USD Swaps: Pre-FOMC pause; Steepeners remain at risk

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Pre-FOMC pause; Steepeners remain at risk

The financial landscape has entered into its typical holding pattern ahead of the FOMC decision this afternoon where the Fed is widely expected to hike 25bps – and possibly for the last time in this tightening cycle.  Ahead of today’s main event, the major domestic equity indices are treading water (Dow +0.09%, S&P -0.25%, Nasdaq -0.6%) after new home sales data fell for the first time in four months (+697k versus +725k Bloomberg consensus, +715k revised prior).

In rates, Treasury yields are narrowly mixed (~ +/- 1bps) with the curve bending slightly flatter. The benchmark 10y note yield is 0.6bps lower at 3.879% while the 2s10s spread is 1.4ps narrower at -101bps.  Similarly, red SOFR futures are narrowly mixed (+/- 1.5 ticks) while SOFR swap spreads are better bid across the board amid below-average SOFR IRS volumes.  In the backdrop, IG issuance has taken a pre-FOMC pause after American Express was the sole issuer yesterday with its $3.5bn 4-tranche deal.

Elsewhere, ahead of multiple central bank meetings this week, strategists at BofA caution that “longs at the front-end of the curve appear vulnerable, biasing the curve flatter.”  Indeed, BofA finds that “asset managers continued to extend longs with leveraged funds taking the other side in what we think represents part of a basis trade. Foreign investor and bank buying remains relatively muted, putting the pressure on asset managers/ investment funds to keep up demand. US fixed income fund inflows cooled on the week, albeit after a very strong influx the week prior.”  The bank expounds on its view below:

”… Open interest contracts, bias is for deeper inversion - Open interest declined on the week, with the most notable change longs destroyed particularly at the belly of the curve. This may reflect some profit taking in the context of the larger rally we have observed in recent weeks. Positions that were created were modestly concentrated in longs across TY, FV, and US. The futures positioning proxy, still points to a bias for rates to sell off, particularly at the front-end. This presents some additional flattening risk ahead of central bank meetings next week, where policy makers are likely to maintain optionality for additional rate hikes.

 

“… Asset manager longs extend alongside LF shorts - Asset managers added to long positions across the curve the week of July 18th while leveraged funds largely took the other side and added shorts. We continue to think that the leveraged fund futures short for the most part represents a basis trade rather than an outright short view on the rates market. Speculative investors ex- leveraged funds modestly reduced their long position, particularly in FV.

 

“…Momentum inflection point for CTAs - Our cross over momentum signal endorses an inflection point and turned modestly less short after the downturn in recent weeks. Similarly, non-reportable positioning also shows a modest uptick after last week's drop. Our top down model shows that CTAs remain in steepeners and cut duration on the week. This drop likely reflects a positioning adjustment that occurred over recent weeks as our model is inherently lagged. In general, data suggests that should the rally continue, CTAs likely have room to add duration.

 

“…Inflows take a breather - US fixed income fund inflows cooled the week ending July 19th. Outflows were most heavily concentrated in mixed allocation funds followed by long- and short-term UST funds. This follows relatively strong inflows in recent weeks. We continue to believe that strong auction performance is likely supported by fund buying as evidenced in the most recent auction buyer statistics….AUM-weighted total return fixed income funds continue to outperform their benchmark. Outperformance is largely dominated by funds that have consistently performed well in prior weeks.

 

“…Foreign investor support sidelined - Foreign flow data largely points to key UST investors sidelined by hedging costs and muted conviction in USD direction. Despite USD depreciation pressures last week, custodial holdings for the week ending July 19th dropped $7bn, the largest decline since the banking risk events in March. MoF data showed that Japanese flows into foreign bonds were limited the week ending July 14th.

SOFR swaps – 2s -7bps (+0.375bps), 3s -13.25bps (+0.375bps), 5s -19.875bps (+0.125bps)*, 7s -27.25bps (+0.125bps), 10s -25.375bps (+0.125bps), 20s -61.875bps (+0.5bps), 30s -64.5bps (+0.125bps).

* adjusted for the 1.5bps give.