USD Swaps: US traders pare risk-off bond rally

US traders crush risk-off bond rally

What could be the most significant week of the year so far began with a worrying fall in sovereign bond yields as (among other things) news of the liquidation of billions of dollars-worth of Credit Suisse AT1 bonds following the bank's shotgun wedding to UBS further sharpened flight-to-quality instincts at this key moment.

But after 2y UST yields dropped as much as 21bps by the time London traders got behind their desks, these thin, panicky moves reversed entirely and with New York traders now calling the shots, 2y UST yields are just -2bps at 3.81%, 10y yields are -2bps at 3.41% and 30y are unch at 3.62%.

A similar pattern has played out in EGBs while equities having opened weaker are now in positive territory across major markets, including the S&P future at +0.2% after its own early plunge.

But there is still a sense out there that this is going to be a long day. During this Monday any feeling that the UBS-CS transaction has ring-fenced most of the risk sloshing around the banking system, known or unknown, will be tested and – if history is a guide – could evaporate at any moment.

The latest point of concern arising from the Swiss news is the subordination of a large quantity of Credit Suisse AT1 bonds, such a rare occurrence that it seems people have forgotten that their disposability in times of stress is one of the reasons they pay high coupons in the first place.

Strategists (such as Soc Gen below) are proving quick to conclude that this cancellation is a one-off, noting that only UBS and CS have issued AT1 bonds that allow for a complete writedown of the assets, with AT1s in the EU and UK only eligible for either just a temporary writedown or compensation via an equity exchange.    

So while AT1 notes in Europe were aggressively sold today, while authorities such as the European Banking Association try to reassure that AT1s are not typically the first victims of these kinds of sudden risk events, over in the US the share price of First Republic Bank continued to gyrate keeping contagion fears in the US regional bank sector alive and kicking.

A helpful downgrade by ratings agency S&P accompanied by a warning that a $30bn deposit package put together by leading US banks would not solve all of its woes saw First Republic shares crash more than 30%, before partially recovering to -18%. Though on the plus side, some mid-size US bank shares have rallied pre-market, including New York Community Bancorp which just hours ago took over some of Signature Bank’s assets.    

So the myriad questions this week include; Can financial markets hold the line if no new bank tragedies emerge? And if they do emerge, will there be a proper collapse of market functionality? Will the Fed hike 25bps and message that they are pausing? If so what will this mean for inflation?  Will the Treasury have to extend the FDIC's insurance scheme? And will UBS find any new unpleasantness under Credit Suisse’s bonnet?

In swap spreads, at the time of writing, the 2y is -0.25bps at -4.25bps, 5y is -0.25bps at -19.00bps, 10y is -0.50bps at -26.25bps and 30y is +0.50bps at -72.00bps. And as for the reversal in UST direction today, some reports say it is a function of this morning’s rally failing to break resistance. Maybe, just maybe, the US is simply saying ‘that’s it. Storm in a teacup is now officially over.’

SocGen: Turmoil changes rate landscape

Writing earlier today, strategists at SocGen said that while the writedown may increase investor concerns and impact the valuation of AT1 capital for other European banks, it believes that investors "will come to see this as a peculiar ‘Swiss Finish’ and confidence in such instruments will not be affected in the long term.”

Continuing, SocGen looks at the big picture in terms of the FOMC and the USD. It says “the long and short of last week is that the rise in the cost of capital and market turmoil is causing financial market conditions to tighten. The question for central banks who are desperate to rein in inflation is how much the crisis will affect economic confidence and if so, will it help in their quest to rein in inflation? Markets respond with a resounding yes. The Fed will try to answer the question when it (meets) tomorrow and Wednesday. Terminal rate expectations have collapsed on both sides of the Atlantic and rate cuts have been brought forward.”