USD Swaps: Resolute Fed; More UST bull steepening; Debt ceiling and spreads

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Fed remains resolute; More UST bull steepening; IG/UST supply eyed

Fed officials continued to send more signals today that the central bank remains absolutely resolute on its rate hiking campaign.  To be sure, Atlanta Fed President Bostic stated today that “we are going to have to hold our resolve” with rate hikes while San Francisco Fed President Daly stated that it’s too early to “declare victory” on inflation. And with the Fed still steadfastly staying on message, today’s nascent rally in equities largely petered out, leaving the major domestic indices mixed but little changed at today’s close (Dow -0.34%, S&P -0.07%, Nasdaq +0.63%).

Meanwhile, after some initial weakness, Treasuries also rallied – aided somewhat by dovish NY Fed survey on inflation (see here) – but also came off the early highs into the close today.  The benchmark 10y note yield is last 2bps lower at 3.538% after hitting a low water mark of 3.5064% late morning.  On the curve front-end has remained the sweet spot after Friday’s soft NFP wage and ISM data with the 2s10s spread another 3bps wider at -67.2bps. 

In swaps, spreads are closing out narrowly mixed amid roughly average swap volumes overall, best seen in longer tenors this session (i.e. 10y and 30y).  In the backdrop, IG issuance kicked off with a vengeance after last week’s roughly $58bn deluge (versus expectations of $35-$40).  On today’s docket, RBC left one of the bigger footprints with its 4-part $3.65bn deal while POSCO came with a 4-part $2bn deal.  Overall, initial estimates for total IG issuance this week land at around $30-$35bn before the big U.S. banks start exiting their blackouts at the end of this week. 

But on top of IG supply, Treasury is also set to kick off another round of coupon issuance with tomorrow’s $40bn 3y note auction followed by a $32bn 10y note auction on Wednesday, and an $18bn 30y bond auction on Thursday.

Currently, SOFR swaps – 2s 3bps (+0.25bps), 3s -16.25bps (-0.125bps), 5s 26.875bps (+0.25bps), 7s -34.25bps (+0.25bps), 10s -34.125bps (-0.125bps), 20s -68.875bps (unch), 30s -74.25bps (+0.25bps).

NatWest: Debt ceiling and implications on supply and spreads

With barely-newly-elected House Speaker McCarthy’s rather arduous – to say the least – appointment to the Speakership, worries around the debt ceiling are resurfacing again.  Indeed, these concerns have come back to the forefront after McCarthy made concessions around lowering the bar to challenge the Speaker in the future where Republicans could use this ability as well as other powers to block legislation as a negotiation tactic. And while strategists at NatWest “do not think the US government will default by any means,” they do believe that “it does increase the odds (even if still small), though (they) think in the end it will be more a question of how long the negotiations will stretch and what the concessions from the Democratic side would be, the latter of which being less relevant for markets.” 

However, assuming that we don’t get a near-term resolution to the debt ceiling, in NatWest’s view, the next months will look like this:

”… 1) Treasury has virtually reached the statutory debt limit, just $78bn shy as of the 4th of January. Once that limit is reached and the Treasury General Account reaches an uncomfortable level (our guess around $300bn), Treasury will most likely declare a Debt Issuance Suspension Period (DISP). As a reminder, Congress has the option to either suspend the debt limit for some time or raise it by a specific dollar amount. In 2021, the limit was increased (twice), rather than suspended. Therefore, Treasury is currently bound by a specific level, rather than a date.

 

“…2) With DISP, Treasury will tap into its ‘extraordinary measures’ – mostly suspending the issuance of non-marketable government debt. Examples of such manoeuvres are not investing the Government Securities Investment Fund (G-Fund), Civil Service Retirement and Disability Fund (CSRDF), Postal Service Retiree Health Benefits Fund (PSRHBF), suspend issuance of State and Local Government Treasuries (SLGS) and the reinvestments from the Exchange Stabilization Fund (ESF). In 2021, all of the extraordinary measures freed up roughly $350bn upfront (and $10bn/month due to SLGS).

 

“…3) Once debt issuance headroom is created through extraordinary measures, we expect Treasury to announce sizeable increases in bill auction sizes. January is typically a month of lower net outflows for the government, but February isn’t. What matters for markets, in our view, is that a large wave of bill supply will hit the market – our estimate is for about $350bn throughout the February and March period.”

So what are the market implications?  NatWest expounds below:

”… Historically, once markets agree on a rough potential default date (the so-called X-date), the bill curve illustrates a sizeable hump for those dates. Understandably, large owners of bills like money funds either don’t have the technology and/or the desire to deal with handling securities that are technically matured, quasi-defaulted with payments guaranteed, but still in arrears. We would expect a similar development to happen again if negotiations stretch that far – however, we do not anticipate the X-date to be before H2 2023, which makes forecasting today useless. Additionally, April is the tax month in the US, so cash flows will turn sharply positive at that point too (traditionally Treasury pays down bills to offset the tax inflow, but that won’t be the case this year).

 

“…With more short-dated collateral supplied to the market, we think bills will cheapen up compared to OIS (and drag repo alongside) in late January/early February. As chart below shows, that spread has been related to the performance of 2y swap spreads as well, where richer bonds imply wider spreads up to the 2y point (alongside other factors such as heavy shorts in the 2y due to the Fed). In our Year Ahead we wrote about our view on 2y spreads settling into negative territory – we think this upcoming supply event could lead to underperformance vs. swaps.

 

“…On the other hand, slightly further out the curve, we think 3y spreads will perform well. In short, our view was that the 3y note suffered since it is the preferred habitat of the likes of foreign FX managers, who sold USTs to prop domestic currencies (or markets took the impression they did). With the Fed, in our view, reaching its zenith and the USD looking to come off its peak, we see room for 3y spreads to perform well (and they have outperformed since November).

 

“…Therefore, we think combining those two views, 2s3s spread steepeners (currently at -19bps), would fit into a trade that we think will benefit directionally and carries very well.”

 New issues

• AIIB is working on a 5y sustainable benchmark via BMO, HSBC, JPM and TD.  Aaa/AAA/AAA.  Price talk; MS + 65bps area.

   

• KfW is working on a 5y benchmark via BofA, Citi and RBC.  Aaa/AAA.  Price talk: MS + 42bps area.

   

• Air Lease is working on a $500m 5y deal via Citi, FITB, RBC, Santander and Lloyds.  BBB/BBB.  Price talk: +215-220bps area.

   

• CaixaBank plans a benchmark 6yNC5 Senior Non-preferred benchmark bond. Barclays, BofA, BNPP, Caixa, JPM and MS are arranging investor calls.

   

• RBC priced a four-tranche benchmark USD issue including a $1bn 3y fixed at +95, a $300m 3y FRN at SOFR + 108bps, a $750m 5y at +125bps and a $1.7bn 10y at +150bps.

   

• Philippines priced a 3-part $500m 5.5y, $1.25bn 10.5y and $1.25bn 25y sustainable benchmark via BofA, DB, BS, HSBC, StanChart and UBS.  Baa2/BBB+/BBB.  Launched at +105bps, +145bps, 5.5%.

   

• National Bank of Canada priced a $750m 2y benchmark via Citi, NBCFM, GS, JPM and RBC.  A3/BBB+/A+.   Launched at +110bps.

   

• Wisconsin-based electric motors company Regal Rexnord priced a four-part benchmark USD deal including a $1.1bn 3y at +215bps, a $1.25bn 5y at +240bps, a $1.1bn 7y at +270bps and a $1.25bn 10y at +290bps. Via BofA, UBS and JPM.

   

• BNP Paribas priced a self-led $1.75bn 6NC5 benchmark.  Aa3/A+/AA-.  Priced at +145bps.

   

• Toyota Motor Credit priced a four-tranche USD benchmark bond issue including a $1.2bn 2y fixed at +63bps, a $300m 2y FRN at SOFR + 56bps, a $1bn 5y fixed at +98bps and a $500m 10y at +118bps. Via BofA, Barclays, Citi, Mizuho and Santander.

   

• Dell International priced a $1bn 5y and $1bn 10y benchmark at +160 and +225bps respectively via Barclays, BofA, Goldman, JPM, MS and WFC.

   

• POSCO priced a $2bn, three-tranche bond issue including a $700m 3y at +190bps, a $1bn 5y at +220bps and a $300m 10y at +250bps. Via BNPP, Citi, Credit Agricole, HSBC and Standard Chartered.

   

• Healthpeak Properties priced a $400m 10y bond at +175bps via BofA, PNC, Scotia, TSI and WFC.  Baa1/BBB+/BBB+.

   

• Crown Castle priced a $1bn 5y benchmark at +137.5bps via BNPP, JPM, MUFC, PNC, RBC and TSI.   Baa3/BBB/BBB+.

   

• Sun Communities priced a $300m 10y deal via Citi, BofA and JPM.  Baa3.  Priced at +223bps.

   

• WEC Energy priced a $650m 3y and $450m 5y benchmark bonds at +85bps and +112.5bps via Barclays (B&D), JPM, MS and WFC.  Baa1/BBB+/BBB+.

   

• F&G Annuities & Life priced a $500m 5y deal via BofA, JPM and RBC.  BBB-/BBB-.  Priced at +375bps.

   

• Realty Income priced a $500m 3yNC1 and $600m 7y USD benchmark at +125 and +145bps respectively via BofA, Goldman, MS and WFS.  A3/A-.