10y tail gamma leads early directional selling
Treasuries are back to near unchanged on the day after seeing an earlier rally. The 10y note yield dropped to 3.34% but is last 3.39% or 2.4bps lower on the day. Vols were hit down this morning with the drop in rates, but have since come off the lows of the day. 3m expiries are last around -0.2 to -1.75 normals lower after seeing a softening of 1.5 to 2.5 normals earlier.
In the selling this morning, 10y tails led the move, a source noted, while the upper left corner lagged after seeing good selling yesterday. Trading activity was active in 10y tails, with 6m10y trading from 485bps this morning to 466bps then 464bps (versus 6m5y at 271.5bps), then back up to 470bps and last at 473bps. Similarly, 3m30y traded at 344bps, to 340.5bps (versus 3m5y at 197bps), down to 333bps (versus 6m10y at 464bps) and up at 337bps and now last at 338bps, according to sources and the SDR.
“Vols are following rates and as the rally abated, vol came back higher,” pointed out one trader.
Vega has also been hit today with some trades in long expiries. Despite the lack of vol supply in vega this year, vega has been mostly directional and following gamma moves, a source remarked and the relative dearth in zero coupon callable supply has not impacted the price action thus far. In today’s activity 10y10y traded at 1510bps and then 1508bps, and 10y5y traded at 873bps. Still, the missing supply in zero coupon callables is a significant “loss in revenue for dealer desks,” one source judged.
As for the ULC, 1y1y traded down to 89bps then down to 87bps, 2y1y traded at 120bps, 1y2y dealt at 179bps, 3m2y traded at 82bps, according to the SDR.
Elsewhere, 1y10y traded 670bps, 648.5bps, 652bps and is now around 654bps, sources say. In switches, 1y5y versus 2y5y dealt at 382bps and 524bps, respectively, and 9m1y dealt at 68.5bps versus a 9m12y caplet at 15bps, sources say.
Short credit risk financed by 6m5y payer sale - Citigroup
Analysts at Citigroup find that “a shallow recession seems to be a near consensus view for this year, and markets are pricing in FOMC rate cuts from July ’23 onward.”
“If this plays out, over 2H 2023 we are likely to see rates rally in a flight to safety, even as risky assets sell off,” Citigroup argues, and the bank recommends positioning for this via using options to go short credit risk while going long rates duration.
In the past year, Citigroup notes that “rates and credit spread correlations defied long-term trends last year to spike into positive territory” and “while spreads admittedly outperformed overall through the year, they still rallied and sold off in sync with rates for the most part.”
Going forward, the bank thinks this dynamic might reverse going into 2H 2023 and it sees the potential scenario of credit underperformance and rate outperformance in 2023 “is being underpriced by markets” and while levels have diverged between rates and credit, “volatility has diverged even more.”
Thus, it finds an attractive way for credit investors to short credit spreads without paying carry via buying “July ’23 expiry CDX IG payers to position for spread widening through the summer and finance this by selling SOFR 6m5y payers 50bp OTM.”
“The much higher level of SOFR volatility relative to that of CDX IG means investors receive 23c as premium at inception and the net theta is around +1.3c” which is “effectively a flat to positive carry way to position for spread widening.” And while the IG payer strike is higher than current spot, “it’s still a slightly ITM payer with respect to the forward price,” it points out. However, Citigroup favors “the higher delta that it helps us achieve on the spread leg to express a more bearish view on spreads since it is being financed by the SOFR leg.”
New structured notes
For a complete review of USD MTN activity over the past week, please see USD MTNs.
- Societe Generale is working on a self-led fixed callable maturing Feb 2028 NC1 that pays 5%. EMTN.
- Societe Generale is working on a self-led fixed callable maturing Feb 2026 NC1 that pays 4.6%. EMTN.
- Bank of America is working on a self-led fixed callable maturing Feb 2028 NC1 that pays 4.5%. EMTN.
- Barclays is working on a self-led fixed callable maturing May 2024 NC6m that pays 5%. GMTN.
- Credit Agricole is working on a self-led fixed callable maturing Feb 2028 NC1 that pays 5.2%. Domestic MTN.
- UBS Bank is working on a self-led $25m fixed callable maturing Jan 2024 NC2m that pays 5.52%. Credit linked. EMTN.
- Bank of Montreal is working on a self-led CAD extendible with initial maturity Feb 2024 and then extendible to Feb 2028 that pays 5.2% to Feb 2024, then pays 5.3%, 5.4%, 5.5%, and 5.6%, stepping up annually. Canadian.
- Bank of Montreal is working on a self-led CAD extendible with initial maturity Feb 2024 and then extendible to Feb 2028 that pays 4.95% to Feb 2024, then pays 5%, 5.05%, 5.15%, and 5.2%, stepping up annually. Canadian.
- Credit Industriel et Commercial is working on a $10m fixed callable maturing Feb 2033 NC3 that pays 5.5%. Lead N/A. EMTN.