Vols rise with underlying selloff; ULC leads
Treasuries have sold off, with a meltdown that began after the weaker than expected 30y auction (3.1bps tail). That said, the front end has taken the reins of the selloff with the 3y swap rate leading the realized move at 9.3bps higher on the day.
The vol surface began the session lower, with 3m to 1y expiries down 0.5 to 1.5 normals around mid-morning - reflecting what was then an underlying UST rally. However, with USTs selling off, vols are now back higher, led by the upper left corner. The ULC seems to have encapsulated “nervousness over next week’s CPI,” surmised one trader.
On the right side, vols are lagging with gamma points on longer tails down around 0.25 to 0.5 normal, to which one source suggested that the vol market is “convinced of the range in the 10y.”
Interbank activity was on the lighter side. 6m1y last dealt at 59bps and was offered on the follow, 1m5y traded at 117bps and 116.5bps, and in longer expiries, 10y10y traded at 1516bps,1510bps and 1508bps, according to sources and the SDR. In switches, 3y1y versus 2y1y dealt at 151bps and 130ps, respectively, 1y30y versus 6m30y dealt at 1282bps and 928bps, respectively.
In CFS, a 5x10 0% floor dealt at 52bps and a 1x3 ATM traded at 133bps versus a 200bps high at 29.5bps, sources say.
Carry efficient 1y10y short with 10y paying position – JP Morgan
Despite the rebound in volatility Friday after NFP, analysts at JP Morgan finds that overall “volatility has fallen sharply, even controlling for the decline in rates.” With this, JP Morgan stops out of its long gamma view that it had going from the start of the year.
Examining an attribution of the YTD performance of long gamma positions by risk factor, JP Morgan finds that “the main driver of returns has simply been the decline in implieds.” In other words, the bank suggests that the market appears to be in an environment “where the outlook for returns on delta hedged straddle positions is largely determined by the outlook for implieds, which themselves are (to a considerable extent) at the mercy of rates.”
The importance of rates as a driver of implieds “stems from the fact that implied basis point volatility is known to exhibit a strong correlation to rates at both low and high rates, with diminished correlation in between,” JP Morgan explains.
As for what this means going forward, JP Morgan considers:
- ”First, it means that if rates rise, implieds will likely increase as well. With our economists now penciling in an additional hike, and with our Treasury strategists now expecting a rebound to higher yields, implieds could somewhat go higher from here as well.
"Therefore, while we stop out of our long gamma recommendations and turn neutral, in deference to the considerable underperformance of our previously bullish stance, we would also caution investors against positioning for a continuing downdrift in vol. This is especially so because implieds remain below our estimates of fair value even if we assume rates will not deviate from the forwards.”
“But an even more interesting implication, given the continuing vol-rate correlation and given the positive carry in short duration positions, is that short vol positions are a positive-carry way to express a lower rate view, while short duration positions are a positive-carry way to position for higher rates.
With this backdrop, JP Morgan finds that “a suitably weighted combination of a short delta hedged straddle, combined with a short duration hedge, should offer attractive carry while being well hedged.”
“For instance, thanks to the expected vol-rate correlation in the 1y10y sector at current yield levels, a long delta-hedged straddle still exhibits vega P/L that would be expected to resemble the characteristics of a 0.74 year long duration position” but “the straddle of course carries negatively.” In contrast, it notes “an outright pay-fixed swap that uses 9.1% of the swaption's notional would mimic the same duration exposure, but with positive carry.”
Therefore, JP Morgan recommends combining a short $100m 1y10y swaption straddle position (delta hedged actively), paired with a $9.1m notional pay-fixed 1y10y swap position, “as an attractive way to earn carry from selling volatility while also hedging the upside risk to vols stemming from higher rates.”
New structured notes
For a complete review of USD MTN activity over the past week, please see USD MTNs.
- IADB is working on a $50m fixed callable via WFS maturing Feb 2033 NC2 that pays 5.15%. GMTN.
- Societe Generale is working on a self-led fixed callable maturing Feb 2028 NC1 that pays 4.7%. EMTN.
- Societe Generale is working on a self-led fixed callable maturing Feb 2028 NC1 that pays 4.6%. EMTN.
- ING Bank is working on a $100m fixed callable maturing Feb 2028 NC3 that pays 5.25%. Lead N/A. EMTN.
- IBRD sold a $50m 10y NC2 fixed callable. The EMTN matures Feb 2033 and is callable annually starting Feb 2025 and pays a coupon of 5.15%. Lead WFS. Announced Feb 8.
- Bank of America is working on a self-led step-up callable maturing Feb 2030 NC1 that pays 5.1% to Feb 2026, 5.5% to Feb 2028 and 6% thereafter. Domestic MTN.
- Barclays is working on a self-led fixed callable maturing Feb 2028 NC2 that pays 5.25%. GMTN.
- Credit Agricole is working on a self-led $20m fixed callable maturing Feb 2028 NC3 that pays 5%. EMTN.
- Credit Suisse is working on a self-led fixed callable maturing Feb 2024 NC2m that pays 6.4%. Also puttable. EMTN.
- CIBC is working on a self-led fixed callable maturing Feb 2029 NC1 that pays 5.15%. GMTN.
- CIBC is working on a self-led fixed callable maturing Feb 2033 NC1 that pays 5.25%. GMTN.
- RBC sold a $20m 15y NC4 fixed callable. The EMTN matures Feb 2038, is callable annually from Feb 2027 and pays a 5.405% coupon. Puttable in May 2023. Self-led and announced Feb 8.
- Greensaif Pipelines plans a USD 19y amortizing Formosa with a WAL of 18y at around around Treasuries +305bps via BNPP (B&D), HSBC, JPM and Citi, plus FADB, MUFG and SMBC Nikko. It also plans a 15y at around +275bps and a 10y Sukuk at +240bps.
- Standard Chartered Bank sold an $100m 5y NC3 fixed callable. The EMTN matures Feb 2028, is callable annually from Feb 2026 and pays a 5.03% coupon. Self-led and announced Feb 9.
- Bank of Montreal is working on a self-led fixed callable maturing Feb 2028 NC6m that pays 4.65%. CD format. Domestic.