Monday, March 23, 2015

Trade Ideas: Opportunities in USD and GBP Rates Post Fed & BoE

After the recent Fed and BoE, here is my take on current opportunities in USD and GBP for longer term positioning in rates.

For USD curves, the slopes and curvature are more or less near there historical mean values, with some limited scope for flattening. However, what is interesting is that this normalization has been primarily been driven by compression of term premiums (one of the reasons is that the term premiums in magnitudes are now much larger compared the rates levels than before) . The risk neutral slopes remain much steeper compared to history. I think the term premia will remain depressed, esp for long end, and the flattening positions still makes sense. However, on the short end, the term premium (which is in fact negative) can pick up. This would suggest a 2s5s or similar steepening position. I prefer to express same view more conservatively through 2s5s10s fly. Note all term premia based on NY Fed regression based model available here.

Also in USD, the 5y has for a long time traded range bound (since the Taper actually), and has been testing either side to break-out. Right now it is roughly in the middle of the range. I think chance of a strong breakout in either side is limited given the level of rates and the state of the economy (unless we have a surprise in inflation). I think this gives us a good opportunity for long vol (vs long end in the gamma maturities) or for long vol vs. short vol of vol positioning in 5y. The range has been - ignoring some extreme points - within 50bps. So the trade is to sell 50bps wide strangle vs straddle (zero cost, which carries great as well). The vol of vol has been marked up recently, and thus makes a good entry point.

For GBP, the slopes and the curvature can follow similar comments as in USD. However, I see the opportunities more in Euro area convergence than outright (at the moment). The long end normalization of Euro can be structured against GBP. Given the trade relationships (most of GBP imports from euro area, so a direct import of disinflation), and the ECB QE driven yield chasing, it is hard to imagine a high GBP long end sustaining with euro area long end under 1 percent handle. The best way to position for this is to sell receiver 10y10y in EUR vs GBP, which will carry fantastic. An alternative way is in swaps directly.

Also watch out for ECB's update on PSPP (expected today). In the week of 13th it ended with Eur 9.75 b purchase of sovereign bonds. That is not a lot to start with (EDIT: target is 42 b per month or 10.5 b per week; EDIT 2: The figure came in 16.55 b, so total Eur 26.3 b).

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