ULC sold; Right side down, but bounces from lows
In the wake of CPI, swap rates are anywhere from +2bp higher in the back end versus -5bps lower in the front end. The vol surface was quick to drop after the passage of the event, but the right side has come off the earlier lows. “As the curve sold off, the right side vol went bid,” a source highlighted. 3m expiries are anywhere from 2.5 to 12 normals lower on the day, led by the left.
1y1y is still above pre-SVB levels - but not by much - with it last around 150 annualized compared to around 135 annualized in the beginning of March. In comparison, on the right side, 3m10y, was already below levels seen right before SVB (around 125 annualized) and are now probing down further to around 113.5 annualized last. A source noted that a lot of the activity appeared to be “flow-driven."
In interbank activity, 10y and 30y tails led flows. For example, 3m10y traded at 386bps, 6m10y dealt at 536bps, and then up at 538bps, 1y10y dealt at 729bps, 3m30y traded as low as 664.5bps but then traded up at 671bps, according to the SDR. In vega points, 5y10y traded at 1341bps shortly after the CPI release, but then traded up at 1347bps later, 10y20y traded at 2439bps and 5y30y dealt at 2590bps, 5y5y dealt at 790bps, and 4y20y traded at 1903bps, according to the SDR.
In the ULC, 6m1y traded at 88bps and 88.25bps, 2y1y traded prior to CPI at 152bps. As for skew, 3y1y 100bp each way risk reversals traded at +9.5bps, 1y30y 100bp each way risk reversal dealt at +24bps and then +25bps and a 4y20y ATM versus 100bp low receiver traded at 951.5bps and 213bps, respectively, according to the SDR.
MBS hedging needs; FDIC and hedgers – Barclays
Analysts at Barclays delve into the changing needs of convexity hedging as MBS shifts hands and the potential vol hedging fallout from FDIC’s acquisition of MBS off the back of the “needs arising from sales of MBS that the FDIC acquired as part of the SVB/Signature Bank transactions.”
Barclays estimates that the FDIC sales related to SVB/Signature “would represent around a 20% increase in the expected amount of MBS taken down by money managers in 2023.” However, the portfolio “is composed mainly of lower-coupon mortgages, the duration of which has extended and which have close to zero convexity.”
That said, Barclays points out that the portfolio “likely has some sensitivity to implied vols (vega)” and it suggests that “even a small amount of vega hedging would be meaningful currently against a backdrop of constrained vol supply and the losses already suffered by vol sellers.” It estimates “up to $2-3mn bp vega of hedging needs (with a wide band of uncertainty) is plausible, spread out over time.”
Aside from the portfolio unwinds from SVB and Signature by the FDIC, Barclays warns that “the wider issue is that convexity hedging needs from the MBS universe are likely only to grow over time.” Indeed, the bank notes that “in addition to the Fed MBS portfolio running off, banks had already been running off MBS at a pace of around $250bn per year, and their appetite for longer-duration negatively convex assets could be lower, considering that deposit betas are also increasing.”
As a result, Barclays believes “this may mean more MBS ends up with hedgers” and it argues “potentially large sources of convexity hedging demand in the future should be priced into the shape of the vol term structure today, but this does not appear to be the case.” In other words, the bank finds that “the forward vol term structure over the first few years in 10y tenors is too downward sloping, and we think this presents an opportunity for those looking to buy cheap vega.”
New structured notes
For a complete review of USD MTN activity over the past week, please see USD MTNs.
- United Overseas Bank sold a $50m 20y NC6 zero coupon callable (non-Formosa). The EMTN matures Apr 2043, is callable annually from Apr 2029 and has an estimated IRR of 4.79%. Self-led and announced Apr 11.
- Toronto Dominion is working on a self-led fixed callable maturing Apr 2027 NC6m that pays 5.65%. GMTN.
- Toronto Dominion is working on a self-led fixed callable maturing Apr 2026 NC1 that pays 5.45%. GMTN.
- Toronto Dominion is working on a self-led fixed callable maturing Apr 2024 NC3m that pays 5.4%. GMTN.
- African Development Bank is working on a $25m fixed callable via WFS maturing Apr 2028 NC2 that pays 4.375%. GMTN.
- National Bank of Canada is working on a self-led $15m FRN puttable maturing Oct 2031 NC3 that pays O/N SOFR +1.48%. Puttable Oct 2023. EMTN.