- We’re hearing issues with: Illiquid TBA trading with bid/asks reaching 4-5/32s from mid. Ultra-wide TBA-roll markets. Margin calls and cash whipsawing. Uncertainty on when loans will close. Fallout.
- With horrific liquidity in TBAs, and TBA options near impossible to source at any price, there is incentive to take mortgage:Treasury basis exposure.
- The proposed treasury option strategies can be simple: BUY a PUT OPTION—that’s it. Pay the premium for the option and there is NEVER a margin call.
- Want to see a full work-up of comparative cost analysis or have specific requests? Please reach out. Put Options on Treasury Futures are being deployed by an increasing number of our pipeline clients already. The mortgage:treasury basis risk is nothing compared to today’s costs of getting in and out of TBAs—and the insane cash requirements for margin calls.
- Own Swaps vs Treasuries in the belly: 5y-10y. Banks are way too short duration. They don’t have room for adding securities and why compete with the Fed to buy non-HQLA? Look for banks to load up LONG on swaps in the belly of the curve given advantage of posting initial margin vs actual balance sheet use.
- Own 20y-30y T. Treasury will focus issuance on front end of the curve to NOT undo the Fed’s QE buying impact on the longer duration securities, where the primary dealers need help.
- Curve will trade directionally. Once some semblance of liquidity is restored, I expect flattening.
- Softening U.S. dollar implies Fed swap lines are working. Begs the question why 3moLI remains so high relative to 1mo and 6mo. But, since short-term LIBOR rates are almost entirely hypothetical, it’s tough to trade this one.
- IG is cheap
- From 10/17/20 on, all cleared swaps and swap futures will change:
• PAI will switch from Fed Funds to SOFR
• Eurodollar Futures will continue to trade, subject to fallback triggers—at which point ED$s and ED$ options will convert to SOFR.
• Cleared swaptions, at this point, will be liquidated/PV’d—though discussion continues.
• Cash flow discounting will switch from OIS/FedFunds to SOFR
- Plenty of talk continues about repo and funding pressure subsequent to the September surge. Many of the best minds and most-veteran traders are warning that the Fed’s multiple patches are not enough. But how does an institution with risk hedge this exposure? Or, how does a smaller fund (without access to all forms of derivatives) protect or wager on year-end funding pressure?
The answer is, “Use SOFR futures.”
- 1mo SOFR vs Fed Funds. Many of the banks got their face blown off being the ‘wrong way’ on the SOFR/FF convergence trade in September. They were buying 1mo Sep SOFR and selling 1mo Sep Fed funds around -10 expecting a convergence to -8/-7. When the spread got there, they did not cover. With the repo surge, the spread blew out to -23bps and has thus been labeled, “the widow-maker”. This trade was akin to the TU/OIS trade that separated large cash from traders that thought ‘free carry’ and got educated on short discreet options.
- ATTN STIR TRADERS, TRANSITION TEAMS: Here’s a look at nine major U.S. short rates, all re-cast into a uniform basis. Using 1-month-in-arrears averaging, the problems in the financing market become crystal clear.
- As is often the case with new instruments—especially derivatives—pricing can get wonky due to relatively small directional flows pushing relationships out of whack. Back-month SOFR futures, specifically SFRH1 (Mar’21 3mo SOFR on CME), have outperformed September’19 2-year futures (TUU9). The overshoot in the relationship peaked last Monday (6/3)—along with the peak of inversion on the front-end of the yield curve.
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