Smaller realizeds vs. a big move risk; Gamma bounce
Treasuries are off the morning lows and climbing higher, led by the back end of the curve in advance of next week’s month end. Lower realizeds and a tighter range has marked today’s session thus far, with yields -0.5 to +3bps changed on the day. The vol surface, however, has found a bit of a floor after cheapening for the past three consecutive sessions. ULC is seeing a little bounce, for example, with 1y1y trading back up to 91bps after trading down on good size yesterday at 90bps.
Still, despite this week’s cheapening, one source believed gamma could go lower still in the coming weeks, especially after the FOMC event. “The bp/day are still pretty high in some parts of the surface and I think that some are still wary of a big move” and thus are pricing in some premium for that outcome, he suggested.
However, the realizeds moves are lower and that will make the cost of carry “increasingly prohibitive” if there aren’t days of “double digit moves” to compensate the more range-bound days, he considered, adding that “the lower realizeds this year has been one reason why vols are lower” thus far this year.
In interbank activity in the ULC - aside from the 1y1y at 91bps - 1y2y dealt at 183bps (after trading at 181bps yesterday afternoon), and 3m2y dealt at 87bps. Further to the right, 1m5y traded at 120.5bps and 6m5y dealt at 293bps and 294bps, and 1m10y dealt at 217bps, according to the SDR and sources.
In OTM, a floor ladder, 3x4 0.75%/1.75%/2.75% may have traded on $250m each at 15.5bps, 37bps, and 77bps, respectively, according to the SDR. For more, please see SDR trades.
Skew views – Citigroup
As implied vols declined amid the rates rally, Citigroup highlight that receiver skews in general have started to cheapen. In particular, the bank sees the cheapening in receiver skews on front-end rates “the most interesting” because it has been one that the bank has been arguing for strongly. To be sure, “the cheapening in left-side receiver skew is justified given that the implied vols have been trading well below what the skews were suggesting just a month ago,” Citigroup stresses.
Indeed, the bank still believes that “left-side receiver skews should not be trading above payer skews until we are much closer to the rate cut scenario” although Citigroup also acknowledges that ahead “the rate/vol directionality probably will not be as positive as it has been in recent weeks.”
In contrast, Citigroup finds that “the cheapening in receiver skew on long tails has caused right-side risk reversals to appear even more steep than they should be” and for example, “the 1y30y payer-receiver skew stands out as being extremely elevated relative to its rate/vol beta.”
As for skew trades, Citigroup sees opportunities to own bearish options “where the rate carry would more than cover the cost due to the extremely wide forward-spot rate rolls” especially, in upper-left “given the combination of aggressively dovish pricing for the Fed and the sharp decline in implied vol.”
For example, the bank calculates that the 3m1y ATMF/A+25bp payer spread “currently costs around 10bps running premium and the forward-spot rate roll is roughly 13bps” which is explains is essentially “a limited downside hedge for a hawkish Fed or simply a longer than expected rate pause where the carry could potentially more than pay for the position.”
New structured notes
For a complete review of USD MTN activity over the past week, please see USD MTNs.
- Societe Generale sold a $10m 10y NC1 zero coupon callable (non-Formosa). The EMTN matures Feb 2033 and is callable annually starting Jan 2024. Lead N/A. Estimated IRR 6.26%. Announced Jan 27.
- Citigroup is working on a self-led fixed callable maturing Jan 2028 NC1 that pays 5%. Domestic MTN.
- IBRD is working on a $50m fixed callable via Barclays maturing Feb 2028 NC3 that pays 4.075%. GMTN.
- Royal Bank of Canada is working on a self-led fixed callable maturing Feb 2033 NC3 that pays 5.25%. GMTN.
- Bank of Montreal is working on a self-led CAD extendible with initial maturity Feb 2024 and then extendible to Feb 2028 that pays 4.9% to Feb 2024, then pays 5%, 5.1%, 5.2% and 5.3%, stepping up annually. Canadian.