USD Vol: Bank stress kicks ULC back higher

Bank stress kicks ULC back higher

With the stress on other regional banks igniting today, Treasuries have bolted higher in the day before the FOMC meeting. To be sure, PacWest (now down -25.6% after dropping as much as -42%) and Western Alliance (-18.5% now after seeing a drop of -27.2%) have been the focus of the selling while the KBW Banking Index is last down -4.76%.

Not surprisingly, the ULC has bolted back higher and have erased yesterday’s losses and then some. 3m expiries are last anywhere from 0.7 to 8 normals higher on the day while 6m expiries are around unchanged on the right side to up 6.7 normals in 6m1y. Vols are going in and out with the tide, sources agreed.

Meanwhile, looking at the recent price action for longer tail gamma, one source suggested that the directionality of vols “seems to have broken down,” noting that yesterday’s big long end move - a selloff, that normally would pressure vol lower - appeared to “rattle some bids loose.”

Interbank trading activity today has seen switches in the left side, with 3y2y versus 1y2y trading at a spread of 89bps, 89.5bps and 90bps, while 6m2y versus 3m2y dealt at a spread of 52.5bps and 52bps, and another switch – 4y2y versus 3y2y – dealt at 354bps and 330bps, respectively. Outright, 3m1y traded at 67bps, according to the SDR.

Earlier today, when vols were lower to start, 2y2y traded at 292.5bps, 2y1y dealt at 155bps and 155.5bps, 3m10y traded at 388bps and 391bps, 4y10y dealt at 1278bps,  1y25y traded at 1258bps and a switch of 7y20y versus 5y20y traded at 2301bps and 2104bps, respectively, and in 30y tails, 1m30y traded at 425bps and 1y30y dealt at 1380bps, according to the SDR.

In skew, a 2y1y ATM versus 200bps high payer traded at 79bps and 32bps, respectively, and a 2wk2y versus 15bps high payer dealt at 31bps and 18bps, respectively, according to the SDR.  

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

Drivers behind the steepening of vol surface - BofA

Analysts at BofA had expected “slow process of normalization” for the volatility grid based on its view that “the market stress continues to fade and the Fed policy shift into an on-hold stance impacts the grid dynamic.”

Specifically, BofA looked for “(1) left side to underperform vs the right side and converge to levels between -20 to -30bp for the 1y10y vs 1y1y vol spread; and (2) gamma to cheapen vs. intermediates to levels between -5 and 5bp for the 1y10y vs 1m10v vol spread” and the bank expected the process of left side and gamma normalization vs. intermediates “to be roughly synchronous.”

However, over the last couple of weeks, while gamma and ULC dropped (with 1m10y reaching flat levels vs 1y10y), “intermediates have stayed supported (particularly in the belly and left side),” BofA finds and with this outcome, it proposes two potential drivers for this decoupling between gamma and left side normalization:

• “The market likely sees the potential for the Fed to stay credibly on hold over the next 3-6m but likely not much beyond that, which continues to support intermediate vols in the belly and left side vs shorter expiries (i.e., left side forward vol).”

   

• ”The debt ceiling debate is gaining momentum and while that allows for some normalization of short gamma (1-3m expiries, and rather frontloaded in this range), for expiries around the x-date (roughly 3m 6m) the uncertainty caps the potential for vols to follow suit.”

“While in general a process of steepening of the term structure of volatility is seen as reflecting more benign market conditions, we don't think the recent cheapening of gamma vs. intermediates can be interpreted quite in that same way,” BofA suggests. Instead, the bank believes that the steepening “likely reflects continuing uncertainty around the policy path (risks for either frontloaded rate cuts on harder landing scenarios of further hikes on signs of sticky inflation and resilient data, shortly after the near-term shift into an on-hold stance) and continuing uncertainty around the debt ceiling debate which peaks at c.3-6m horizons.”

New structured notes

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

• Royal Bank of Canada is working on a self-led CMS inverse FRN linked note maturing May 2026 NC1 that pays 7% to May 2024, then pays 6*(4%-CMS10y), floored at zero. EMTN.

   

• Morgan Stanley is working on a self-led fixed callable maturing May 2033 NC2 that pays 5%. Domestic MTN.

   

• Citigroup is working on a self-led $100m fixed callable maturing May 2025 NC1 that pays 5%. EMTN.

   

• UBS is working on a self-led fixed callable maturing May 2025 NC3m that pays 5.4%. Domestic MTN.

   

• UBS is working on a self-led fixed callable maturing May 2026 NC6m that pays 5.25%. Domestic MTN.

   

• UBS is working on a self-led fixed callable maturing May 2024 NC3m that pays 5.2%. Domestic MTN.

   

• Verizon Communications is working on a fixed callable via InspereX maturing May 2030 NC1 that pays 4.65%. Domestic MTN.  

   

• Dow Chemical is working on a fixed callable via InspereX maturing May 2053 NC6m that pays 5.6%. Domestic MTN.  

   

• Dow Chemical is working on a fixed callable via InspereX maturing May 2033 NC6m that pays 4.95%. Domestic MTN.  

   

• Dow Chemical is working on a fixed callable via InspereX maturing May 2028 NC6m that pays 4.5%. Domestic MTN.  

   

• Ally Financial is working on a fixed callable via InspereX maturing May 2033 NC6m that pays 7.1%. Domestic MTN.  

   

• Ally Financial is working on a fixed callable via InspereX maturing May 2026 NC6m that pays 6.6%. Domestic MTN.