Vols, rates swing around; Chasing delta
CPI added to a retracement from the nosebleed levels in USTs that began overnight. After the unprecedented moves yesterday, the front end saw a selloff of around 30bps in 2y and up to 50pts in front EDs earlier as still high fluctuations rocked the market.
The vol surface attempted to correct lower after the massive moves high yesterday that saw 1m expiries gain as much as 45 normals in a vacuum of liquidity. This morning 1m expiries were down around 10 normals on the left side, but since then 1m expiries have pushed back higher to around unchanged on the day, according to the screens. The upper left corner has continued to hold a bid compared to the right side with 3m expiries last around unchanged on the left versus around 4-5 normals on the right.
Meanwhile desks continue to scramble to get a hold of changes in positioning amid the large rate swings as even the smallest buckets of risk have seen significant shifts. Asked for market reflections, one source remarked “Honestly not much…(I’ve) been so tied up with delta.”
Interbank activity saw more flows than yesterday, with increasing activity this afternoon. Starting with the ULC, 1y2y dealt recently at 254bps, 3m2y earlier traded at 147bps (potentially versus 3m5y at 304bps), 1y1y traded at 138bps (potentially versus 1y10y at 837.5bps) and then at 135.5bps, and also traded at 132bps (potentially versus 2y1y at 170bps on a switch), according to the SDR.
Further to the right, 6m4y traded at 329.5bps, 1m5y traded at 204bps, 6m10y dealt at 625bps and then down at 615bps, 1m10y traded at 331bps at the start of the day and then last traded 310bps, and 1m30y traded at 554bps, according to the SDR.
In vega, 5y5y dealt at 877bps (potentially versus 7y30y at 3180bps), 7y20y dealt at 2481bps, 7y30y dealt outright at 3182bps last, 7y10y traded at 1607bps, and 10y10y dealt at 1700bps and then down at 1690bps. In a switch 5y30y versus 10y30y traded at 2890bps and 3485bps, respectively. And in a fly, 2y20y/2y25y/2y30y traded at 1671bps, 1898bps and 2098bps, respectively, according to the SDR.
In skew, a 3m10y 50bps each way risk reversal may have dealt at +2bps, payers over, several times, while 1m10y 30bps each way may have dealt at -7bps, receivers over.
Reasons to unwind long vol positions – JP Morgan
Pre-yesterday’s unprecedented moves, analysts at JP Morgan already favored unwinding their vol longs. “In the near-term, despite the prevailing flight-to-quality sentiment, we recommend turning neutral and unwinding long-volatility positions,” it recommended Friday.
For one, implieds rose “despite yields being sharply lower” and JP Morgan finds this “particularly notable given that vol-rate correlation (i.e. lognormality) continues to be strongly prevalent.” To be sure, the bank points out that “yields remain in a high enough regime for rates to exhibit lognormal behavior and for normal implied volatility to exhibit a strong positive correlation with yields.”
However, due to the risk-off tone in markets, “delta hedged straddles have outperformed and delivered positive returns, well exceeding the negative returns that would have been expected based on typical vol-rate correlations.”
Overall, JP Morgan finds that the past week's rise in implieds “alongside a sharp fall in rates is at odds with a lognormal backdrop” and “thus, should financial contagion fears subside as we expect, implied volatility could decline from current levels.”
Further, according to the bank’s fair value framework, it now “suggests that implied volatility is now at or above fair value in most sectors” which makes it “much more likely that this week's spike in volatility could reverse.”
Third, JP Morgan highlights that “implied volatility has tended to decline following a sharp rally in rates (defined as a decline of 27bp more in 2Y UST yields)” and “implied volatility has tended to rise into such events, but decline steadily thereafter” which of course “pre-supposes that the current decline in yields is not a harbinger of a broader financial contagion” - consistent with JP Morgan’s expectations.
New structured notes
For a complete review of USD MTN activity over the past week, please see USD MTNs.
- UBS is working on a self-led fixed callable maturing Jan 2025 NC4m that pays 6.5%. EMTN.
- Royal Bank of Canada is working on a self-led CMS-linked note maturing Mar 2028 that pays 6.86% for the first year, then pays 1y ICE SOFR+2%* days CMS2y/10y is greater than or equal to zero, floored at zero. EMTN.
- Ford Motor Credit is working on a fixed callable via InspereX maturing Mar 2025 NC1 that pays 5.8%. Domestic MTN.
- Dow Chemical is working on a fixed callable via InspereX maturing Mar 2033 NC6m that pays 4.9%. Domestic MTN.
- Dow Chemical is working on a fixed callable via InspereX maturing Mar 2028 NC6m that pays 4.6%. Domestic MTN.
- Dow Chemical is working on a fixed callable via InspereX maturing Mar 2053 NC6m that pays 5.6%. Domestic MTN.