Swap spreads widen; USTs, equities waver
Treasuries are ending the session with the belly coming off the lows of the day, but with yields still 10-11bps higher in the 5y to 10y maturities. The wings, by contrast, are only around 5bps higher on the day. The 10y note yield is last 3.743% after seeing a high of 3.787% and an overnight low of 3.611%. Equities closed back a touch lower after climbing out of the lows of the day into positive territory for a time late in the afternoon (DJIA -0.14%, S&P +0.05% and Nasdaq +0.25%).
Swap spreads marched out wider as equities climbed higher and yields pulled off the highs of the day amid mixed volumes seen best in the 5y and 7y maturities. On the issuance side, $2.25bn priced in IG new issuance (ex-SSA).
Looking at recent spread price action, one trader found that prices have “skipped” all over the place and that SOFR swaps spreads have been acting more like “LIBOR spreads” even though SOFR spreads “should be more stable.” Last week, he noted that the market seemed like it was “going to break” but it didn’t in the end. As for the bouts of illiquidity, the source was resigned, saying “it is what it is” and the source generally disagreed that the market was “broken,” but did find the current state of the markets “confusing" As for trading these market, he regarded that if you can, you “just try to stay out of trouble.”
As for the key factor of inflation, with the Fed continuing its beating of the hiking drum and staying at a restrictive level, one source believed that “it all points to inflation” and beyond inflation “at 3-4%, the Fed will stay at restrictive levels,” he judged.
Currently, SOFR swaps 2s +2.5bps (+2.125bps), 3s -19.25bps (+3.125bps), 5s -23.5bps (+1.625bps), 7s -27.125bps (+2.25bps), 10s -25bps (+3bps), 20s -70.75bps (+4.375bps), 30s -70.75bps (+3.5bps).
USTs hedging utility hampered - BofA
Even before the September FOMC and UK budget shocks, analysts at BofA highlight that the market was “already showing a higher level of fragility and inelasticity to the hawkish Fed shift over the summer” and “one of the ways in which this inelasticity was becoming obvious in the market dynamic was through the exacerbation of the deficit of USTs utility as a portfolio hedge.”
BofA stresses that the significance of this shift in USTs utility “cannot be overestimated,” as it impacts “the entire logic of how to construct portfolios.” Indeed, BofA points out that as PMs “run out of options on reliable hedges and assets to put on the safety corner of portfolios, they would need to cut risk instead of hedging the risks.”
In turn, “this creates scope for episodes where market shocks drive a negatively convex dynamic, where deleveraging pushes investors to chase lower and lower valuations across asset classes until the market finds value-driven clearing levels (uncoupled from fundamentals),” it explains.
That said, BofA stresses that market participants “were largely setup” for the “bearish rates dynamic” and outside of structurally long portfolios (e.g., pension funds), “the bulk of the pain in these moves comes in other forms: one-sided markets, volatility spikes, selling pressures across assets, and collapsing liquidity.”
The bank believes that factors that will allow USTs to recover some of their utility as a portfolio hedge include “a firm downward trajectory for inflation; a crystallization of the Fed policy path, and a shift in the dynamic of equities whereby earnings expectations become a more significant driver.” However, BofA believes that the timeline for meeting these conditions “is likely to be backloaded into late-2022/early 2023.”
- Enel (Baa1/BBB+) plans USD 3y, 5y, 10y and 30y Sustainability bonds. Leads are BNPP, GS and JPM.
- TD Bank plans a USD 60y NC5 Limited Resource Capital Note (LRCN). Leads Citi, GS, Santander, SocGen, TD and WFS. Baa1/BBB.
- Philippines (Baa2/BBB+) launched a $2bn 3-part ($500m 5y, $750m 10y and $750m 25y Sustainability bond). Leads BofA, GS, HSBC (B&D), JPM, MS, SMBC Nikko, StanChart and UBS. +120bps, +185bps and 6.1%.
- the Public Investment Fund (PIF) launched a $3bn 3-part Green bonds ($1.25bn 5y, $1.25bn 10y and $500m 100y). Leads BNPP, Citi, DB, GS (B&D) and JPM. +125bps, +165bps and 6.7%.
- Cargill priced a $1.25bn 2-part ($750m 3y and $500m 10y). Leads DB, Citi, HSBC and JPM. A2/A/A. +75bps, +140bps.
- CCDJ priced a $1bn 3y covered bond. Leads Citi, HSBC, NatWest and RBC. Aaa/AAA. SOFR +87bps.
- John Deere Capital priced a $1bn 2-part ($600m 2y and $400m 7y). Leads Citi, HSBC, JPM and TD. A2/A/A. +43bps, +100bps.