GBP Vol: Cheap vs EUR; Payer spread value

Cheap GBP implied vol
In its weekly rates research, JP Morgan finds GBP implied vols to be cheap, particularly in the top right of the vol grid and when compared with EUR implieds. The bank writes:

• “On a cross market basis, GBP implieds appear cheap versus EUR, especially at the long-end of the curve. 3m30y (GBP-EUR) implied vol spread has declined sharply in the recent repricing of implieds and the cross market volatility spread is close to the lows of the past few years.

  
  

• “Over the past few years, the spread has been lower than current levels only during prior episodes of crisis such as the onset of the pandemic, summer of 2019 when position technicals and illiquid markets pushed EUR implied volatility higher.

  
  

• “Looking ahead, we have a bullish bias on GBP volatility (see United Kingdom) but also favour expressing that view on a cross market basis. At the long/ultra-long end, we prefer expressing this cross market view in 30y over 10y on RV considerations. Overall, we favour selling 3m30y EUR gamma versus GBP; 3m delivered vol spread is around 0.1bp/day above current implied vol spread.

Payer spreads attractive
Meanwhile, strategists at Barclays turn their focus to the mid-left of the grid and opportunities in payer spreads. In the research published the end of last week, the bank suggests positioning for a rate selloff in the medium-term. It explains:

• “Buy GBP 6m5y 1x2 payer spreads to position for a gradual selloff in the medium term. UK rates have rallied together with the global duration resilience… the rally does not reflect changing policy rate expectations and the market may begin to question the sustainability of the rally, given the domestic economic data and upbeat message from MPC.

  
  

• “However, the outlook remains uncertain and any selloff would likely be of limited size, in our view. Top-left payer skew continues to stay elevated where GBP 6m5y payer skew remains around its highest level since 2017. The payer skew is also rich compared with recent estimates of the realized skew (0.5*beta of the change in 6m5y ATM vols to changes in 6m5y rates).

  
  

• “A rich payer skew, together with the possibility of a gradual reversal of the recent rally means that initiating 1x2 payer spreads is attractive. Specifically, we recommend buying GBP 6m5y 1x2 costless payer spread, struck ATM vs ATM+18…The maximum gains on expiry would be reached if the rate sells off to 18bp above the ATM rate (0.59%). This would be possible with a brighter recovery and recent rallies are reversed over the coming months.

  
  

• "The trade will only lose if rates sell off sizeably, to levels beyond 0.77%. The last time the 5y rate was materially above this level was in H1 2019, when the economic backdrop was better and the policy rate stayed at a much higher level. We therefore assign a low probability for the level to be breached in the near term.”