Vol shifts back higher; Noisy, chaotic
Treasury yields popped back higher with the 10y note yield crossing 3.75% once again to 3.765% last (+13.5bps). Equities have come off the earlier lows and are now down modestly (DJIA -0.17%, S&P-0.52% and Nasdaq -0.62%). The vol surface has popped back higher, negating much of yesterday’s nascent softening. 3m to 1y expiries are around 2 to 5 normals higher, with the belly of the surface leading. Further out vega is around 0.5 to 1 normal higher.
The surface is “small up” today after seeing a small down yesterday, noted one source, who regarded the price action as mostly “noisy” ahead of payrolls on Friday. Another source found that the price action in rates and vol remains “very chaotic.”
As for a normal vol producing event such as payrolls, the vol market is currently pricing in around 14bps breakeven in the TY or around 13.5bps in the 10y note yield, according to one source’s calculations. That said, the source half-jokingly pointed out that the expected breakevens for payrolls is “hardly more than a standard day.”
Meanwhile, traders continue to say that liquidity remains bad. With the wider bid/offers that hedging has been subjected to, one source remarked that the increase in delta hedging costs could amount to “0.5 to 0.75bps” and thus eats into any potential gains.
Looking at recent customer flows, a source pointed out that heavy corporate flows centered in the ULC amid the selloff and prompted demand in caps and floors that dealers needed to cover those short positions. Thus, helping the bid feel in the ULC, sources say.
As for interbank activity today, starting with the ULC, 1y1y traded at 128.5bps, it also traded at 129bps versus 2y2y at 334bps on a switch. In the lower left, 5y1y traded at 221bps and 10y2y dealt at 438bps on a total of $200m. 1y3y versus 1y5y traded at 351bps and 516bps, respectively.
In 5y tails, 1y5y traded at 530bps and earlier at 528bps, 3m5y dealt at 283bps versus 3m10y at 465bps. Also, 3m10y traded at 455bps and 458bps earlier. 1y10y dealt at 842bps, 2y10y traded at 1120bps, 3y10y traded at 1279bps, 1m30y traded at 564bps, and in a switch, 2y30y traded at 2086bps versus 10y10y at 1668bps, according to the SDR.
In other longer expiries, 5y10y versus 5y30y traded at 1478bps and 2809bps, respectively, 10y10y traded at 1670bps and then 1680bps, 5y30y dealt at 2805bps and 10y20y dealt at 2540bps, according to the SDR. For more, please see SDR trades.
Vol stuck between more market stress and potential Fed put - BofA
With rates volatility reaching “new cycle highs” last week, analysts at BofA believe that in the near term, “the outlook for volatility is stuck between ‘what if’ (recent market stress persists) and ‘or else’ (where the Fed may need to exercise its financial stability put).”
- “The known-unknowns (around Fed policy, financial stability, the unwind of BoE purchases, the dynamics of duration and risk, or the dollar strength impact on global markets to name just a few) are more than enough to keep the volatility market on a wait-and-see mode… and then there are the unknown-unknowns, which we referred to in our 2022 year ahead as a highly diffused level of risk. It is generally when one stresses a system that one starts to find its cracks, and it is clear that global markets are coming under stress from a globally synchronized monetary policy-tightening process.”
However, BofA finds that “it is clear from the policy reaction to the UK budget shock that the near-term outlook for rates and volatility is also limited by ‘or else’ type constraints”:
- ”Either… the market finds consolidation ranges (even if relatively wide ones) around terminal expectations (more Fed driven) and at the backend of the curve (more value driven)…. and as the bond market finds these ranges we are likely to see more two-way flows, improvements in liquidity conditions, and a decay of volatility from the current peak levels;
“Or else… the Fed may need to calm the market with at best more nuanced guidance, because despite all the recent optimistic pronouncements on market functioning…the recent stress levels look rather unsustainable as they do create significant scope for a drift into financial stability concerns.”
BofA judges that the Fed put has changed in nature, “from a focus on risky asset valuations towards a financial stability put,” and thus supports the ‘or else’ view, but it finds it “difficult to gauge at what level of vol this financial stability put may start to be exercised” but in its view “it may not be much above the recent highs.”
New structured notes
For a complete review of USD MTN activity over the past week, please see USD MTNs.
- UBS is working on a self-led floating callable maturing Oct 2023 NC3m that pays O/N SOFR flat. EMTN.
- Toronto Dominion is working on a self-led fixed callable maturing Oct 2024 NC1 that pays 5%. GMTN.
- Royal Bank of Canada is working on a self-led fixed callable maturing Oct 2024 NC1 that pays 5%. GMTN.
- Royal Bank of Canada is working on a self-led fixed callable maturing Nov 2023 NC6m that pays 4.5%. GMTN.