USD Swaps: USTs limp off near the lows; Bill valuations should remain supported

down chart red 26 May 2022
USTs are closing out near their session lows amid an illiquid trade after this morning’s data. NatWest sees T-bill valuation remaining supported.

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  • USTs limp off near the lows; Bill valuations should remain supported

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    USTs limp off near the lows; Bill valuations should remain supported

    Treasuries are closing out near their session lows after a rather illiquid – and subsequently outsized – sell-off after some stronger U.S. data that hit the tape this morning (i.e. GDP, personal consumption, jobless claims) has had the full day to thoroughly sink it.   


    Indeed, the benchmark 10y note yield is last a sizeable 13.2bps higher at 3.84% while the 2s10s spread has compressed 1.5bps as the front-end underperformed this session.  Meanwhile, the major domestic equity indices failed to cover much ground in either direction today (Dow +0.80%, S&P +0.45%, Nasdaq 0%).


    In SOFR-space, ahead of the LIBOR cessation tomorrow, red SOFR futures are closing out 15 to 18.5 ticks softer today while SOFR swap spreads narrowed across the board amid the underlying rates sell-off with SOFR IRS volumes running at a below average clip in all but the 1y and 2y tenors.   In the backdrop, IG issuance saw a sole deal from Mizuho that came with $1.4bn 6y NC5 (Green) and $1.1bn 11y NC10 fixed-to-fixed TLAC bonds.


    Elsewhere, with the first part of the TGA rebuild and the June FOMC meeting now behind us, strategists at NatWest recently updated their issuance outlook and broke down their expectations.  In a nutshell, the bank now expects a somewhat higher bill supply, on top of auction size increases in coupons that we should see at the August refunding (see Total Derivatives).    


    Moreover, NatWest expects to see continued demand for risk free products like Treasury bills for reasons such as high absorption capacity from money market funds as they have kept their weighted average maturities low, views that the Fed might be reaching the end of its hiking cycle and thus investor willingness to extend, and the need to invest maturing agency debt that is not likely be rolled over might keep T-bills well bid.


    Against this backdrop, NatWest believes that bill valuations could remain supported for similar reasons to those that have allowed supply to be so well absorbed thus far.  It expounds on these reasons below:


      ”… First, there is still plenty of cash ready to be deployed into alternative investments from the Fed’s ON RRP. Given the overnight design of the facility, MMFs significantly lowered their portfolio weighted average maturities (WAM) and they still remain near historically low levels. Due to the issuance from FHLBs in March that was used to fund lending to banks, MMF WAMs did increase somewhat, but there is still plenty of capacity.


      “…Second, the ON RRP was a good place to ‘hide’ as the Fed was going through its aggressive rate hiking cycle. The debate on whether the Fed is done or not is inconclusive – their forecasts indicate that they are not – but the light at the end of the tunnel is certainly getting brighter and brighter. On balance, we should see more investors willing to extend duration in the front end with a lower risk of catching a falling knife in the form of outsized rate hikes. If bills offer any pick-up to SOFR, which for the most part they do, we believe MMFs will likely extend.


      “…Third, there was a very large amount of FHLB debt that was issued in March – about $240bn or 6x the average month…That was largely due to the mini-banking crisis post SVB, which led to high demand for advances by banks. Natural buyers of that agency paper are MMFs and as pointed above this led to extending portfolio WAMs. However, the turbulence within the banking system has calmed down and banks are likely to try and replace those (costlier) advances. We think a large reason for the continued (and marginally increasing) take-up of Fed facilities like the Bank Term Funding Program (BTFP), which lends at 1y OIS+10bps, is to replace those advances. All of that should mean that FHLBs won’t need to roll over the maturing paper and in that case MMFs will have to replace those investments. The main alternatives are: 1) ON RRP, 2) Treasury bills/short coups, 3) Private market repo. We could see an increase in the ON RRP due to that, while private market repo is more of a function of demand and is end-user dependent. In any case, we think T-bills should benefit from this windfall later this year, helping support valuations.


      “…Bill valuations themselves are much closer to historic levels now compared to a few months ago when Treasury was running down the outstanding stock of bills….Valuations have returned to a place that is much more consistent with historical levels. We expect to see any further cheapening, particularly in the 0-3m area, to be met with buying demand, which should provide a soft ceiling at SOFR + a few basis points in the near term.”


    SOFR swaps – 2s -7.375bps (-1.25bps), 3s -13.375bps (-0.625bps), 5s -22.5bps (-0.625bps), 7s -27.625bps (-1.125bps)*, 10s -26.5bps (-0.625bps), 20s -64.875bps (-1.25bps), 30s -67.25bps (-1.625bps).


    *adjusted for the 1.5bps give.



    New issues

    • Mizuho priced a $1.4bn 6y NC5 (Green) and $1.1bn 11y NC10 fixed to fixed TLAC bonds. Leads are JPM and Mizuho (B&D).  Priced at +165bps, +190bps.