USD Vol: Gamma in the belly leads a small bounce

Gamma in the belly leads a small bounce

Treasury yields have come off the morning highs after the softer than expected ISM data and swap rates are up to 4bps lower, led by the belly of the curve. After dropping every day last week, implieds are slightly higher, with the belly of the surface leading the move, following the underlying rate move.

3m expiries are anywhere from 0.3 to 3.5 normals higher on the day, after seeing a rise of 1.5 to 4 normals mid-morning.  Further out, 1y expiries are anywhere from roughly unchanged to up 2 normals while longer expiries are up around 0.2 normals.

Sources are scratching their hands over today’s bid in vol – “to be honest I have no idea,” remarked one source.  But perhaps after dropping in so much last week, the vol surface was due for a bit of a bounce now that levels look less elevated. Indeed, analysts at JP Morgan note, for example, that last week’s move in 3m2y - a decline of 2.8bp/day - was “the largest weekly decline since the Global Financial Crisis” while the bank notes that “delivered volatility continues to remain elevated as markets continue to exhibit large daily moves.”

Meanwhile, interbank activity has been light. 1y3y traded at 318bps, 2y1y dealt at 148bps, 1y10y traded at 734bps and 731bps, 1m10y dealt at 247bps, 1y30y traded 1395bps and also as a switch versus 9m30y at 1370bps and 1211bps, respectively, and more recently, 3m10y traded at 413bps, possibly as a switch versus 1y10y at 743bps, according to the SDR.  

In skew, 6m5y 50bp each way risk reversals traded at -8bps and 4m10y 50bp each way risk reversal traded at +5bps, according to the SDR.  

For USD option trades on the SDR see here and for volumes please see here.  

Further scope for vol normalization - BofA  

Analysts at BofA find that the fading of the vol highs “is just another sign that the worst-case scenarios around the recent bank stress episode are starting to fade.” Going forward, BofA sees "scope for volatility to continue to normalize from here," driven by:

• “Further fading of bank stress, which is likely to push gamma slightly lower and help fade some of the more aggressive scenarios for near-term Fed cuts, which in turn puts downward pressure on the left side of the grid.”

   

• “A market that refocuses on the medium-term outlook as the near-term stress fades. Our baseline continues to be for a slowdown in 2H23, and rate cuts only in 1Q24, which should help the process of normalization of the vol dynamic."

   

• “The Fed pivots decisively to an on-hold stance, which should drive the left side and gamma lower."

In terms of near-term significance, BofA believes the pecking order for these drivers is likely to be: “(1) a further fading of bank stress; (2) shift in Fed communication to an on-hold stance; and (3) a refocus on a slower macro backdrop for 2H23.”

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 inflation-linked note maturing Apr 2025 that pays CPI*spread between 1.55-1.85 for the first year, floored at zero, and then pays 4%. Eurodollar.

   

• Citigroup is working on a self-led fixed callable maturing Apr 2025 NC1 that pays 5.15%. EMTN.

   

• Citigroup is working on a self-led fixed callable maturing Apr 2033 NC18m that pays 5.4%. Domestic MTN.

   

• Deutsche is working on a self-led fixed callable maturing Apr 2026 NC2 that pays 5.01%. EMTN.

   

• UBS is working on a self-led fixed callable maturing Apr 2024 NC3m that pays 5.1%. Domestic MTN.

   

• Toronto Dominion is working on a self-led fixed callable maturing Apr 2038 NC1 that pays 5.75%. GMTN.

   

• Toronto Dominion is working on a self-led fixed callable maturing Apr 2028 NC1 that pays 5.5%. GMTN.

   

• Royal Bank of Canada is working on a self-led fixed callable maturing Apr 2026 NC2 that pays 4.9%. EMTN.

   

• Bank of Montreal is working on a self-led CAD extendible with initial maturity Apr 2024 and then extendible to Apr 2030 that pays 5%. Canadian.

   

• BMO Harris is working on a self-led fixed callable maturing Apr 2028 NC6m that pays 4.8%. CD format. Domestic.

   

• Standard Chartered is working on a self-led step-up callable maturing Apr 2026 NC1 that pays 4.13% to Apr 2024, 4.23% to Oct 2024, 4.33% to Apr 2025, 4.43% to Oct 2025 and 4.53% thereafter. EMTN.