Wide bid offers; Surface ticks steeper; Wedge,10y2y risk reversal
Treasuries are near unchanged after the $19bn 5y TIPs reopening tailed 1.5bps versus the 1pm level, drawing a rate of 1.504% with lower indirects (74.1%) partially offset by higher directs (17.8%), leaving primary dealers with 8.1% of the total allocation. The bid-to-cover came at 2.51x or higher than seen in October.
The implied vol surface is seeing minimal moves today with the surface steepening slightly. Gamma is down around 0.5 to 0.7bps while vega is up around 0.2bp. Illustrative of the wide bid offers that interested parties must contend with to offlay risk these days, today a 10y2y 100bp each way risk reversal dealt at +15bps, with the offer lifted and the market prior to the lift a wide +2bps/+15bps, sources say.
Elsewhere, in ATM swaptions activity, 10y10y traded early this morning at 1660bps and then last dealt at 1669bps. In the ULC, 1y1y dealt at 110.5bps, 2y1y traded at 157bps, and 1y2y traded at 219bps, and the 1x2 1y1y wedge traded at 30.5bps, according to sources and the SDR.
In other activity, 1m10y traded at 233bps, 2y25y traded at 1910bps, 2y10y dealt at 1094bps and 1y10y dealt at 821bps, and in a possible switch 1y1y versus 1y20y traded at 110.5bps and 1295bps, respectively, according to the SDR.
Right side to underperform left; 3m10y 100 annualized – Citigroup
Analysts at Citigroup still believe that “more uncertainties lie in the front-end of the curve rather than in the long-end” and thus, on a relative basis, they see “better risk/reward to be short vol on 10y and 30y tails.”
Looking back to the late 1970s/early 1980s, Citigroup sees “that the realized vol ratio of 2y Tsy to 10y Tsy never fell below 110% throughout the policy rate rollercoaster” during the time that the Fed was “not simply reducing the pace of hikes during this period, but they were actually cutting rates,” a scenario Citigroup sees for the current time period “is still far away from materializing.”
The bank points out “it was not until 4Q 1982 after the Fed had become fully entrenched in an easing cycle did the 2y vs 10y vol ratio fall below 110%.”
“From a relative change perspective, it is also not always clear cut that the 2y vs 10y vol ratio would need to decline at the onset of a dovish Fed pivot” and specifically, when examining the vol ratios after the last rate hikes between 1979 and 1984 (regardless how quickly the subsequent rates cut were reversed), Citigroup highlights that “the subsequent 3m realized vol on the 2y did not always immediately cheapen relative to the realized vol on the 10y.”
Citigroup see this dynamic made sense “given the constant flip-flopping between rate hikes and cuts during that time” and thus “even if the economic cycle turns much sooner than expected, there should be a limit to how much 2y vol can cheapen relative to 10y considering that upper-left vols have historically outperformed ahead of an easing cycle” -though it points out this is not the bank’s base case expectation for the next 6 months.
Further, it finds that the outlook is consistent with its macro-vol fair value model, “which suggest that upper-right is one of the relatively richer sector on the swaption surface whereas upper-left is the most undervalued.” To be sure, the bank calculates the following:
- “Using the rate/vol beta over the past 12-month along with our 2023 base case yield forecast for the 2y, we estimate that 3m2y vol can decline modestly to 110-120bp vol. Assuming that the 2y versus 10y vol ratio will fluctuate between 1.1 and 1.2, we estimate that 3m10y can average around 110bp vol in the first half of the year before moderating to around 95-100bp vol in H2. Currently the short- to intermediate-expiry part of the vol term structure on the 10y tails appears to be about 5 normals too steep relative to the outright level of vol. This relationship should normalize over the near term, so we expect 1y10y vol to underperform 3m10y vol early on in 2023."
New structured notes
For a complete review of USD MTN activity over the past week, please see USD MTNs.
- IBRD is working on a $15m fixed callable via WFS maturing Jan 2033 NC3m that pays 6%. GMTN.
- Citigroup is working on a self-led fixed callable maturing Dec 2027 NC2 that pays 5.52%. Domestic MTN.
- JP Morgan is working on a self-led fixed callable maturing Dec 2023 NC6m that pays 4.9%. Domestic MTN.
- JP Morgan is working on a self-led fixed callable maturing Jun 2026 NC1 that pays 5.125%. Domestic MTN.
- Toronto Dominion is working on a self-led fixed callable maturing Dec 2026 NC3m that pays 5.6%. GMTN.
- Toronto Dominion is working on a self-led fixed callable maturing Jan 2024 NC9m that pays 5.25%. GMTN.
- Toronto Dominion is working on a self-led fixed callable maturing Dec 2027 NC1 that pays 5.65%. GMTN.
- National Bank of Canada is working on a $10m fixed callable via RBC maturing Dec 2037 NC5 that pays 5.8%. EMTN.