USD Swaps: USTs rally post PMI; SOFR updates; Synthetic LIBOR?

LIBOR to SOFR 11 Oct 2021
USTs are drifting higher after latching onto lower PMI data amid a dump of economic data. NatWest's SOFR transition update. Synthetic LIBOR proposed.

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  • USTs rally post data dump focus on PMI; Spreads leak wider  

  • Transition to SOFR in fairly good shape – NatWest

  • UK FCA proposes synthetic LIBOR to Jun 2023 to Sep 2024


    USTs rally post data dump; Spreads leak wider 

    A slew of economic data this morning showed lower-than-expected inflation PMI (S&P PMI Manufacturing/Services/ Composite 47.6/46.1/46.3 vs 50/48/48 forecast). USTs are higher after latching onto the friendly inflation readings. However, to note, amid the slew of economic data this morning, new home sales (+7.5% vs. -5.1% forecast), durable goods orders (+1% vs 0.4% forecast) and UofM sentiment and conditions (56.8/58.8 vs 55/57.8) all surprised to the upside.


    The 10y note yield is last 3.722% or 3.4bps lower while 2s10s is roughly unchanged at -75.9bps and 5s30s is 2bps steeper at -13.2bps. Equities are up on the day thus far (DJIA +0.26%, S&P +0.23% and Nasdaq +0.81%). This afternoon sees the FOMC Minutes.    


    Swap spreads are wider amid light mixed volumes and on the supply side, IG new issuance saw nothing yesterday and likely is done for the week with $5.9bn priced for the week – all on Monday. The total is slightly higher than the modest $5bn that was expected for the holiday week.


    Currently, SOFR swaps 2s 2bps (+0.25bps), 3s -16.25bps (+0.5bps), 5s -22.125bps (+0.5bps), 7s -31.625bps (+1.25bps)*, 10s -31bps (+1bps), 20s -69.625bps (+2bps), 30s -72.875bps (+1.125bps).


    *adjusted for the 1bp give


    Transition to SOFR in fairly good shape – NatWest

    Analysts at NatWest see the SOFR transition from LIBOR with 6 months to go “in fairly good shape”:


      ”SOFR liquidity has built in derivatives, there hasn't been any new USD LIBOR for nearly a year now (other than permitted hedging), fallback protocol for derivatives is almost universally adhered to, and there has been regular SOFR bond issuance. There is even legal safe harbour to apply ARRC sanctioned fallbacks for US law governed contracts in the form of the federal LIBOR Act.


      “Probably the one to watch, just like 6 months out in £, is the 'loan tail' - there will likely be a last minute scramble to get loan documentation amended to include fallback / switch language to SOFR. Finally one area of some controversy seems to be Term SOFR - in use in the cash markets (esp loans) but not permitted (per ARRC guidelines) for derivatives except for direct hedging of Term SOFR underliers, leaving a basis between Term SOFR and compounded in arrears SOFR for the interbank market to manage (without a Term SOFR interbank swap market).


      Derivatives: "wide adoption of SOFR now (latest ARRC minutes have usage stats, incl 90% new swaps in SOFR); most USD LIBOR swaps either cleared (and subject to CCP transition plans in Q1/Q2 2023 - see LCH and CME) or subject to fallback protocol; note the extra 2022 protocol for CMS / Swaptions referencing $ LIBOR ICE Swap Rate (ISR); some bilateral derivs, eg loan linked swaps, will require bilateral fallback agreement."


      To note, NatWest highlights that term SOFR is “not permitted for use in derivatives market except where the Term SOFR swaps are direct hedges for Term SOFR underliers.  So there is deliberately no developing Term SOFR interbank swaps market, though that does leave banks offering Term SOFR hedges for loans for example with basis risk between Term SOFR and SOFR In Arrears to manage."


      Further, NatWest points out that “ARRC has made quite a point recently of reinforcing the guidelines - for example in the latest read out from ARRC progress meeting in November "The ARRC expressed concern about some recent trends, such as securitizations using Term SOFR when they did not have underlying Term SOFR assets, that were outside the scope of the ARRC’s best practice recommendations."


      Bonds: "FRN issuance in SOFR by FIs has steadily increased through 2022; there has been some commentary in press on limited SOFR uptake by NFCs, however in the context of most corporate issuance being fixed rate anyway that may not be significant; for US law governed issuance, contracts without fallbacks can depend upon LIBOR Act to support the ARRC waterfall replacement rates (with Term SOFR at the top for cash); non-US law bonds will require transition / amendment if robust fallbacks not in place."


      Loans: "Perhaps the furthest still to go; the path and options are clear, and as with bonds if US law then there is a legal safe harbour; less certain whether there will also be a USD LIBOR synthetic rate post cessation - most likely as with GBP it will be left to a last minute announcement; but both bilateral and syndicated loans will for the most part be repapered, and that is quite a resource intensive process with time running out; recent loan remediation survey by ARRC indicated that > 50% expect majority of their loans to transition only by end Q2 '23 or will use fallbacks at cessation.”   



    UK FCA proposes synthetic LIBOR to Jun 2023 to Sep 2024

    ICE today reports that the UK FCA has published a consultation on a proposal to require ICE IBA to publish 1m, 3m and 6m USD LIBOR settings “under an unrepresentative ‘synthetic’ methodology after the end of June 2023 until the end of September 2024, and that the FCA intends to require IBA to continue to publish the 3m ‘synthetic’ sterling LIBOR setting until the end of March 2024.”


    “Publication of the Overnight and the 1m, 3m, 6m and 12m U.S. dollar LIBOR settings currently continues using panel bank contributions under the ‘panel bank’ LIBOR methodology. IBA expects to continue to determine and publish these settings on this basis until the end of June 2023, at which point panel banks will stop contributing and the Overnight and 12-month U.S. dollar LIBOR settings will permanently cease.


    “In light of feedback received in respect of its June consultation, the FCA is consulting on using its powers under the U.K. Benchmarks Regulation to compel IBA to continue to publish the 1m, 3m and 6m USD LIBOR settings under an unrepresentative ‘synthetic’ methodology for a temporary period after the end of June 2023 until the end of September 2024. The consultation also seeks views on the proposed methodology the FCA would require IBA to use to determine ‘synthetic’ USD LIBOR and on which legacy use of 'synthetic' USD LIBOR the FCA should permit. The consultation will remain open until January 6, 2023, and the FCA expects to announce its decision in late Q1 or early Q2 2023.”


    For full press release, please see link