USD Swaps: Fraught, ugly, illiquid pounding aftershocks

down chart red 26 May 2022
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UST yields and EDs saw additional violence into the close. Sources fear additional dead bodies with the unknown causing angst.

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  •  Fraught, ugly, illiquid pounding aftershocks 

  • New issues

     

    Fraught, ugly, illiquid pounding aftershocks

    The dust has not settled on the massive moves in USTs since the shockwave of SVB’s collapse and the subsequent Fed/Treasury/FDIC liquidity backstop and the market ended with an ugly finish into the close. The KBW Banking Index lost 11.5% while First Republic banking shares are down 60.5%. Front ED Sep ended up a full 1.1% while front Dec is up 97pts. The 2y note yield is last 59.5bps lower at 4% while the 10y is down 16bps to 3.543%. Broader equity indexes ended with relatively minor gains/losses (DJIA -0.28%, S&P -0.02% and Nasdaq +0.45%)

     

    Looking at the debacle of SVB, one source remarked that while the concentration of depositors is unique, the fear is that “nobody knows and that is a probably not just them." Further, the source blamed the era of ultra-low rates, saying the current crisis "is a consequence of policy allowing rates to stay less than 2% in the long end.” Meanwhile, the Fed announced that it was launching an internal review of the supervision of SVB, with results to be released May 1st.

     

    Swap spreads plunged in the front end of the curve, with the 2y spread dropping more than 15bps intraday with an accelerating finish lower amid strong volumes. The lack of credit component in SOFR has been starkly illustrated in the past couple of sessions, sources note, and further, analysts at Barclays highlight that the “unwinding of SOFR shorts and a decrease in short interest in front-end Treasuries” has pressured short end spreads while they “have been largely directional with duration.”

     

    Ahead of CPI tomorrow - with economic data taking a backseat to the turmoil in the banking sector - the probability of a March Fed hike has morphed to a 64% chance of a 25bps hike and 36% of no hike, after seeing as much as 70% probability of a 50bps hike last week mid-week post-Powell.

     

    Meanwhile analysts at Citigroup believe that the uncertainty around bank balance sheets means that:

     

  • "The Fed likely goes 25bp instead of 50bp next week.

     

  • "Rate cut pricing in late 2023 and 2024 will likely stay persistent for now and we continue to like steepeners. Risk aversion will stay elevated until either recession risks subside, or investors feel that policy backstop is sufficient to cover up weakness in balance sheets. History suggests that once weaknesses in the financial ecosystem come to the fore, it takes time for them to recede.

     

  • "If the Fed wants to maintain a more hawkish Fed funds path if inflation surprises to the upside, they may need to end QT early to preserve reserves in the financial system. For example, their new BTFP facility is QE in another name – assets will grow on the Fed balance sheet which will increase reserves. Although technically they are not buying securities, reserves will grow. The facility does not address a key fact – deposit outflow risks may be non-linear as reserves fall during the most aggressive hiking cycle in Fed history."

     

    In the medium to longer term, “if our recession model turns out to be right and it is currently signaling a 68% probability of a recession in the next 12 months, then the reach for duration will re-assert itself” and “if investors start worrying about credit risks in the economy, the banking sector may not be out of the woods yet.”

     

    Thus, “the positive correlation between Treasury yields and bank sector performance will likely re-assert itself, which means that demand for Treasuries from the broader investor base will increase,” Citigroup asserts. 

     

     

    2s -11.25bps (-13.5bps), 3s -19.25bps (-5.25bps), 5s -24.75bps (-1.375bps), 7s -32.25bps (+0.5bps), 10s -28.375bps (+1.25bps), 20s -65.5bps (+0.25bps), 30s -72.5bps (-0.5bps).

     

     

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    For a complete review of issuance over the past week, please see USD New Issues.

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