TD Enter 5-Year SOFR Swap Spread Tighteners

TD Securities note that “with the Fed likely to accelerate QE tapering at the December FOMC meeting, we expect Treasuries to cheapen to SOFR and OIS as the market will need to absorb more supply. While net coupon supply net of Fed buying is set to shrink from $1.8tn in 2021 to $1.6tn in 2022, 10-Year equivalent of issuance will stay high at about $2.7tn. Treasuries have richened sharply amid strong bank buying, but we expect banking system reserves to shrink in 2022 which should cheapen Treasuries to SOFR. We think that the belly might be the most impacted given the weighted average maturity of issuance, and we enter a 5-Year SOFR swap spread tightener.”

• “Note that swap spreads seasonally tend to compress in the first half of January amid heavier IG issuance, and we expect this to help the trade as well. The risk to the trade is that the Fed turns even more hawkish, accelerating paying needs in swaps and outpacing any cheapening in Treasuries. However, with the market already pricing in the first hike in June 2022 and 66bp of hikes in 2022, pricing is already quite hawkish. Our short 10-Year real rates call should help hedge against a more hawkish scenario.”
• They enter the 5-Year SOFR swap spread tightening positioning at -14.3bp, targeting a move to -25.6bp, with a stop set at -9.0bp.