POV. USD LONG DATED VOL SHOULD RISE? -......>

OPTIONS: POV. USD LONG DATED VOL SHOULD RISE?

- USD swaption implied vol picked up smartly at the beginning of Feb as equities

dropped, bond yields spiked and fear briefly gripped the market. For example,

USD 5Y30Y normalised implied rose from a 3.5Y low of 61bp/vol to a 3 month high

of 65bp/vol but has since slipped to 62bp/vol again.

- There were flow and economic justifications for low longer dated vol. From the

flow side, Formosa bond issuance was depressing influence upon longer maturity

USD implied vol (the bottom-right of the matrix) since around 2014.

- Formosa bonds are callable, usually long-dated USD sold in Taiwan and most

often purchased by Taiwanese life insurers looking for additional yield. As USD

yields rise, the need for yield enhancement wanes and regulation changes,

particularly the need for a 5Y period before the first call date, have made it

less attractive for issuers to sell Formosa debt. Relative to the same point in

2017, issuance is 12% lower in 2018 and so flow justification for low vol slips.

- QE has long depressed rate volatility but the Fed is now reversing this

process alongside hiking rates. It's difficult to justify the low price of vega.