USD Vol: Implieds flip back in lower; Thin conditions

Somersault flip 12 Aug 2020
Gamma is leading a move back in lower as rates bear flattened. The ULC continues to lead in both directions. JPM fades negative vol-rate correlations

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  • Implieds flip back in lower; Thin conditions   

  • Position for normalization of skew – JP Morgan

  • New structured notes


    Implieds flip back in lower; Thin conditions   

    Treasuries have sold off as the market appears to have moved on from focusing on First Republic’s continued woes (-21% today) for the time being - with yields up anywhere from 4 to 9bps amid a bear flattening move. The vol surface has contracted back in lower with gamma dropping around 3 to 8 normals, led by the left side, as has been the case in both rate directions.


    Trading has been thin with very little going through after the London close. 1y1 traded at 137bps and then down at 134bps and is last marked on the screen at around a 131bps mid. Although yesterday’s risk off move was much milder compared to March’s explosiveness, sources see still remnants of dislocations and scant liquidity.


    Meanwhile, dealers are working on the LIBOR to SOFR conversion that see some major milestones ahead, including the conversion of cleared vanilla IRS and basis swaps by LCH the weekend of May 20th.


    Outside of the vanilla world, the change to SOFR options has more complicated outcomes. For example, one source pointed out that “for some of the trades, like caps, the change is coming halfway through a fixing period” and all the details are “taking up more time” with sources unsure “what the PNL outcome is going to be.” As for end users, some are converting, compressing trades while others are relying on the fallbacks, a source noted.


    In interbank activity today, 3y10y traded at 1185bps and 1186bps and also dealt versus 3y30y as a switch at 1178bps and 2270bps, respectively, while 3y30y traded at outright 2276bps as well. 5y10y traded early on at 1410bps and 3m10y dealt at 407bps but is now mid around 394bps.


    In skew, 2y2y 100bp each way risk reversal traded at +12bps while a 3m5y 50bp each way risk reversal dealt at -7bps and then at -6bps, 1y5y 100bp each way traded at +4.75bps and some 2y30y 100bp each way risk reversals dealt at +60.5bps, according to the SDR.


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



    Position for normalization of skew – JP Morgan

    Analysts at JP Morgan highlight that the still negative vol-rate correlation is “lagging the broader normalization.” To be sure, the bank points out that “vol-rate betas tend to turn negative during times of crisis,” which is a “significant change from the positive correlation we have been experiencing due to lognormality as rates rose to higher levels over the last year.”


    To be sure, JP Morgan finds “the fact that negative vol-rate beta is still priced into skews creates an opportunity to position for an eventual normalization in this correlation.” In its analysis of 1y10y skew, the bank notes that “the receiver swaption skew richened considerably in response to the crisis, and is currently pretty close to flat” while “the payer skew similarly cheapened, and is flatter than pre-crisis levels.”


    As a result, JP Morgan finds the A-50/A+50 skew to be “about 0.6bp/day rich relative to an empirical reference.” Therefore, the bank recommends selling 1y10y 50bp OTM receiver swaptions versus buying 50bp OTM payer swaptions, and receiving fixed in the underlying swap to hedge the delta.



    New structured notes

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


    • Barclays is working on a self-led CMS steepener maturing May 2038 NC2 that pays 10% for the first two years, then pays 35*(CMS2y/30y), capped at 9% and floored at zero. EMTN.


    • Societe Generale is working on a self-led fixed callable maturing May 2025 NC6m that pays 5%. Domestic MTN.