USD Vol: Debt ceiling vigil; Vols bounce around

 Debt ceiling vigil; Vols bounce around

With Biden and the Republican leadership set to meet early this evening on the debt ceiling, Treasuries are lower, with yields last around 1.5 to 3.5bps higher, with the belly holding up better than the wings. The vol surface saw the ULC push initially higher this morning, but implieds have since pulled back in lower as USTs came off the lows of the day and delivereds dropped. 3m expiries were up as much as 4 normals but are now around 0.25 to 3 normals higher, with not a lot of trading.

Meanwhile, further out, 1y expiries are roughly unchanged while longer expiries (5y+) are modestly firming by roughly 0.25 to 0.75 normals. The market is cautiously waiting the outcome of debt ceiling impasse, sources judge, with the very short-term price action hostage to the negotiations/headlines for the time being - outside of new economic data. 

Trading activity has been mostly on the right side. For example, 1m30y traded at 418bps, 419bps, 421bps and 424.5bps, 3m10y traded at 403.5bps and then down at 401bps, 1y30y dealt at 1396bps, 5y10y traded at 1370bps, 7y10y traded at 1485bps and then 1490bps, 2y10y traded at 1020bps and 20y20y dealt at 2960bps, according to the SDR. On the left side, 2y2y dealt at 296bps

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

Vol ratios to revert – Deutsche  

Analysts at Deutsche points out that “since the beginning of March, Fed funds have risen by 50bp while 2s have rallied by 110bp and 10s by 55bp” amounting to “an additional 160bp of inversion between the Fed funds and the belly, and 55bp of bull-steepening of 2s/10s.”

“Such repricing of the spreads has never taken place while the Fed was still hiking,” Deutsche highlights, and the bank finds “there is a considerable negative risk premium priced by the belly of the curve that is consistent with near-term (6M-9M) rate cuts.”

However, Deutsche finds “it is difficult to see inflation declining to target levels by that time, and if such cuts are realized, we would likely see a twisted response of the curve: The front end would submit to lower Fed funds, but the long end could price in a higher inflation risk premium and future rate hikes.”

In this scenario, “as the curve pivots around a midpoint during the twist of the curve triggered by rate cuts and above-target inflation, there is likely to be less movement and volatility in the belly than at the long end of the curve,” Deutsche suggests.

Currently, “the pricing of the vol surface disagrees with the curve and resides on the other side of these possibilities. As most of the risks have been concentrated at the front end of the curve through which the policy response has been transmitted, vol in the upper left corner has been systematically outperforming the other sectors since the beginning of the cycle,” Deutsche assesses.

“Currently, vol ratios between short and long tenors are at all-time highs” and if “we believe that if the curve twist is realized, vol ratios should reconverge to their usual range, perhaps not to their QE levels, but possibly closer to the 100-120%,” Deutsche projects.

New structured notes

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

• Merrill Lynch sold a $60m fixed callable Formosa 10y NC2. The EMTN matures Jun 2033, is callable annually from Jun 2025 and pays a 5.6% coupon. Leads are Bank of Taiwan, KGI and Yuanta. Announced May 19.

   

• Merrill Lynch sold a $25m 10y CMS-linked Formosa. The EMTN matures Jun 2033 and pays USD 1y CMS + 160bps floored at 0%. Leads are E.Sun and First Commercial. Announced May 22.

   

• Rabobank sold a $50m zero coupon callable 20y NC5 (non-Formosa). The EMTN matures May 2043, is callable annually from May 2028 and has an estimated IRR of 5.15%. Lead is Deutsche Bank. Announced May 19.

   

• Deutsche Bank sold a $80m fixed callable 20y NC5. The EMTN matures May 2043, is callable annually from May 2028 and pays a 6.287% coupon. Self-led and announced May 19.

   

• EBRD sold a $25m fixed callable 10y NC2. The GMTN matures Jun 2033, is callable annually from Jun 2025 and pays a 4.95% coupon. Lead is WFS and announced May 19.  

   

• KfW is working on a $50m fixed callable via JPM maturing May 2043 NC4 that pays 4.612%. EMTN.

   

• IBRD is working on a $10m fixed callable via Barclays maturing May 2033 NC1 that pays 5.55%. EMTN.

   

• IBRD is working on a $25m fixed callable via SocGen maturing May 2033 NC1 that pays 5.53%. EMTN.

   

• Deutsche is working on a self-led $279m FRN callable maturing Dec 2029 NC5 that pays O/N SOFR +281bps. Coupon paid quarterly from Dec 2028 if not called. EMTN.

   

• Asian Development Bank is working on a $20m fixed callable via Deutsche maturing Jun 2033 NC3 that pays 4.7%. EMTN.

   

• Morgan Stanley is working on a self-led step-up callable maturing Nov 2025 NC1 that pays 4.9% to May 2024, 5% to May 2025 and 5.25% thereafter. CD format. Domestic.

   

• Citigroup is working on a self-led $14m fixed callable maturing May 2033 that pays 5.22%. EMTN.

   

• Deutsche is working on a self-led fixed callable maturing May 2024 callable Jun 2023 that pays 5.65%. Eurodollar.  

   

• UBS is working on a self-led fixed callable maturing Jun 2024 NC3m that pays 5%. EMTN.

   

• UBS is working on a self-led step-up callable maturing May 2024 NC6m that pays 5.06% to Nov 2023 and 5.07% thereafter. 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 4.9% to May 2024, then pays 5.05%, and 5.1%, stepping up annually. Domestic MTN.

   

• Jefferies is working on a self-led fixed callable maturing May 2026 NC1 that pays 6%. Domestic MTN.