USD Vol: ULC drops as risk premium falls; Right side gains

ULC drops as risk premium falls; Right side gains  

With First Republic acquired by JP Morgan and stronger ISM (47.1 vs 46.8 forecast) and ISM prices paid (53.2 vs 49 forecast), Treasuries have sunk lower with yields last around 11-13bps higher on the day while swap spreads are around 0.5 to 1.5bps wider. The implied vol surface is seeing the ULC underperform lower while the right side is higher on the day. For example, 3m expiries are down 9.5 normals for 3m1y while up around a normal for 3m10y and 2.5 normals higher for 3m30y, according to the screens.

The risk premium over banking stress has dropped as First Republic was sold, and thus the upper left is lower as the least disruptive scenario emerged as the outcome for First Republic. “That is pretty much it,” concurred a source. Meanwhile, the longer end of the underlying curve is leading the move lower, he highlighted, as the move in the front end has been more “lackluster.” 

With the FOMC in two days, the market is currently pricing in near certainty (92% probability) of a 25bps move, in comparison to around 84% on Friday, according to the CME Fed Watch tool (see link).  

In interbank activity today, starting with the ULC, 1y1y traded at 130bps and 129bps but is last mid around 127bps, 3m1y traded at 62.5bps, 2y1y dealt at 155bps, 1y2y dealt at 236bps. Further down the expiry curve, 4y1y versus 10y1y traded at 185bps and 219bps, according to the SDR.

Elsewhere, 6m5y traded at 350bps, the low of the day, 3y10y traded at 1150bps and 1152bps, 3m20y traded at 550bps and 555bps, 6m10y traded at 538bps and 540bps, and 10y10y dealt at 1598bps, according to the SDR.

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

Sell 6m5y OTM rates payer vs buying 6m IG CDX payer spread - Citigroup  

Over the medium term, analysts at Citigroup are “structurally bullish on rates with the expectation for the growth slowdown to pick up momentum in the second half of the year.” With this view, the bank favors selling OTM rates payer to buy IG CDX payer as a way to position for the potential recession.

Back in January, Citigroup highlighted that the directionality between rates and credit spread “had defied long-term trends last year by turning sharply positive (wider credit spread with higher yields) with the realized beta essentially reaching its post GFC peak” which it found was primarily due “to the higher than-expected inflation prints and the aggressively hawkish Fed response, which negatively impacted both equities and bonds.”

“To position for a return to the ‘normal’ rates/credit spread inverse relationship with falling inflation allowing the Fed to shift its focus on the potential recession, we recommend selling 6m5y OTM rates payer to buy 6m IG CDX payer spread,” Citigroup proposes.

“The trade monetizing the elevated implied rates vol to buy the still relatively low credit vol, allowing the investor to take in more premium credit” and by buying the IG CDX payer spread instead of a simple payer this “also takes advantage of the credit payer skew that appears slightly elevated relative to the level of the underlying credit spread.”

In a recession, Citigroup expects “credit vol to increase and converge toward rates vol, which would benefit the trade on a mark-to-market basis.”  The bank views the main risk to the trade “is a complete avoidance of a growth slowdown, in which case rates could continue to rise and credit spread could remain tighter.”

New structured notes

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

• JP Morgan sold a $40m 5y NC3 FRN callable Formosa. The EMTN matures May 2028 and is callable May 2026 and the year thereafter and pays a coupon of O/N SOFR +100bps. Leads JPM, KGI, Sinopac. Announced Apr 21.

   

• Swedish Export Credit is working on a $50m fixed callable via JPM maturing May 2026 NC6m that pays 5.3%. EMTN.

   

• Goldman Sachs is working on a self-led fixed callable maturing May 2028 NC1 that pays 5.4%. Domestic MTN.

   

• JP Morgan is working on a self-led fixed callable maturing May 2025 NC6m that pays 5.25%. Domestic MTN.

   

• JP Morgan is working on a self-led fixed callable maturing May 2028 NC1 that pays 5.2%. Domestic MTN.

   

• JP Morgan is working on a self-led fixed callable maturing May 2027 NC6m that pays 5.25%. Domestic MTN.

   

• JP Morgan is working on a self-led fixed callable maturing May 2028 NC1 that pays 5.45%. Domestic MTN.

   

• JP Morgan is working on a self-led fixed callable maturing May 2026 NC6m that pays 5.1%. Domestic MTN.

   

• JP Morgan is working on a self-led fixed callable maturing May 2025 NC6m that pays 5.15%. Domestic MTN.

   

• JP Morgan is working on a self-led fixed callable maturing Jun 2024 NC6m that pays 5.1%. Domestic MTN.

   

• Barclays is working on a self-led fixed callable maturing May 2029 NC5 that pays O/N SOFR+170bps. EMTN.

   

• CIBC is working on a self-led fixed callable maturing May 2027 NC1 that pays 5%. GMTN.

   

• Royal Bank of Canada is working on a self-led fixed callable maturing Nov 2024 NC1 that pays 5.03%. EMTN.

   

• Royal Bank of Canada is working on a self-led fixed callable maturing Jun 2024 NC9m that pays 5.15%. EMTN.

   

• Royal Bank of Canada is working on a self-led fixed callable maturing May 2025 NC1 that pays 5.1%. GMTN.

   

• Bank of Montreal is working on a self-led fixed callable maturing May 2025 NC6m that pays 5.3%. Domestic MTN.