and Cap at same strike

Range Accruals

Pays N/12 * Fixed Rate, Annual N = No. of months 1% < YoY EUR

HICP


39/48


Building Blocks Selling a 0% YoY oor Selling a 1x / 2x cap spread

Premiums 5Y 0% oor generates 160bps 5Y 2% cap costs 260bps 5Y 5% cap costs 100bps

Using these componentsZero cost and benets from inationbetween 2% and 8%

Covered Linker Switches Sell nominal bond Buy Linker Sell year on year caps @ 2.5% on

coupons and principal

OATei15 OATei22 OATei32

Covered Caps (%) (%) (%)

Upfront Premium 1.59% 3.95% 11.39%

Running Premium(annual, 30/360) 0.40% 0.42% 0.73%

Real Yield Pick-Up 0.32% 0.35% 0.43%

EectiveBreakeven Rate foroutperformance of

nominals

1.25% 1.44% 2.67%

Fig. 1:Sell 0% oor, But 1x/2x Cap SpreadSource: Deutsche Bank

6.6Ination Options

-1.5

3.0

1.5

2.5

1.0

0.5

0.0

-0.5

-1.0

-2 -1 1 20 3 654 7 8 9 10

Payoff (%)

YoY Inflation Print (%)

Expand

Creating Optimal Hedges

Contents

7Deation Tail Risk


40/48


7Deation Tail Risk

Deation Tail Risk: DB 5 Year Note

ContentsContents

7 1


41/48


Deation tail risk: DB 5 Year NoteInvestors can take advantage of thesubstantial dislocations in the InationOption Market by selling deep out ofthe money Ination Floors.

A 5 year DB Deation Noteprovidesa return over 4% per annumif YoYEuro-zone Ination prints above -2.0%,providing 190 bps of pick up over 5yEUR Swap Rates.

Euro-zone ination printing below-2.0% is an unprecedented event, neverseen in ANY Euro economy.

The below note details indicativeterms and compelling reasons forinvestors to take on this risk for abovemarket returns.The last section looksat variations in USD, GBP in additionto alternate ways of monetizing theopportunity in EURs

The underlying market dislocationsare unsustainable and will soon beremoved by exogenous liquidityprovided by real money accounts.This opportunity represents clear value.

DB Short Deation Risk Note Indicative Trade Terms

Indicatitive Terms

Currency EUR

Format DB Funded Note

Maturity 5 years

Issue Price 100.00

Re-Oer 99.00

Redemption121 - Floor(T), minimum

return of 0.00

Where

FLOOR(T)121 * Sum[ Floor(t) ] for

t = 1,2,3,4,5

Floor(t)12 * Max (Floor Strike - YoY

Ination, 0%)

Floor Strike -2.00%

YoY Ination

CPI(t) / CPI(t-1) -1Where CPI(t) is the EURHICP ex Tobacco Index(CPTFEMU Index) 3m

prior to Observation Date tCPI(t-1) is the EUR HICP exTobacco Index (CPTFEMU

Index) 15m prior toObservation Date t

Reference Rates5y Ination B/E 1.735%5y Swap Rate 2.16%Max IRR 4.065%

7.1Deation Tail Risk

Deation tail risk: DB 5 Year Note

Contents

8Case Study: Zero Coupon Option Trade


42/48


8Case Study: Zero-Coupon Option Trade

ContentsContents

8.1


43/48


During the rst six months of 2010,a Toronto-based insurer purchaseddeation protection worth $21.539billion in notional, paying $173.7 millionin premium. The 10-year zero-coupon0% options were denominated indollars, euros and sterling, and wereexecuted by Deutsche Bank and Citi.

The other side of the trade was largelytaken by California-based xed-incomemanager Pimco, which reported it had

sold more than $8 billion of 10-yearzero-coupon 0% ination oors in aling dated August 27. The oors weresold in return for more than $70 millionin premium, with Deutsche and Citi ascounterparties.

The transaction made perfect sensefor both participants. For the insurer,the 0% oors acted as a hedge againstdeation and the impact that wouldhave on its equity portfolio. At the

same time, Pimco was able to cash inon 0% ination oors embedded in itssizable portfolio of Treasury ination-protected securities (Tips). Dealers saythe headlines generated by the tradehad a positive impact on the market,encouraging other clients to express

their views on the direction of inationby buying or selling zero-couponoptions.

Daragh McDevitt, DB Global Head ofInation Structuring said, It sparkedinterest because you have veryintelligent investors on both sides whoare taking opposite sides of the trade.

Since Q2, 2010, quantitative easinghas encouraged more clients to sell

implied ination volatility at levels thatlook expensive. In particular, manymarket players have looked to playination volatility versus interest ratevolatility for example, by buyinginterest rate caps and selling inationcaps at similar strikes. Weve seen alot of clients coming in on the sameside as Pimco, viewing the probabilityof deation priced in by these optionsto be inated. They are either sellingthe options embedded in their bond

portfolios, selling the options outrightor entering into some kind of interestrate options strategy, says McDevitt.

The transaction made perfect sensefor both participants. For the insurer,the 0% oors acted as a hedge againstdeation and the impact that wouldhave on its equity portfolio. At thesame time, Pimco was able to cash inon 0% ination oors embedded in itssizable portfolio of Treasury ination-protected securities.

Case Study

Case Study: Zero-Coupon Option Trade

Contents

9Further Reading


44/48


9Further Reading

ContentsContents

9.1


45/48


Ination Hedging for InstitutionalInvestorsExamining dynamic asset allocationstrategies for high ination scenariosand the eect of nancial marketchanges on ination hedginginstruments.

Weekly Ination Research update

Research Ination Markets Guide

Ination Big Picture Study

Further Reading

Further Reading

Contents

Examining dynamicassetallocation

strategies forhigh inflation scenarios and

the effectof financialmarketchanges on

inflation hedging instruments

INFLATION

HEDGING FOR

INSTITUTIONALINVESTORS

PU

B

LISH

ED

BY

ALSO SPONSOREDBY

MEDIA PARTNERS

JUNE | 2011

CLEARPATH ANALYSISINPARTNERSHIPWITH

Global

7 October 2011

DB Inflation Report

Weekly Inflation Update

Deutsche BankAG/London

Allprices are those currentatthe endof the previoustrading session unless otherwise indicated. Prices aresourcedfrom local

exchangesvia Reuters, Bloomberg andother vendors. Data is sourcedfrom Deutsche Bankandsubject companies. DeutscheBankdoes andseeks todobusiness withcompaniescoveredin its researchreports.Thus, investorsshouldbe aware thatthe firm

may have a conflictof interestthatcouldaffect the objectivity of thisreport. Investorsshould considerthisreportas only asinglefactor in making their investmentdecision. DISCLOSURES ANDANALYST CERTIFICATIONSARE LOCATEDIN APPENDIX1.

MICA(P)146/04/2011.

Strategy Update

Change inbreakevens, US& UK

-10

-5

0

5

10

15

20

25

30

2 y 5 y 10 y 3 0y 2 y 5 y 10 y 3 0y

1Wchange inBEI

carryadjusted

GBP USD

Changeinbreakevens,EUR& FRF

-10

-5

0

5

10

15

20

2 y 5 y 1 0 y 3 0y 2 y 5 y 10 y 2 0y

1WchangeinBEI

carryadjusted

EUR FRF

ILB rich/cheap vsnominals

-20

0

20

40

60

80

100

120

2 01 2 2 01 7 2 02 3 2 02 8 2 03 4 2 03 9 2 04 5

G BP D EM

U SD F RF

ITL

Rich(-)/cheap (+)vs nominalcurve

Source: DeutscheBank

Upcoming data

Mkt Indicator Date, GMT

FRF CPISep 12Oct, 05:30

DEM CPI Sep 13 Oct, 06:00

EUR HICP Sep 14 Oct, 09:00

Research Team

MarkusHeider (+44)20754-52167

[email protected]

AlexLi(1) 212 250-5483

[email protected]

Vanshree Verma (+44)20754-77583

[email protected]

Macro

GlobalMarketsResearch

Economics: This weeks PPIdata pointto further upwardpressure on UK and

euroarea consumer core inflation in the coming months. Business survey price

balances havecontinuedto fallin September however, whichis consistentwith

theviewthatCPI inflationwillslow in 2012.

Global: 10y EURreal rates looktoohigh relative toUSD againstthe recentdata

divergence. We prefer long-endTIPS andUKTi B/Es over OATei.

EUR: Theongoingdeterioration ineconomicdata remainschallenging for B/Es. In

RV, we prefer the 10y sector andthe DBRei-20 in particular.

GBP: While realyield valuations are challenging,the schedulednew 50ylinker

issue shouldlook attractive relative tonominal gilts (in B/Eand ASW), RPIswaps

andB/Es in other markets.

USD: ForwardTIPS B/Eshave divergedfrom survey-basedmeasuresofinflation

expectations,althoughdeclines may be exaggeratedby liquidity factors.

AUD: In our view, the marketi s underpricing inflation riskover the short term, with

the gapbetween RBAinflation expectationsand breakevens extremely wide. Our

preferredtrade is long the bellyin 2y/5y/10y ZCS B/Ebutterfly.

Asia: Inflation in Thailand&South Korea fellmore than expectedin September,

supporting ourexpectations of nopolicy ratechange at the next CB meeting.

InflationMarkets

Bond Yld BEI 1Mfwd ASW ASWdiscnt

ZC Rate SprdZC-BEI

CPI/RPI

fcst

US CPI

T I I Ap r -1 6 - 0 . 65 1 . 53 1 . 51 - 18 1 4 5y 1 . 87 3 4 s p ot 3 . 8

T I I Ja n -2 1 0 . 05 1. 8 3 1 . 82 1 3 3 1 10 y 2 . 30 4 8 D e c- 1 1 2 . 9

T I I F e b- 4 1 0 . 90 2 .0 2 2. 0 2 7 6 5 4 3 0 y 2 . 54 5 2 J u n- 1 2 1 . 7

EAHICPxt

D B Re i 1 6 - 0 . 2 2 1 . 24 1. 1 6 -6 5 2 0 5 y 1 . 69 4 5 s p ot 2 . 5

D B Re i 2 0 0 . 31 1 .4 0 1. 3 6 - 48 2 6 1 0 y 1 . 84 4 4 D e c- 1 1 2 . 7

O A Te i 4 0 1 . 4 4 2 . 07 2 . 06 10 9 3 9 3 0 y 2 . 11 4 J u n- 1 2 1 . 8

FRCPIxt

B T AN i -1 6 0 . 2 3 1 . 52 1 . 47 2 1 3 9 5 y 1 . 88 3 6 s p ot 2 . 2

O A Ti - 19 0 . 68 1 . 68 1 . 65 3 7 3 5 1 0 y 2 . 07 3 9 D e c- 1 1 2 . 1

O A Ti - 29 1 . 29 2 . 10 2 . 09 9 8 37 20 y 2 . 18 7 J u n- 1 2 1 . 5

UKRPI

U K T i- 1 6 - 1 . 5 2 2 . 86 2 . 76 -3 1 15 5 y 3 . 11 2 6 s p ot 5 . 2

U K T i- 2 2 - 0 .3 7 2 . 80 2 . 76 9 3 2 10 y 3 . 21 4 1 D e c- 1 1 5 . 0

U K T i- 4 0 0 . 18 3 . 15 3 . 14 4 4 33 30 y 3 . 50 3 5 J u n- 1 2 3 . 7

Source: Deutsche Bank

March 2011

Global Inflation Markets

A guide

Markus [email protected]

Allprices arethosecurrent at theendof theprevious tradingsessionunless otherwiseindicated.Prices are sourcedfrom localexchangesi R t B l b d th d D t i d f D t h B k d bj t i D t h B kd d kvia euters, loombergand othervendors. ata is sourcedfrom eutsche ank and subjectcompanies. eutsche ank does and seeks

todobusiness withcompanies coveredinits researchreports. Thus, investors shouldbeawarethat thefirm may haveaconflictof interestthatcouldaffecttheobjectivityofthis report. Investors shouldconsider this report as only a singlefactorinmakingtheir investmentdecision.DISCLOSURES AND ANALYST CERTIFICATIONSARELOCATEDIN APPENDIX1.MICA(P)007/05/2010

Global

1March2011

Global Macro Issues

Issues in Inflation

Deutsche BankAG/London

Allprices are those currentat the endof the previous trading session unless otherwise indicated. Prices are sourcedfrom local

exchangesvia Reuters, Bloomberg andother vendors. Data issourcedfrom DeutscheBank andsubject companies. Deutsche

Bankdoes andseeks todobusi nesswithcompanies coveredin its researchreports. Thus, investorsshouldbe aware thatthe

firm may havea conflictof interestthatcould affectthe objectivity of this report. Investors shouldconsider this reportas onlyasinglef actor in making their investmentdecision. DISCLOSURES AND ANALYST CERTIFICATIONSARE LOCATEDIN

APPENDIX1.MICA(P)007/05/2010

Economics

Research Team

MarkusHeider

(+44)20754- 52167

[email protected]

Macro

GlobalMarketsResearch

Economics

Abstract

The uncertainty aboutthe longer-term inflation outlookhas risen substantially since

theonsetof thef inancialcr isisin 2008.Af ter15yearsormoreof lowandstable

inflation, professional forecasters, investors andindeedcentralba nks themselves

now consider below andabove targetoutcomes as possible, even probable. The

non-standardreaction of economic policy duringthecrisi s, thediscussion about

potentialchanges tomonetary policyobjectives, the run-up in public debt, butalso

apparentchanges to the inflation process itself during the GreatModeration as

well as theopen inflation implicationsof structural trends like globalisation all have

contributedto the rise in uncertainty. In this notewe look atsome of the main

issues surrounding the inflation outlookand conclude that inflation risks for the

coming yearsseem tobe skewedtothe upside of centralbanktargets.

10Contacts


46/48

ContentsInationHedging it & Trading it Deutsche Bank

10Contacts

ContentsContents

10.1


47/48


SalesHaroon [email protected] +44 20 754 73671

Matthew [email protected]+31 2 8258 2010

Michael [email protected]+44 20 754 73671

David [email protected]+44 20 754 74159

Matthew [email protected]+65 68 83 16 20

Ed [email protected]+1 212 250 0551

Tai-Zhong Jiang (Tai-Chu)[email protected]+81 3 5156 6186

StructuringDaragh [email protected]+44 20 754 52750

Xavier [email protected] +44 20 754 72731

Michael [email protected] +65 68 83 08 88

Josh [email protected] +61 2 8258 3619

Research

Markus [email protected] +44 20 754 2167

Alex [email protected]+1 212 250 5483

TradingStephane [email protected] +44 20 754 78809

Nicolas [email protected]+44 20 754 55748

Allan [email protected] +1 212 250 7105

Katsuya [email protected] +81 3 5156 6205

Vaughan [email protected] +61 2 8258 1848

Integrated trading, structuringand research

Unlike some of our competitors, DeutscheBanks ination trading, structuring andresearch professionals work closely together,combining strategic and technical expertisewith the macro-economic insights so

important with this oering.

Contacts

Contacts Deutsche Bank Global Ination Team

Contents
mailto:Markus.Heider%40db.com?subject=mailto:Dominic.Konstam%40db.com?subject=mailto:Markus.Heider%40db.com?subject=mailto:Dominic.Konstam%40db.com?subject=mailto:Dominic.Konstam%40db.com?subject=mailto:Dominic.Konstam%40db.com?subject=mailto:Katsuya.Miyoshi%40db.com?subject=mailto:Daragh.McDevitt%40db.com?subject=mailto:Xavier.Avila%40db.com?subject=mailto:Michael.Parker%40db.com?subject=mailto:Michael.Parker%40db.com?subject=mailto:Markus.Heider%40db.com?subject=mailto:Dominic.Konstam%40db.com?subject=mailto:Stephane.Salas%40db.com?subject=mailto:Nicolas.Tabardel%40db.com?subject=mailto:Allan.Levin%40db.com?subject=mailto:Katsuya.Miyoshi%40db.com?subject=mailto:Vaughan.Harvey%40db.com?subject=mailto:Vaughan.Harvey%40db.com?subject=mailto:Katsuya.Miyoshi%40db.com?subject=mailto:Allan.Levin%40db.com?subject=mailto:Nicolas.Tabardel%40db.com?subject=mailto:Stephane.Salas%40db.com?subject=mailto:Dominic.Konstam%40db.com?subject=mailto:Markus.Heider%40db.com?subject=mailto:Michael.Parker%40db.com?subject=mailto:Michael.Parker%40db.com?subject=mailto:Xavier.Avila%40db.com?subject=mailto:Daragh.McDevitt%40db.com?subject=mailto:Katsuya.Miyoshi%40db.com?subject=mailto:Dominic.Konstam%40db.com?subject=mailto:Dominic.Konstam%40db.com?subject=mailto:Dominic.Konstam%40db.com?subject=mailto:Markus.Heider%40db.com?subject=mailto:Dominic.Konstam%40db.com?subject=mailto:Markus.Heider%40db.com?subject=


48/48

This document is intended for discussion purposes only and does not create any legally binding obligations on the part of Deutsche Bank AG and/or its aliates (DB). Without limitat ion, this document does notconstitute an oer, an invitation to oer or a recommendation to enter into any transaction. When making an investment decision, you should rely solely on the nal documentation relating to the transaction andnot the summary contained herein. DB is not acting as your nancial adviser or in any other duciary capacity with respect to this proposed transaction. The transaction(s) or products(s) mentioned herein may notbe appropriate for all investors and before entering into any transaction you should take steps to ensure that you fully understand the transaction and have made an independent assessment of the appropriatenessof the transaction in the light of your own objectives and circumstances, including the possible risks and benets of entering into such transaction. For general information regarding the nature and risks of theproposed transaction and types of nancial instruments please go to http://www.globalmarkets.db.com/riskdisclosures www.globalmarkets.db.com/riskdisclosures. You should also consider seeking advice fromyour own advisers in making this assessment. If you decide to enter into a transaction with DB, you do so in reliance on your own judgment. The information contained in this document is based on material webelieve to be reliable; however, we do not represent that it is accurate, current, complete, or error free. Assumptions, estimates and opinions contained in this document constitute our judgment as of the date ofthe document and are subject to change without notice. Any projections are based on a number of assumptions as to market conditions and there can be no guarantee that any projected results will be achieved.Past performance is not a guarantee of future results. This material was prepared by a Sales or Trading function within DB, and was not produced, reviewed or edited by the Research Department. Any opinionsexpressed herein may dier from the opinions expressed by other DB departments including the Research Department. Sales and Trading functions are subject to additional potential conicts of interest whichthe Research Department does not face. DB may engage in transactions in a manner inconsistent with the views discussed herein. DB trades or may trade as principal in the instruments (or related derivatives),

and may have proprietary positions in the instruments (or related derivatives) discussed herein. DB may make a market in the instruments (or related derivatives) discussed herein. Sales and Trading personnel arecompensated in part based on the volume of transactions eected by them. The distribution of this document and availability of these products and services in certain jurisdictions may be restricted by law. Youmay not distribute this document, in whole or in part, without our express wri tten permission. DB SPECIFICALLY DISCLAIMS ALL LIABILITY FOR ANY DIRECT, INDIRECT, CONSEQUENTIAL OR OTHER LOSSESOR DAMAGES INCLUDING LOSS OF PROFITS INCURRED BY YOU OR ANY THIRD PARTY THAT MAY ARISE FROM ANY RELIANCE ON THIS DOCUMENT OR FOR THE RELIABILITY, ACCURACY, COMPLETENESSOR TIMELINESS THEREOF. DB is authorised under German Banking Law (competent authority: BaFin - Federal Financial Supervising Authority) and regulated by the Financial Services Authority for the conductof UK business. This document is intended for discussion purposes only. You may not distribute this document, in whole or in part, without express written permission. Without limitation, this document does notconstitute an oer, an invitation to oer or a recommendation to enter into any transaction. The information contained in this document is based on material we believe to be reliable; however, we do not representthat it is accurate, current, complete, or error free. Assumptions, estimates and opinions contained in this document constitute our judgment as of the date of the document and are subject to change withoutnotice. Any projections are based on a number of assumptions as to market conditions and there can be no guarantee that any projected results will be achieved. Past performance is not a guarantee of futureresults. The services described in this document are provided by Deutsche Bank AG or by its subsidiaries and/or aliates in accordance with appropriate local legislation and regulation. Deutsche Bank SecuritiesInc., a subsidiary of Deutsche Bank AG, conducts investment banking and securities activities in the United States. Deutsche Bank Securities Inc. is a member of NYSE, FINRA and SIPC. Investments are subject toi st t isk i cl di k t ct tio s l to ch co t t isk ossibl d l s i t d loss of i co d i ci l i st d Th l of i st t c f ll s ll s is d o

[deutsche bank] inflation - hedging it and trading it.pdf

Documents