USD Vol: Rally ensues with risk-off whiffs; Vols down, but supported

Price charts 25 Nov 2021
The front end of the curve rallied hard this afternoon amid fresh lows in banking stocks. Vols are lower, but appear decently supported.

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  • Rally ensues with risk-off whiffs; Vols down, but supported

  • Payer timing can be punishing at the end of hiking cycle - Citigroup

  • New structured notes


    Rally ensues with risk-off whiffs; Vols down, but supported

    Treasuries have pushed higher with the 2y note yield dropping up to 18bps lower to 4.893%, and sources are pointing to banking stock weakness as a possible driver in the wake of SVB losses. The price action has whiffs of something is being unwound that is “not visible to all to all to see,” considered one source. Though yields are lower, the reasons for the rally appear to be more risk off. The vols surface, while off the highs of the day, has been relatively well supported in the face of the underlying rally.


    3m expiries are last around unchanged on the right side and up to 2.5 normals lower on the left side while 6m to 1y expiries are down around 1 to 3 normals, also led by the left. In addition to the weakness in banking stocks, sources note that the market’s outsized reactions to secondary data – like today’s initial jobless claims – is attention grabbing.


    “With the sensitivity of the market to 2nd tier data and the cracks forming in certain banking sectors, it feels like vol should remain supported in the near team,” one trader suggested, though he added that his conviction level remains low.


    In interbank activity today, 1m5y traded at 154bps and 155bps, 6m5y traded at 342bps, 1m10y dealt at 251bps, 1y10y dealt at 754bps and 755bps, and 6m10y at 554bps, 3m30y at 760bps and then traded down at 755bps, according to the SDR.


    In the ULC, 3m2y traded at 112bps, 1y1y traded at 111bps and 112bps, 6m1y versus 1y1y traded as a switch at 73bps and 112bps, respectively, and 2y2y versus 2y10y dealt at 290bps and 1020ps, respectively, according to the SDR.  In butterflies, a 1m30y/3m30y/6m30y traded at 452bps, 759bps and 1053bps, respectively, and a 1y10y/18m10y/2y10y traded at 753bps, 903.5bps and 1018bps, respectively. In vega, 5y10y versus 10y10y may have dealt at 1393bps versus 1624bps.


    As for skew, 3m5y 50bp each way risk reversal may have dealt at +8bps and a 2y1y 100bp each way risk reversal may have dealt at +5.25bps. Elsewhere, a 2x3 2y1y wedge may have dealt at a spread of 19.5bps (158bps versus 138.5bps), according to the SDR.


    For USD option trades on the SDR see here and for volumes please see here.  



    Payer timing can be punishing at the end of hiking cycle - Citigroup  

    Analysts at Citigroup recently delved into payer skew and hiking cycle dynamics.  Examining the relationship of the 3y3y swap rate around the last rate hike in the previous four hiking cycles, it finds that “on average, the 5y5y rate tends to peak about 2-3 months before the last rate hike.”


    Citigroup sees generally “significant upside for payers when entering 6 months before the last hike+” though with the 2018-2019 cycle “seems to be the exception.” On the other hand, Citigroup points out “payers look less attractive when entering 3 months prior to the last hike, as some structures further out the curve (such as 1y10y, 2y10y and 2y30y) average negative returns.” Indeed, it notes that “this is consistent with the pattern we have seen in 5y5y which has historically peaked about a couple of months ahead of the last hike.”


    And given the uncertainty around the timing of the last hike of the cycle, Citigroup “replicated the analysis for payers from the last hike to 1 month after to estimate how costly it was to get the timing wrong” and it finds that “in all of the last four hiking cycles, forward rates rallied significantly after the last hike, undoing most of the pnl investors would have made on payers during the 3 months before the last hike.”


    Thus “while payers in the very front end of the curve outperform right into the last hike, the downside of holding them even only a month after the last hike is greater,” Citigroup concludes. As a result, the bank stresses that “entering payers in the late stages of the hiking cycle requires investors to perfectly time the last Fed hike, a challenging feat that makes being short duration a potentially dangerous proposition at this point in the cycle.”



    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 Mar 2033 and is callable annually starting Mar 2024. Lead N/A. Estimated IRR 6.89%. Announced Mar 9.


    • Bank of America is working on a self-led step-up callable maturing Mar 2030 NC1 that pays 5.45% to Mar 2025, 6% to Mar 2028 and 7% thereafter. Domestic MTN.  


    • Bank of America is working on a self-led fixed callable maturing Mar 2026 NC3m that pays 4.9%. Domestic MTN.   


    • Credit Agricole is working on a CMS-linked note maturing Mar 2035 NC3m that pays a coupon tied to CMS30y, capped at 8% and floored at zero. EMTN.


    • HSBC is working on a self-led $31.2m fixed callable maturing Mar 2028 NC1 that pays 5.88%. EMTN.


    • Bank of Montreal is working on a self-led fixed callable maturing Mar 2028 NC6m that pays 5.3%. CD format. Domestic.


    • Societe Generale is working on a self-led $40m CMS linked note maturing Jul 2028 NC3 that pays CMS1y +1.6%. EMTN.