USD Swaps: Steeper, tighter as deal talk grows; 2y spread view

• USTs bull-steepen, spreads tighten as deal hopes rise

• 2y spread view

• New issues

 USTs bull-steepen, spreads tighten as deal hopes rise

A raft of data including the core PCE deflator (seen steady at 4.6%) and durables (consensus is -1.0% for headline) plus headline risk from the debt ceiling negotiations are in store for the market today, with the WSJ reporting that a two-year deal is “starting to take shape” (see link). UST yields are near session lows and the curve is steepening a touch with the 10y at 3.78% (-3bps) while SOFRs are 4bps stronger in the whites and 1.5-2.5bps firmer in the reds. Risk assets are up again led by a 0.3% rise in Nasdaq futures. 

Meanwhile swap spreads are tighter across the curve led by the front end with 2s at -10.00bps (-1.75), 5s at -19.25bps (-0.50), 10s at -26.50bps (-0.25) and 30s at -70.50bps (-0.125). Swap flows are strongest at the front end but below normal beyond about 7y.

In the news, Bloomberg reports that the SEC and the Fed have "questioned prime brokers" about leveraged trading in government bonds by fast money, including trading in the futures basis with leverage of up to 50:1. That comes against data suggesting a big hedge fund short in the futures and concern about the status of UST collateral in the event of a technical default. Citadel, Millennium, ExodusPoint and Capula are all mentioned.  

Ahead, SocGen looks at the possible impact of a debt deal on issuance, repo and front end swap spreads.

The bank expects T-bill supply to ramp up "dramatically” after the debt ceiling is raised, with coupon issuance increased as well (but the latter “after August refunding”).

In turn, the sharp rise in collateral should “pressure repo rates higher” with many of the factors that caused SOFR to rise well above the Fed’s target range in September 2019 seen “lining up again".

SocGen reckons that the $2.25trn Fed ON RRP facility plus the Standing Repo Facility should be enough to put a ceiling on repo rates and make a “dramatic” rise in SOFR above the Fed target range "unlikely". Still, SocGen does expect SOFR to rise "within the target range" in the coming months.

Against the background of a post-deal collateral “glut” and higher repo rates, front-end swap spreads are expected to remain “tight”. However, SocGen judges 2y spreads to be “too narrow” relative to its simple model, which includes the 3m T-bill rate, the 2y UST yield, 1y1y OIS, 3m OIS and a liquidity premium. The bank concludes:

“Spreads are likely to remain relatively narrow when the debt ceiling is lifted. The increased bill issuance immediately following a debt limit deal would put narrowing pressure on the 2y swap spread. However, the spread may trade more in line with its fair value when the T-bill curve normalises in anticipation of a debt ceiling deal in Congress. This would fit the pattern observed during the last debt ceiling standoff, when the 2y Libor swap spread widened in October ahead of a deal, then narrowed in January 2022 as the Treasury issued a deluge of bills.

New issues

• Kexim (Aa2/AA) plans USD 10y and/or EUR 3y, 5y or 7y (Green) bonds after meeting investors on May 25. Leads are Citi, CA, HSBC, ING, JPM and SocGen.