J.P.Morgan Recommend A Couple Of Swap Widener Positions

J.P.Morgan suggest that “issuance-related swapping activity was likely not a major factor pressuring spreads narrower (last week). We estimated that major domestic banks were likely to see continued AOCI drawdowns in Q222, albeit half as large as Q222. Thus far, 3 of the 4 largest domestic banks have reported Q222 earnings, and our estimates are tracking. For the three that have reported so far, their total AOCI drawdown in 2Q22 has been $10.5bn, versus $20bn for those banks in 1Q22. Thus, information available so far is consistent with our projection of $14-15bn in AOCI drawdown for the top four domestic banks.”

• “More importantly, this suggests that our inference regarding the duration risk in AFS books is also reasonable. Our AOCI drawdown projections for 2Q22 relied on (i) the fact that negative convexity in AFS books was likely greatly reduced, and (ii) on the assumption that only about half the overall AFS duration extension of $120mn/bn that occurred in Q122 was offset via hedges. The fact that AOCI drawdowns are thus far largely in line suggests that our aggregate estimate of AFS duration risk is also reasonably accurate. This implies that AFS portfolios remain long to the tune of $240mn/bp, which is about $60mn/bp longer than late 2021.”
• “What does this mean going forward? It means that banks’ demand for duration will likely remain tepid for now, and banks could be opportunistic duration shedders in AFS books, especially in rallies. On the margin, assuming that such duration management actions are likely to be implemented via swaps rather than securities, this lends support to our view that swap spreads will be counter-directional with rates and prone to widening in a rally. Thus, we continue to favour spread wideners in a rally, and recommend adding such exposure via TY calls and receiver swaptions.”
• They recommend buying 1,000 TYU2 Sep 119 calls vs. selling $117.9mn notional matched receiver swaptions. This package is constructed to be forward bpv-neutral and approximately premium neutral and is expected to be profitable if the CTD's maturity matched swap spread is wider than -32.3bp in a rally at option expiry.
• J.P.Morgan also noted that “on an outright basis as well, we continue to favour swap spread wideners in the belly of the curve. Mid-July marks a seasonal short-term trough in swap spreads, which have tended to be biased wider in the subsequent 2- to 4-week period. Given this seasonal tendency, as well as spreads that appear narrow to fair value, we favour initiating swap spread wideners in the 10-year sector”
• They recommend paying fixed in 2.875% May 15 2032 maturity matched SOFR swap spreads at a spread of -21.5bp.