Implied soften amid Fed’s hawkish pause; ULC underperforms
Despite yesterday’s near consensus CPI data and today’s below consensus PPI data (-0.3% MoM versus -0.1% Bloomberg consensus), the Federal Reserve – after a string of hikes spanning the past 15 months - delivered a rather hawkish pause on rate hikes today. To be sure, in a unanimous 11-0 vote, Fed officials held rates unchanged at 5%-5.25% - as was widely expected - but the Fed’s projections now imply two more 25bps hikes for a median fed funds rate of 4.6% in 2023 - up from 4.3% - and a median rate of 3.4% in 2025 – up from 3.1%.
And with today’s hawkish curveball from the Fed, the markets were quick to show their dissatisfaction once the headlines hit the tape with equities plunging lower and USTs bear-flattening sharply. But with the dust now settling into the close after Powell’s press conference, markets have largely retraced the initial jerk reaction with equities mixed but little changed (Dow -0.61%, S&P +0.06%, Nasdaq +0.25%) and the UST curve bending flatter (2y note yield up 4.1bps at 4.705%, 30y bond yield down 3.9bps at 3.882%).
Against this backdrop, vols are mostly lower across the board in a move driven by the upper left and a move that started already this morning heading into today’s main event – continuing a broader move lower that already commenced late last month. Today, 3m expiries are another 2 to 8 normals softer, while 1y expiries are down around 1 to 5 normals and vega points are unchanged to 0.25 normals softer as long continue to pare positions.
However, strategists at JP Morgan reckon that today’s pause in rate hikes “may not shed much light on the future path of policy,” and as such they think that “policy clarity will not be easily forthcoming in the near term.” Therefore, the bank thinks that “the recent declines in implied volatility may be premature, and we remain cautious about expecting a steady continuation. “ Therefore, given the clearly bearish momentum in implieds as well as its view that policy uncertainty will likely persist in the near term, JP Morgan now turns “neutral on volatility” and would look “to reset new longs once this downward trend has run its course,” perhaps soon after today's FOMC meeting.
Interbank activity today has included 1m5y dealt at 136bps and 1m10y dealt at 202bps. For more USD option trades on the SDR see here and for volumes please see here. Note that the Total Derivatives SDR now shows broker/platform information for each trade, where available.
JPM: Cross-asset volatility; Buy 6Mx5Y swaptions vs. S&P futures
On a cross-asset basis, one theme strategists at JP Morgan have explored in the past is to compare the risk premium priced into the swaptions market with the risk premium priced into riskyassets such as stocks. The bank does this by modeling delta hedged straddle returns as a functionof in-sample returns on the S&P500, in addition to other factors (such as ex-ante level of implied vol).
By doing this, JP Morgan finds that it can assess whether current levels of implied vol are high enough for selling straddles to be profitable (after hedging the exposure to the S&P), in which case it might conclude that implied vols are pricing in too much risk premium relative to stocks. Indeed, the bank notes that “as recently as late April, this was the case and we recommended selling risk premium in the swaptions market (by selling swaption straddles) versus buying risk premium in stocks (by selling S&P futures).” However, with its latest revisit of its model JP Morgan finds the following:
- ”… Interestingly, thanks to the recent declines in implied volatility, the reverse is now true….Selling swaption volatility is projected to deliver negative returns after hedging the exposure to stocks, to the tune of nearly 3 standard deviations and in all sectors of the curve (with 5Y tails standing out as the best choice). In other words, after recent declines, we believe that the risk premium priced into swaption implied volatility is now too low in comparison to risky assets. Therefore, we recommend buying 6Mx5Y swaption straddles on a delta hedged basis, versus buying S&P futures. This trade may be thought of as a way to buy risk premium in the swaptions market versus selling risk premium in stocks.”
- Initiate longs in 6Mx5Y swaption straddles, versus weighted longs in S&P futures - Risk premium priced into swaption implied volatility is likely too low in comparison to risky assets.
- Buy $100mn notional 6Mx5Y ATMF swaption straddles. (Notification date: 2023-12-11, swap tenor: 5Y, ATMF: 3.457%, strike: 3.457%, spot premium: 329.7bp per notional, forward premium: 338.4bp per notional, bpvol at inception: 8.3bp/day). This trade assumes active delta hedging every business day.
- Also buy 31 contracts of S&P 500 E-Mini Sep futures at 4349.
New structured notes
For the latest weekly wrap of USD structured notes, please see USD MTNs.
- Barclays sold a $100m 5y floating rate Formosa. The EMTN matures Jun 2028 and pays SOFR +140bps. Leads are Bank of Taiwan, Mega, Sinopac, Taishin and Yuanta. Announced Jun 13.
- IBRD is working on a $500m fixed callable via Wells Fargo maturing June 2028 NC3 that pays 4.50%. Global MTN.
- Goldman Sachs is working on a self-led CMS dual ranger maturing June 2027 NC3 that pays SOFR for the first year and then pays 5.1% as long as CMS2y/30y is greater than zero. EMTN.
- JP Morgan is working on a self-led fixed callable maturing Jun 2025 NC1 that pays 5.58%. EMTN.
- Citigroup is working on a self-led fixed callable maturing July 2024 NC6m that pays 5.70%. Domestic MTN.
- Santander is working on a self-led fixed callable maturing June 2026 NC1 that pays 13.65%. EMTN.
- Deutsche Bank is working on a self-led fixed callable maturing June 2026 NC1 that pays 5.7%. EMTN.
- Deutsche Bank is working on a self-led floating callable maturing June 2026 NC1 that pays SOFR-flat. EMTN.
- HSBC is working on a self-led step-up callable maturing December 2024 NC1 that pays 4.2% to Dec ‘23, 4.25% June ’24 then 4.3% thereafter. Eurodollar.
- UBS is working on a self-led fixed callable maturing June 2025 NC1 that pays 5.56%. EMTN.
- UBS is working on a self-led step-up callable maturing June 2025 NC1 that pays 5.4% to 2024 then 5.6% thereafter. EMTN.
- UBS is working on a self-led floating callable maturing June 2025 NC1 that pays 1y ICE SOFR. EMTN.
- Toronto Dominion is working on a self-led step-up callable maturing June 2027 NC1 that pays 5.75% to 2025, 6.5% to 2027 then 7% thereafter. Global MTN.
- Royal Bank of Canada is working on a self-led fixed callable maturing June 2038 NC2 that pays 6%. Global MTN.