Left side underperforms versus right
Treasuries have sold off further this afternoon with the front end taking over as the weakest link, from a belly led move earlier in the day. Swap rates are last around 5.5 to 7.5bps higher on the day. The vol surface is seeing a left to right move today in gamma and intermediate points, with the left side underperforming the right.
The bid in the ULC that was seen at the beginning of the week into early yesterday has faded, sources note, with the sense building that Fed hikes are nearly done and front-end rates will likely plateau and be less volatile as a result.
For example, 3m expiries are down around 0.25 to 2 normals on the screens for 1y to 3y tails while 3m expiries on the 5y to 30y tails are firmer by around 0.75 to 1 normal. 1y expiries are seeing up to 2 normal losses for 1y1y while are around +0.5 normal firmer on the right side.
Trading activity in the ULC today included 1y1y down at 116.5bps after trading last yesterday down at 118bps while 2y3y dealt at 151bps. Meanwhile, on the right side in gamma, 3m10y traded at 347bps, likely versus 3m30y at 634bps.
Intermediate and longer expiries have been more active today. 2y10y traded at 934bps, 2y20y dealt at 1400bps, 4y2y versus 3y5y traded at 330bps and 659bps, respectively, 5y30y traded at 2492bps and 4y10y dealt at 1207bps, 1y20y traded at 1030bps, 5y10y traded at 1300bps and 1y10y dealt at 689bps, according to the SDR.
In skew, some 6m2y 100bp each way risk reversals dealt at -11bps, 7y30y 100bp each way risk reversals may have traded at +140bps and 2y30y 100bp each way risk reversals may have traded at +67bps, according to the SDR.
ULC terminal breakeven analysis – Citigroup
Analysts at Citigroup compare “the implied terminal breakeven of a short-dated straddle to the expected fair value of the underlying rate based on a wide range of possible Fed fund paths” to help determine the relative value of the ULC.
For example, taking 6m1y ATMF straddle, “which has a breakeven of ATMF+/-80bp based on model pricing,” Citigroup constructed “4 somewhat extreme but yet still plausible Fed fund paths for the next 18 months,” and then “bootstrapped the estimated fair value 1y rate for the end of the year (approximately 6 months from now) for each of these paths.”
Using Fed fund path scenarios with #1 and #2 being hawkish and #3 and #4 being dovish, the bank proposes:
- “Scenario 1 (high terminal): Fed hikes 3 more times (July, September, November), holds until 2H2024, then cuts 25bp at each of the 4 remaining meetings for the year.
Scenario 2 (long pause): Fed hikes 2 more times (July, September), holds for 12 months until September 2024, then cuts 25bp at each of the 3 remaining meetings.
Scenario 3 (front loaded cuts): Fed hikes 1 more in July, holds until January 2024, then cuts 50bps in each of the first 2 meetings and cuts 25bp per meeting for the next 5 meetings.
Scenario 4 (no more hikes): Fed is already on pause and starts cutting January 2024 at 25bp per meeting through 2024.”
Citigroup finds that the “fair values under 3 of the scenarios would fall within the short 6m1y straddle’s terminal profit region, and the only exception (scenario #3 front loaded cuts) would only be 4bps outside the breakeven range.”
Given the bank’s view that these 4 scenarios represent the more extreme and unlikely rate paths, Citigroup is “surprised that they would fall within or close to the implied breakeven that is supposed to reflect a level where investors would be agnostic to buy or sell the straddle.”
As a result of this analysis, Citigroup expects “the implied breakeven range to narrow going forward through more cheapening in upper-left vols.”
New structured notes
For a complete review of USD MTN activity over the past week, please see USD MTNs.
- JP Morgan is working on a self-led fixed callable maturing Jun 2028 NC2 that pays 5.45%. Domestic MTN.
- JP Morgan is working on a self-led fixed callable maturing Jun 2028 NC2 that pays 5.5%. Domestic MTN.
- Barclays is working on a self-led fixed callable maturing Oct 2024 NC1 that pays 5.6%. EMTN.
- CIBC is working on a self-led fixed callable maturing Jun 2025 NC1 that pays 5.25%. GMTN.
- Toronto Dominion is working on a self-led USD extendible with initial maturity Jun 2024 and then extendible to Jun 2025 that pays 5.9%. Canadian.
- National Bank of Canada is working on a fixed callable via InspereX maturing Jun 2026 NC6m that pays 6%. Domestic MTN.
- Societe Generale is working on a self-led fixed callable maturing Jun 2028 NC1 that pays 5.25%. Eurodollar.
- Ford Motor Credit is working on a fixed callable via InspereX maturing Jun 2025 NC1 that pays 6.85%. Domestic MTN.
- Verizon Communications is working on a fixed callable via InspereX maturing Jun 2053 NC1 that pays 5.45%. Domestic MTN.
- Verizon Communications is working on a fixed callable via InspereX maturing Jun 2033 NC1 that pays 5.1%. Domestic MTN.
- Dow Chemical is working on a fixed callable via InspereX maturing Jun 2028 NC6m that pays 4.95%. Domestic MTN.
- Dow Chemical is working on a fixed callable via InspereX maturing Jun 2033 NC6m that pays 5.25%. Domestic MTN.
- Dow Chemical is working on a fixed callable via InspereX maturing Jun 2053 NC6m that pays 5.75%. Domestic MTN.
- Ally Financial is working on a fixed callable via InspereX maturing Jun 2028 NC6m that pays 7.25%. Domestic MTN.