USD Vol: ULC cheapens further; Right side gamma skew comes in

ULC cheapens further; Right side gamma skew comes in  

Treasuries have rallied in the front end while selling off a touch in the back end with realizeds +/-4bps. The vol surface has seen the upper left side drop in lower today by around 4 to 7.5 normals while the right side is near unchanged to slightly higher on the day.

For example, 6m1y is now under 100bp annualized, with today’s drop of around 7.5 normals to around 96.5 annualized while 3m1y is now around a mere 88 annualized or around 5/5bp/day breakeven. Meanwhile 1y1y is back down to 116.5 annualized which one source called “no man’s land” having broken down through the previous low of 120 annualized seen last May.

One source suggested that the ULC cheapening is a direct result of the market pricing in the Fed “on hold” after the expected smaller hikes in Q1, and thus there is “no need for 8bp/day breakeven” with the Fed expected to pivot.

In trading activity in the ULC, 1y1y traded at 95bps and then 94bps, 1y2y dealt at 188bps, 6m1y versus 6m2y traded at 55bps and 132.5bps, respectively. In CFS, 1x3 traded at 273.5bps, 2x4 traded at 307bps and a 1y 4% cap dealt at 73bps, according to the SDR.

Longer tails saw a bunch of mostly switches, which a source described as “clean up” flows. For example, 1y30y versus 3y30y traded at 1470.5bps and 2283bps, respectively, 1y20y versus 4y20y traded at 1159bps and 2002bps, respectively, 5y10y versus 3y5y traded at 1390bps and 693bps, 2y20y versus 3y25y traded at 1573bps and 2045bps, respectively, and 1y20y versus 3y20y dealt at 1155bps and 1830bps, respectively, according to the SDR. For more, please see SDR trades.

In skew, right side gamma payer skew has come in a bit as 1y10y 50bp each way risk reversal traded today at +9bps. One source had it previously marked around +11bps.

Fed convexity management missing in this cycle – Deutsche  

Analysts at Deutsche highlight that the volatility behavior in the current cycle has been “qualitatively different from any other tightening episode in recent history.”

To be sure, “its precipitous rise was last year’s most outstanding anomaly.” In conventional settings, Deutsche notes that the recession/recovery dynamics follow the logic of their “stylized” facts:

”The inertia of stimulus unwind is a risk-on mode with a volatility-reducing mechanism as rate hikes become periods of decelerated growth. In contrast, the unwind of financial repression (where both bonds and risk rally) goes against the grain of recovery and has potential to ignite volatility, creating conditions for a risk-off mode. This complicates things, and for that reason convexity management is an essential part of policy unwind in this case.”

“Although the previous episode of tightening (2015-2018) was also unwind of financial repression, the main reason volatility did not ignite then was a careful effort of convexity management through Fed gradualism, excess transparency, forward guidance, and removal of the fourth wall,” Deutsche explains, and “despite the baggage of years of administered markets and misallocation of capital, unwind was orderly.”

However, “none of these tools could be deployed in the current cycle” as “they have been suspended in favor of unconditional war on inflation.” The bank finds that “the upward-sloping vol trajectory in 2022 is the main complication that distinguishes the current cycle from any other in the past” and indeed, Deutsche points out that “it stands out relative to any previous tightening cycle” as the unwind of stimulus in 2022 “was a disorderly risk-off trade with sell-off in both bonds and risk assets.”

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 MS  maturing Jan 2038 NC4 that pays 4.73%. EMTN.

   

• Citigroup is working on a self-led fixed callable maturing Jan 2028 NC1 that pays 4.75%. EMTN.

   

• Citigroup is working on a self-led fixed callable maturing Jan 2025 NC1 that pays 4.3%. EMTN.

   

• Bank of America is working on a self-led $25m fixed callable maturing Jan 2028 NC2 that pays 5.25%. EMTN.

   

• Credit Agricole is working on a self-led $50m fixed callable maturing Jan 2028 NC2 that pays 5.25%. EMTN.

   

• CIBC  is working on a self-led fixed callable maturing Jan 2026 NC1 that pays 5.15%. Domestic MTN.

   

• CIBC is working on a self-led fixed callable maturing Jul 2024 NC1 that pays 5.05%. Domestic MTN.

   

• Toronto Dominion is working on a self-led fixed callable maturing Jul 2025 NC1 that pays 5.25%. GMTN.

   

• Royal Bank of Canada is working on a self-led fixed callable maturing Jan 2028 NC2 that pays 5%. GMTN.

   

• Royal Bank of Canada is working on a self-led fixed callable maturing Jul 2025 NC1 that pays 5%. GMTN.

   

• Royal Bank of Canada is working on a self-led fixed callable maturing Jan 2033 NC5 that pays 5.2%. GMTN.

   

• Royal Bank of Canada is working on a self-led fixed callable maturing Jan 2025 NC1 that pays 5.1%. GMTN.

   

• Bank of Montreal is working on a self-led fixed callable maturing Jan 2026 NC6m that pays 5.25%. Domestic MTN.

   

• Bank of Montreal is working on a self-led fixed callable maturing Jan 2028 NC1 that pays 5.4%. Domestic MTN.

   

• Bank of Montreal is working on a self-led fixed callable maturing Feb 2026 NC6m that pays 5%. Domestic MTN.

   

• Standard Chartered is working on a self-led $50m fixed callable maturing Jan 2028 NC2 that pays 5.48%. Domestic MTN.

   

• Jefferies is working on a self-led fixed to floating note maturing Jan 2043 NC3 that pays 7% to Jan 2026, then pays ICE SOFR5y +2%, capped at 8% and floored at zero. Domestic MTN.