USD Swaps: Bull flattening; Swap curve steepens; DL risks

Chart lines Oct 2022
USTs grinded higher and flatter while the spread curve steepened in response. FIG issuance pressured spreads. BofA sees real debt limit risks.

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  • Bull flattening; Swap curve steepens; DL risks

  • New issues


    Bull flattening; Swap curve steepens; DL risks

    Treasuries grinded higher and flatter as the session wore on. The 10y note yield is last 6.1bps lower at 3.46% while 5s30s is last 3.2bps flatter at +2.8bps while 2s10s is last 3.6bps lower at -75.6bps. The $42bn 2y auction was strong, drawing a rate of 4.139% or 1.6bps through the 1pm bid side. Equities closed mixed (DJIA +0.31%, S&P -0.04% and Nasdaq -0.27%).


    The stats for the auction included higher indirects (65%), unchanged directs from the month earlier (18.7%) and primary dealers saw a smaller share of 16.3% while the bid-to-cover was a strong 2.94x.  


    IG new issuance saw $9.25bn price and included $4bn in FIG supply (a $2.5bn 2-part from Bank of Nova Scotia and a $1.5bn 2-part from Bank of NY Mellon). Swap spreads tightened in with the pricing of the deals, but then the long end drifted out wider against the underlying flattening move amid mostly lower volumes outside of the wings. 


    Turning to the debt limit (DL) issue, analysts at BofA find that the Treasury’s tentative X-date of June 5th that was announced last week “comes ahead of our projected X-date sometime in July or August, it likely results from large outflows typically seen in the first two business days of June” and the bank suggests that “Treasury is likely penciling in a larger deficit forecast than we currently project.”


    “Notably, during the previous debt issuance suspension period, Secretary Yellen initially warned of hitting the X-date roughly 3 weeks before the ultimate X-date” and thus BofA therefore assumes that Treasury is “being conservative in their expectations and, while risks are skewed to earlier, we now project an X-date sometime in July or August.”


    On the trading front, BofA believes that “the recent mini-surge in bill supply cheapened the front-end, as they expected and “is a case study for the much larger bill surge post DL resolution.” The surge in bill supply has also likely increased dealer UST holdings and “resulted in a meaningful increase in SOFR volumes” and BofA believes increased dealer UST holdings and higher SOFR volumes “should also push SOFR higher vs ON RRP.” Further, these dynamics have also resulted in a drop in ON RRP that BofA  expects “will hold until Q2 bill supply cuts." After the debt limit resolution, BofA  expects a similar set of market dynamics but expect to see larger magnitudes: 


      “We expect the post DL supply surge could be 4x bill supply in January and expect larger cheapening of bills and SOFR + a much larger drop in ON RRP use.”


    To best to play an X-date standoff or possible technical UST default, it recommends for Fed monetary policy response trade BofA likes:


      “Long SOFR swap receivers for Aug / Sep financed by selling receivers for Jun (similar expression in SOFR or FF futures), long duration in UST securities not expected to be impacted by technical default (i.e. May coupon payments).” Overall, BofA continues to believe DL default risks “are a very compelling reason the market will not be able to credibly fade the extent of Fed rate cuts in 2H '23 until there is a debt limit resolution.”


    Currently, SOFR swaps 2s -2.25bps (-0.5bps), 3s -13.5bps (+0.25bps), 5s -23.75bps (-0.125bps), 7s -31.625bps (-0.375bps), 10s -32bps (unch), 20s -60.5bps (+0.875bps), 30s -66.5bps (+0.625bps).



    New issues


    • Colombia launched a $1.8bn 11y benchmark via BBVA, ITAU and JPM.  Baa2/BB+.  7.6%.


    • Bank of Nova Scotia launched a $2.5bn 2-part ($1.25bn 3y fixed and $1.25bn 7y). Leads DB, BofA and Scotia.  A2/A-/AA-.  +93bps and +135bps. It dropped plans for a 3y FRN.


    • Manufacturers &Traders Trust launched a $3.5bn 3-part ($1.3bn 3y, $1.2bn 5y and $1bn 11y NC10). Leads Barclays, BofA (B&D) and MS. A3/A-/A on 3y and 5y and A3/BBB+/A on 11y NC10. +85bps, +115bps and +160bps.


    • BNY Mellon priced a $1.5bn 2-part ($750m 6y NC5 and $750m 11y NC10).  Leads Barclays, BofA, BNYM and UBS.  A1/A/AA-.  +97bps, +125bps.


    • New York Life priced a $1bn a 10y FA-backed 10y deal via Citi, JPM and MS.  Aaa/AA+/AAA.  +110bps.


    • Ashtead Capital priced a $750m long 10y benchmark via BofA, Citi and JPM.  Baa3/BBB-/BBB.  +212.5bps.


    • IFC priced a $600m 3y FRN Global via BofA, BMO and WFS. SOFR +28bps.