HOUSE_OVERSIGHT_014751.jpg

Chart 38: Low repo rates and ECB QE tapering push 10s to pre-QE levels Chart 39: 10y Germany is historically cheap on the OIS curve 20 * OlS-B i 2 -Bund spread Penphery Blow-out ECB QElannounc. Brbxit 35 P 10 I l - 30 4 25 -10 20 i 15 -20 4 ; I 10 - I 30 5 | ——2s5s ———2s106 4 -40 : 0 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-15 Apr-15 = Jul-15. Oct-15 Jan-16 Apr-16 Jul16 Oct-16 Source: BofA Merrill Lynch Global Research Source: BofA Merrill Lynch Global Research 10s would be particularly supported if the ECB increases the holding limit of non-CaC bonds to 50% — a tweak we see as the most likely. Also, given the already stretched valuations in the 2y, we think a rise in geopolitical risks or a blow-out in peripheral spreads would increase collateral values of 5s and 10s more than the front-end — as happened during the first BTP spread widening in 2011 or the Brexit referendum. We recommend investors go long the DBR Aug26 vs OIS and short the BKO Dec18 vs OIS at current levels of -17bp, targeting 14bp and with a stop at -34bp. The position has 1.1bp in 3m Carry and Roll. The main risk in the short term is ECB QE failure, while tighter short-maturity securities supply or lending is the main risk over the longer term. Bank of America Global Rates, FX & EM 2017 Year Ahead | 16 November 2016 21 Merrill Lynch HOUSE_OVERSIGHT_014751