Implieds drop as hawk retreats
Dovish comments from ECB hawk Klaas Knot saw Euribors rally up to 12bps, the Bund future jump over a point and the euro swap curve bull steepen.
The dovish outlook and underlying rally pushed euro implieds lower, led by the left hand side of the grid. For instance, 3y2y declined by 2.1 to 108.9nvol.
“The amount of realised is less important… it’s more about the peak (in rates) being scaled back and getting closer to the terminal rate,” said one vol trader earlier.
Elsewhere, the right-hand side saw a similar decline with 1y10y and surrounding pieces dropping around 2 normals. “Long-end steepeners via payers are attractive trades for carry and could be seeing some interest,” a dealer suggested.
Further out, vega declined in sympathy to gamma with 5y10y down by 2 normals at 87nvol and through the July lows.
Callable supply on LHS - Barclays
Strategists at Barclays conclude that supply from callables is low in euros, but remains focused on the left hand side. It writes:
- “Vol supply from callable issuance in EUR remains low, and the pattern of a shift to short expiry short maturity callable supply has continued as rates and vol remain elevated. Long-end callable supply (maturity >= 10y) continues to be depressed, leading to lower vega supply overall, but short maturity supply has picked up compared to recent history (€5.5bn per month in H1 2023 compared with €4.8bn in H1 2022 and €5.4bn in H1 2021).
- “The most popular structures include 3NC1 and 5NC2, which appear to be commonly used by banks and financials. The high coupon rates in these callable notes are attractive for investors, while the call likely acts as a source of convexity for issuers.
- ”Supply pressure on the left hand side has caused implied/realized ratios and volatility roll-up to look very different from other parts of the surface in 2y-3y expiries…. The supply of vol in the intermediate-left part of the vol surface is 2-3 times larger than what was typical.
- “One of the drivers for the pick-up in callable issuance of shorter maturities in march was the high rate level, and the ECB’s current stance, both of which have only become more entrenched now, suggesting that this vol supply pattern is likely to continue.”