USD Swaps: Flatter and wider as Yellen pledges to vaccinate small banks

Flattening and wider as Yellen pledges to vaccinate small banks

Treasuries are bear-flattening on the back of a 12-16bps selloff at the front end of the curve in early trading today as Treasury Secretary Janet Yellen prepares to tell the American Bankers Association that “similar actions (to SVB) could be warranted if smaller institutions suffer deposit runs that pose the risk of contagion.” Previous reports have suggested that the authorities have been studying whether they can “temporarily” expand FDIC insurance to cover all deposits. Among the regional banks, First Republic shares are +14% in pre-market trading while S&P futures are +0.8% and the VIX is down another 1.3 points to 22.9. UBS is +5.8% and its CDS are 20bps tighter although at 150bps they are still double the level seen pre-crisis.  

With the FOMC decision approaching, Fed funds futures are pricing an 80% chance of a 25bps hike while SOFR futures are down are much as 25bps in Jun23 and 30bps Jun24 as the market reprices the Fed (again) as market conditions ease.

Similarly, swap spreads are wider amid paying into the selloff with 2s at +1.0bps (+2.00), 5s at -17.50bps (+2.00), 10s at -24.50bps (+1.75) and 30s at -71.75bps (+2.00). Ahead, Citigroup favours positioning for more spread widening.

“We think paying in swap spreads in the US in front-end/belly looks attractive. In our view, there are increasing risks that the Fed could end QT early either due to the cycle turning or, more likely, to relieve stress in the banking sector. For example, the current challenge for the financial system is one of reserve distribution, not necessarily the outright level of reserves. Overall, small banks have lost more reserves, on a percent basis, than large banks. If QT ends early this would reduce T-bill supply, ~$400bn for CY23 based on our original base case. This would also reduce the risk that Treasury would need to increase coupon auction sizes at some point.”

 

“The BTFP facility also helps limit tail risks for spreads if small banks need liquidity, for example they would lend to the Fed instead of selling securities. Finally, larger banks who may have gained some deposit inflow in the past few weeks may look to buy front-end asset swaps, perhaps in the 3y to 5y sector which can earn them higher than IORB. Risk to spreads remains a risk-off event – this could especially hit long-end spreads although they have been relatively well supported over the past few weeks except for 20y which has cheapened against the spread curve.”

Today, SOFR swap volumes are moving up to above average and strongest in the 3y to 7y buckets as the market awaits the return of issuance. The CDX IG CDS index is 4.5bps lower and EUR/USD 3m cross-currency basis is 7.5bps tighter at -21bps, versus around -10bps shortly before the SVB collapse.

Ahead, some analysts remain wary and it remains unclear whether their caution will be overtaken by a swift market recovery. Barclays highlights the “massive” equity-bond disconnect seen last week and plays down any talk of emergency Fed easing.

“At this point, US rate cuts only make sense if there is an imminent recession coming. Equity markets are not pricing that, and we believe stocks have the more correct view.”

Still, the bank acknowledges that recent events will have a lasting impact on the banks and beyond:

“Central banks will have to factor in the impact of a credit crunch after recent event. For example, in the US, regional banks are a big provider of credit to smaller businesses. But a credit crunch is not a financial crisis, and central banks want to slow things down”

And just as hedge funds with short positions begin the grim task of updating investors on their performance this month, Barclays highlights the example of a past crisis: “LTCM is a good example of when a near-systemic crisis left the economy unaffected.” Barclays concludes:

“Our baseline is for some of the front-end rally to reverse, but headlines are too fast and uncertain. After the sale of CS, the focus is likely to shift back to US regional banks. Moreover, bond market liquidity is shockingly poor, and it is not clear that all unwinds are done. We recommend staying in cash or as close to their benchmarks as possible for now.”