J.P.Morgan: Sell Belly Of Weighted SFRU3/M4/H5 Butterfly

J.P.Morgan note that “although front end yields have in fact repriced significantly, we believe there is more to go. The fronts/reds curve has bounced off of its most inverted recent levels, but it remains highly inverted at nearly -75bp and the recent steepening has merely undone the effects of the late December/January rally. We believe this steep inversion remains at odds with the Fed's messaging which continue to sound caution around expectations of premature easing. There is little support for easing in Fed-speak, but markets remain steeply inverted even after the recent correction. Therefore, we see fronts/reds dis-inversion as a key source of carry and slide on the curve, as the roll-up towards spot is favourable for shorts in the Reds.”

• “One way to position for such slide, while also maximizing the ratio of slide to overall risk, is by selling the belly of a U3/M4/H5 SOFR futures butterfly (33:77 weights on the wings). This weighted butterfly spread has been fairly mean-reverting - indeed, the 6-month standard deviation of rolling 3-month changes in this spread has been about 8.4bp. But this butterfly also has very attractive slide, to the tune of 36bp over 3 months, which is over 4 times the 1-sigma move in the spread. Thus, given attractive slide relative to the risk, we recommend selling the belly of the 33:77 weighted SFRU3/M4/H5 butterfly.”