USD Vol: ULC screams higher, but then come off from highs

Financial chart 24 Nov 2021
The ULC shot up higher amid the renewed regional banking turmoil and double digit realizeds in the front end, but now are off the highs.

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  • ULC screams higher, but then come off from highs

  • Rate risk premium high versus equity risk premium – JP Morgan

  • New structured notes


    ULC screams higher, but then come off from highs

    Treasuries are well off the intraday highs that posted at apex of concerns over more regional bank turmoil today, and are now anywhere from 3bps higher in the back end versus 10bps lower in the front end. The vol surface jumped higher with the double digit rally seen earlier, but are now off the highs of the day. 3m expiries are roughly 3 to 18 normals higher on the day while 1y expiries are around 1.5 to 9 normals firmer last, led by the left side.


    “Vols skyrocketed today, but at the start this morning, they weren’t that much higher.” But after the new reports of another regional in trouble, “it was capitulation and panic,” remarked one source.


    1y2y was illustrative of the moves today, with trading at  240bps this morning, and then up at 245bps, and then 248bps. Meanwhile 2y1y dealt at 156bps, and then up at 162bps and last at 160bps. 1y1y traded late yesterday at 130bps (“a good lift,” a source reflected) and then traded today up at 139bps.


    The right side was also better bid as 1y10y traded at 755bps and then as high as 770bps and then back down at 768bps, according to sources and the SDR.


    On a realized basis, the upper left is certainly exceeding the breakevens, but for the right side, one trader wondered that lifts up at 770bps or 7bp/day BE in 1y10y made much sense on a longer term basis. Meanwhile, in skew, 1y1y 100bp each way risk reversals traded earlier today at -4.75bps and -4.875bps, according to the SDR.  


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



    Rate risk premium high versus equity risk premium – JP Morgan  

    Analysts at JP Morgan highlight that the rates markets “are already pricing in significant odds of a policy reversal by the Fed” as the OIS forwards “are pricing in considerable rate cuts the next year ahead, representing a sharp shift since the early March onset of banking sector stresses, although this is now much less than during the worst of the March crisis.”


    Moreover, “these expectations are the probability weighted averages of vastly different outcomes that span scenarios with further tightening as well as scenarios with sharp rate cuts” and thus “such a setup promises to deliver elevated volatility,” JP Morgan finds.


    “Indeed, jump risk (which we define as the observed frequency of moves in yields larger than some predetermined threshold like 10bp) remains large in comparison with what would be expected under a Normal distribution,” and thus JP Morgan stresses “this is a key reason for our continuing bullish bias on gamma in the current environment, especially in short tails where jump risk remains more pronounced.”


    However, at a more nuanced level, JP Morgan examines whether risk premium is being “consistently priced into different markets and whether is value to be extracted across markets.” For instance, it finds that the “risk premium is likely being underpriced in stocks at the moment” while risk premium is likely “being overpriced in short expiry volatility on long tails.”


    Thus, JP Morgan favors selling 6m30y swaption straddles on a delta hedged basis coupled with a weighted short in S&P500 futures.


    New structured notes

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


    • Natixis sold a $22m 10y NC5 fixed callable Formosa. The EMTN matures May 2033 and is callable annually starting May 2028 and pays a coupon of 5.2%. Leads Natixis, Shanghai Commercial and Taishin International. Announced May 2.  


    • Credit Agricole is working on a self-led $15m fixed callable maturing May 2033 NC1 that pays 5.56%. EMTN.  


    • Bank of Montreal is working on a self-led USD extendible with initial maturity Nov 2023 and then extendible to May 2026 that pays 5.45% to May 2024, 5.6%, and 5.75%, stepping up annually. Domestic MTN.