USD Swaps: Front-end hit as First Republic gets lifeline; What contagion risk?

News that troubled First Republic is in talks to get a lifeline has ease some angst, hitting front USTs hard today. JPM sees no contagion risk.

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  • Front-end hit as First Republic gets lifeline; What contagion risks?  

  • Formosas & ZC Callables


Click here for SDR USD IRS trades.


Front-end hit as First Republic gets lifeline; What contagion risks?   

First Republic Bank stock was off 37% at one point this morning as it continued to circle the drain in the wake of this week’s increased banking angst.  But news that JP Morgan, Morgan Stanley and other big banks are in talks with First Republic to provide a lifeline has lifted the stock off its low – currently off 26% - as investors wait to see where the chips fall on the bank’s fate.


However, the ECB did not let a little nuisance like an impending financial crisis/contagion veer it off its course today.  To be sure, the central bank raised rates a full 50bps to 3.50% in an off-consensus decision (for more see Total Derivatives) as the dust has still not fully settled regarding the fate of Credit Suisse just yet.  Notably, even ECB President Lagarde herself called today’s hike “a bold move” in her presser, but one needed to combat inflation.


Against this backdrop, the major domestic equity indices have paired earlier losses and are now modestly in the green (Dow +0.37%, S&P +0.73%, Nasdaq +1.47%).  In rates, some of the recent financial angst is being wrung out of the front-end with the 2y note yield up 20.5bps at 4.095% while the 2s10s spread is 22bps narrower at -66.2bps.  SOFR futures are -3bps in the front reds but +7.5bps in the back greens while swaps spreads wider in shorter tenors and tighter further out with still no new IG activity in the screens.


More broadly, while markets have remained on edge all week as there’s been a loss of confidence in a few banks, strategists at JP Morgan believe that “fears of broader financial contagion are unwarranted and the current issues are isolated to banks with undiversified business models.”  Nevertheless, the bank believes that this week's risk-off tone “is likely to have somewhat lasting effects on the Rates markets,” for the following reasons:


    ”… First, smaller banks are likely to turn more cautious with respect to managing their liquidity positions. On the margin, this will likely mean growth in term funding such as FHLB borrowings, as well as higher deposit rates. This could on the margin result in upward pressure on Reserves relative to RRP balances.


    “…Second, although large banks are much more diversified and hold larger liquidity buffers, their appetite for duration risk in AFS portfolios will likely be lower on the margin, in light of recent events. To be sure, our view has already been that large banks will be very cautious regarding securities purchases for this very reason. Nevertheless, these banks are likely to turn ever more cautious with respect to AOCI-sensitive duration risk.


    “…Third, recent events could also make the Fed more cautious about accelerating the pace after having painstakingly managed a slowdown to 25bp rate hikes. In other words, the balance of risks surrounding the path of policy rates now likely skews towards a more modest 2-3 hikes of 25bp (our economists currently look for two), with a continuing bias towards maintaining those levels rather than a quick pivot to easing.”


Currently, SOFR swaps – 2s -1.25bps (+1.75bps), 3s -11bps (+2.375bps), 5s -17bps (-0.375bps), 7s -26.25bps (-0.625bps), 10s -24.25bps (-1.625bps), 20s-63.375bps (-3.25bps), 30s -69.625bps (-1.375bps)



Formosas & ZC Callables

  • Royal Bank of Canada sold a $10m 10y NC6 zero coupon callable (non-Formosa). The EMTN matures Mar 2033 and is callable annually starting Mar 2029. Self-led. Estimated IRR 5.41%. Announced Mar 15.