USD Vol: ULC slips down lower amid UST bear flattening

ULC drives back down amid UST bear flattening

Bear flattening in USTs has been the dominant theme today, with front end swap rates realizing double digits to around 13bps while the back end of the swap rate curve is 6.5 to 8bps higher. Despite the uptick in realizeds, the move is well within the recent range, and the vol surface is seeing the ULC cheapen further while gamma on longer tails is also softer to a lesser extent. Vega points are close to unchanged to a touch higher. 

For example, 3m expiries are last around 1.5 to 6.5 normals lower, led by the left side, while 1y expiries are around unchanged on the right side to down 3.5 normals on the left. Looking toward the May FOMC, one source reckoned that the Fed goes 25bps and then “keep rates up there longer” - much longer than the market has priced in, he highlighted – “as inflation is sticky.” Meanwhile, he argued that an easing toward the terminal rate could be one that takes a much longer time frame – and if that is the case “then vols should come in.”

As for skew, the ULC skew remains receivers over for short expiries, with for example, 6m1y 100bp each way risk reversal trading yesterday afternoon on the SDR at -8.5bps. However, for pieces like 2y1y and 3y1y risk reversals, they are all payers over, and a trader remarked that “typically payer skew is higher” and thus the longer expiries reflect the more normal premium for payers.

In interbank activity today, 1y10y traded at 723bps and then down at 720bps, 6m5y versus 1y5y dealt as a switch at 330bps and 441bps, respectively, 6m10y traded at 525bps and also dealt as a switch earlier in the session versus 3m10y at 529bps and 374bps, respectively, and 6m30y traded recently at 942bps or around 1 normal lower. Further out the expiry curve, 3y10y traded at 1127bps, and in a possible fly trade, 3y10y/5y10y/7y30y traded at 1127bps, 1341bps and 2840bps, respectively, and 5y10y dealt this morning at 1345bps (the high of the day), according to the SDR. 

In the ULC, 3m1y traded at 59.5bps, 2y2y dealt at 278bps, and 1y2y traded at 220bps, according to the SDR. 

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

Vega systematic strategies performed poorly – Barclays  

Analysts at Barclays examine recent systematic long expiry vol strategy performance. “One common systematic protective strategy in the rates market is to hold long-expiry options on long tenor rates and roll them systematically.”

“But despite all the volatility in rates, this strategy barely delivered during the events of the past few weeks, mainly because the volatility was exclusively in short tenors to a degree never seen before,” the bank finds.

Barclays believes that “the lack of performance of long vol in longer tenor rates should be seen in light of low volatility in other asset classes like equities” and thus “while some long-rate vol investors have been disappointed in the performance, the episode underscores that longer-expiry rates options hedge against structural long-term risks rather than against events that just change the near-term path of Fed policy,” Barclays argues.  As a result, it views that “this is not necessarily a bad thing when it comes to the diversification properties of the strategy.”

However, at the same time, Barclays finds that “this kind of myopia is not justified if banking system stress evolves into a significant economic event, potentially caused by credit losses from non-rates asset classes.” Going forward, Barclays suggests “moves in long- term rates could be bi-directional, and long dated options offer value as a hedge against longer- term risks after the recent decline in volatility.” In the meantime, it believes that “the lack of new vol supply will remain an issue for the rest of 2023.”

With this vol-risk premium, and the retracement of longer-dated volatility, Barclays finds that short-gamma/long-vega structures in long tenors “look quite attractive.” Specifically, Barclays recommend buying 10y20y and 3m10y vs selling 3m30y straddles with equal notionals.

New structured notes

For a complete review of USD MTN activity over the past week, please see  USD MTNs.

• Asian Development Bank sold a $50m 20y NC5 zero coupon callable (non-Formosa). The GMTN matures Apr 2043, is callable annually from Apr 2028 and has an estimated IRR of 4.69%. Lead is JPM and announced Apr 14.

   

• DZ Bank sold a $50m 20y NC5 zero coupon callable (non-Formosa). The GMTN matures Apr 2043, is callable every year from Apr 2028 and has an estimated IRR of 4.89%. Self-led. Announced Apr 14.

   

• Barclays is working on a self-led fixed callable maturing May 2024 NC6m that pays 5%. GMTN.

   

• UBS is working on a self-led fixed callable maturing Apr 2024 NC6m that pays 5.05%. EMTN.

   

• UBS is working on a self-led step-up callable maturing Apr 2025 NC6m that pays 4.3% to Oct 2023, 4.55% to Apr 2024, 4.8% to Oct 2024 and 5.05% thereafter. Eurodollar.

   

• UBS is working on a self-led step-up callable maturing Apr 2024 NC6m that pays 4.6% to Oct 2023 and 4.61% thereafter. EMTN.

   

• UBS is working on a self-led fixed callable maturing Apr 2024 NC6m that pays 4.75%. EMTN.

   

• UBS is working on a self-led fixed callable maturing Apr 2024 NC6m that pays 5.06%. EMTN.

   

• Toronto Dominion is working on a self-led fixed callable maturing Apr 2025 NC6m that pays 5.4%. GMTN.

   

• Toronto Dominion is working on a self-led fixed callable maturing Apr 2028 NC1 that pays 5.65%. GMTN.

   

• Toronto Dominion is working on a self-led fixed callable maturing May 2024 callable Jan 2024 that pays 5.3%. GMTN.

   

• Toronto Dominion is working on a self-led fixed callable maturing Apr 2028 NC1 that pays 5.35%. GMTN.

   

• Bank of Montreal is working on a self-led USD extendible with initial maturity Apr 2024 and then extendible to Apr 2026 that pays 5.2% to Apr 2024, then pays 5.3% and 5.4%, stepping up annually. Domestic MTN.

   

• Bank of Montreal is working on a self-led USD extendible with initial maturity Apr 2024 and then extendible to Apr 2026 that pays 5.4% to Apr 2024, then pays 5.5% and 5.6%, stepping up annually. Domestic MTN.

   

• African Development Bank is working on a $50m fixed callable via WFS maturing Apr 2026 NC1 that pays 4.7%. GMTN.

   

• Standard Chartered is working on a self-led fixed callable maturing Apr 2028 NC2 that pays 4.7%. EMTN.