ULC sinks lower post-FOMC; Right side holds up
The Fed hiked 25bps to 5-5.25% in a unanimous vote and indicated a possible pause ahead as it omitted the phrase “some additional policy firming” in the statement. Further the statement stated that the rate path ahead “will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” Powell in the Q&A said banking conditions have “broadly improved” and the banking system is “sound and resilient," and in terms of the future rate path, that “we’re getting closer, maybe there for a pause.”
Treasuries yields are last -1bp lower in the back end to down -10bps in yield in the front end. Aside from selling into and out of the passage of the event, the expected outcome has caused the ULC drop into - and more precipitously out of the FOMC - while the belly and the right side of short expiries has held up better. For example, 3m expiries on short tails are last down around 9 to 19 normals while 3m expiries for longer tails is last around 1.5 normals lower on the day.
In trades, 1y2y traded at 228bps after the FOMC or around 8 normals lower on the day. Prior to the FOMC it dealt at 241bps. 1y1y traded at 122bps post-FOMC or around 9 normals lower after trading earlier in the day at 129bps in a switch versus 6m1y at 93.875bps. Also, 3m1y traded at 58bps post-FOMC or down 19 normals, according to the SDR.
In skew, 1y30y 100bp each way risk reversals traded at +29bps around the time of the FOMC release, while 3m10y 50bp each way risk reversal dealt at -6.5bps today before the FOMC, after dealing at -5bps in the late afternoon yesterday, according to the SDR.
Vol going higher for multiple reasons – Barclays
Analysts at Barclays observe that “volatility has again been rising for the past couple of weeks as swaption market investors reassess the amount of uncertainty that should be expected over the next year” with the rise in volatility “mainly led by the left-hand side of the vol surface, where 1y1y vol is back to 170bp/y, but right-hand side volatility such as 1y10y has also increased.” The bank see three reasons:
- “First, concerns about potential banking turmoil have returned” and “the associated rate rally and the increase in vol as rates rallied are both reflections of the events in March.”
“We also believe that swaption market participants have been biased towards buying of volatility on both the left-hand and right-hand sides, especially in the short and intermediate expiries. On the other hand, the net vol bias seems to have been relatively neutral in longer expiries.”
Further, Barclays’ SDR-based indicator of the direction of vol flows has been positive which “likely suggests that there is still a short vol base in the market that has waited for vol levels to become somewhat attractive before buying.”
- Secondly, “Concerns about the debt ceiling have not been priced to a substantial extent yet in the rate vol market, but given that this is has already caused a significant widening in US sovereign CDS and has cheapened bills with maturity dates beyond June, the possibility of disorder should be positive for rate volatility over the next few months.”
- “Finally, it is quite clear from more recent data” - such as the $50bn to $100bn disposal of MBS and longer-dated securities announced by First Republic the week previous - that “banks are likely to continue to view long duration/negative convexity assets negatively after they sparked recent concerns. In our view, the vol market is starting the price in the possibility that convexity hedging demand from MBS investors could be higher in the future.”
With this backdrop, Barclays continues to believe that “top-right upside rate risk protection (such as 6m1y 5% payers) is attractive, given that we think that the modal path of rates priced by markets is low and that cuts are likely to be pushed out, but the volatility on such points is cheap given that the market is not pricing a sufficiently high probability of the fed being on hold for over a year.” The bank also continues to like long vega/short vega structures on the right-hand side, such as buying ATM-100 3y10y receivers vs selling ATM-50 6m10y receivers, and being long 10y20y + 3m10y vs 3m30y option triangles.”
New structured notes
For a complete review of USD MTN activity over the past week, please see USD MTNs.
- Bank of America is working on a self-led $33m fixed callable maturing May 2028 NC1 that pays 5.4%. Domestic MTN.
- Bank of America is working on a self-led $35m fixed callable maturing May 2026 NC6m that pays 5.55%. Domestic MTN.
- JP Morgan is working on a self-led fixed callable maturing May 2033 NC3 that pays 5.3%. Domestic MTN.