USD Swaps: Bunds lead way as USTs bull-flatten

Fly 26a Aug 2020
The last session before a three-day weekend in Europe saw Bunds lead the way. As they bull-steepened, USTs bull-flattened. HSBC eyes flies.

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  • Bunds lead way as USTs bull-flatten

  • HSBC: Chasing flies in overpriced 2y-3y sector


    Bunds lead way as USTs bull-flatten

    The last session before a big three-day weekend across Europe saw Bunds lead the way, as a week flecked with intermittent sell-offs linked to potential strong growth and persistent inflation on both sides of the Atlantic was offered some relief by a double digit drop in yields in the front end of the German government bond curve after weak data.


    Q1 German GDP flat-lined instead of growing 0.2% as forecast, and this took some of the hawkishness out of ECB hike bets and bull-steepened the Bund curve. It makes no difference to US rate expectations but has given longer-dated sectors such as the 10y a chance to claw back some of the 15bps rise in yields since Wednesday.  


    Thus, as the US digests a raft of second-tier data releases (everything from PCE to the Employment Cost Index and personal spending data came in on, or close to, forecast for a change today), the curve has bull-flattened with the 10y yield currently down 6.6bps at 3.455% (Bund yields are -8.5bps) as that sector took the bulk of short-covering interest either side of the data.


    The 2s/10s curve flattened 5.6bps to 60.5bps while 2s/30s flattened 6bps to 36bps. In swap spreads with issuance predictably inactive spreads are lightly mixed, with the 2y ASW currently -0.25bps at +0.5bps, 5y is +0.125bps at -20.75bps, 10y is +0.375bps at -28.375bps and 30y is +0.375bps at -70.25bps.   


    Looking ahead, with Europe shut on Monday all drivers are likely to be domestic which in this case means the set of ISM data that comes out on Monday morning. Meanwhile there is still today’s close to get through and as UST traders are often keen to note on a Friday morning, anything could happen although the current mood and recent price action, as well as the European holiday, might just favour short-covering into the close.                                                                                                                                       


    HSBC: Chasing flies in overpriced 2y-3y sector

    Strategists at HSBC today took a look at the UST curve and decreed that the 2025 and 2026 maturities are too expensive from a curve perspective, and recommended fly trades to take advantage of this.


    HSBC said that “the UST 2025-2026 sector is too rich” and suggested:

    • Selling this sector of the yield curve versus the one- to five-year sector offers attractive value given its recent richening versus the interpolated yield curve.

    • A combination of the short and longer maturity issues diversifies the relative value view and reduces the net sensitivity to any changes in the yield curve’s slope.

    • A proceeds and duration weighted risk spread could tighten 4 to 10bp based on their recent ranges; the trade ideas also offer a circa +20bp yield pickup.


    Looking in slightly more detail, HSBC added that “. Given the bowing in of the yield curve (and using the example of the June 2025 maturity UST), investors can pick up yield by selling it versus buying the wings of various one- to five-year maturity barbells. he projected return for the wings assuming an unchanged yield curve is +20bp over a threemonth holding period. This reflects the interest earned and the price impact of the significant roll up the yield curve in the 2025 maturity versus the wings.”


    And edging a little further along the curve, HSBC looked at the a May 2026 seasoned five-year UST. It said that “in this case, the duration-weighted yield has often been 4bp to 10bp tighter than the current level. In this case, the proceeds-weighted yield pick-up is circa +17bp. The three-month projected return advantage is +3bp given the moderate carry and roll for the 2026 issue versus the wings. However, a 5bp spread tightening would add roughly +15bp to this level. The combination of the two trade ideas significantly reduces the net sensitivity to changes in the yield curve slope and diversifies the relative value view. The risk to the trade is that the curve bows in further on even more aggressive expectations of Fed easing.”