USD Swaps: Headline trading rules amid end-week exhaustion; Liquidity assessed

Headline trading set to see week out

The week that is at the beginning of its end right now was summed up by one USD swapper this lunchtime in one word. “Exhausting.” The trader said that it will stay that way until the markets shut this evening and into next week.

Looking at a late morning dart lower in yields that saw 10y yields shift from 3.55% to 3.47% in an hour, the same trader said that “I think Credit Suisse headlines about another slide in its share price spooked everyone and the market is obviously still very nervous, while liquidity today is terrible.” CS is -11% at the time of writing with most other large European banks around 1-3% lower,  led by Deutsche Bank. 

That said, he said that generally market liquidity (which Barclays looks at in the next section) this week “has not been great but the rates market got through it well enough and bid/offer spreads haven’t blown out to 10bps like they did in March 2020, but they’ve widened to 3bps… 4bps.”

The swapper is optimistic though that while the problems relating to the handful of banks that caught the eye in this risk-off week remain consequential, there are positives to take away for those hoping for a rapid return to normal trading.

“There’s been a deleveraging and positioning has proven painful for shorts in US rates. But if you look at the words of the Fed and the actions of the SNB they have been sensible and effective in calming things. However it doesn’t stop you from being tapped on the shoulder and told to sell shares in Credit Suisse, so in the short-term there is still scope for sharp moves across a range of things,” he said. Unlike in the 2008 financial crisis though, he noted that “funding markets are under no material distress.”

So far today the moves in fixed income have been emphatically positive, with 10y UST yields now battered 12bps lower by a barrage of anxious Credit Suisse and First Republic headlines, to 3.4575%, while Bunds are -12bps and gilts -14bps. The UST 2s/10s curve has flattened 2bps while 10s/30s has steepened 4bps while 5y, rather than 2y, is the strongest area of the curve today. SOFR futures are up to 20bps stronger in the greens and back reds.

The spread curve has also headed lower with the 2y -1bps at -2bps, 5y is little-changed at -17.5bps, 10y is -0.25bps at -24.5bps and the 30y is -0.5bps at -71.25bps. First IMM FRA-OIS has popped 8bps wider but EUR/USD 3m cross-currency basis is only 3bps lower.

Looking at the strategies that will come into play for the remainder of the day as trading desks look to their positions going into the weekend, the above swapper said “I think everyone’s going to look at the headlines and play it by ear.”

Barclays: Liquidity worsens, promoting futures over cash 

Flash panics such as the one triggered by SVB just over a week ago, can often put liquidity under pressure across a range of markets, including even USTs. Strategists at Barclays today say that this has been the case this time round, serving to highlight what it sees as a long-term problem.

The sharp risk-off rally in Treasuries this week repriced the Fed’s tightening cycle, with the expected terminal rate falling back below 5.0%, Barclays notes. “Treasury yields declined across the curve, led by the front end, with 2y yields falling as much as 60bp on Monday, the largest recorded daily move that we have seen in some time. Treasury liquidity conditions are deteriorating, albeit unevenly across an array of liquidity metrics.”

Looking at how this plays out on the curve, Barclays said that “most of the increases in the spline errors are occurring at the front end in the under 3y sector, as well as the 20y sector (11- 21y).”

Among the tell-tale signs, and consequences, of this liquidity problem, Barclays highlights:

• "The increase in dispersions at the 0.25-2y sector are benign compared with last year’s highs, but those at the 2-3y sector appear elevated. This suggests potential pressure from sales of short dated Treasuries by banks. Other components of the proxy also show some worsening, such as cash underperforming corporate CDS basis, and cross-currency basis spreads widening (ie, more negative).

   

• "Front-end dislocations can also been see on the Treasury asset swap curve (vs. fed funds OIS), where most of the cheapening in Treasuries (ie, spread tightening) is occurring.

   

• "Bid-ask spreads for benchmark tenors have been well behaved across the curve during this risk-off move. However, off-the-run tenors are seeing wider bid-ask spreads across the curve, particularly at the front end (2s and 3s), where Treasury yields have rallied the most as the curve steepened. Higher transaction costs would likely dis-incentivize investors from arbitraging the Treasury dislocations, as it reduces the attractiveness of these opportunities because it raises the breakeven or hurdle for investors. As a result,
• these dislocations generally tend to persist.

   

• "Lastly, the futures basis shows Treasury futures richening relative to cash using the implied vs. term repo spread. For context, in March 2020, the implied vs. term repo spread was as wide as 50-100bp across the curve, which suggest futures were rich to cash, whereas it is currently less than 30bp."

“Overall,” concluded Barclays, “Treasury liquidity conditions are deteriorating, albeit unevenly across an array of liquidity metrics, long-basis positions came under immense pressure, exacerbated by the unwind and stop-out of leveraged positions.”