TD Securities Recommend SFRM4/M5 Flatteners

TD Securities write “the recent bear steepening in rates is likely being driven by a number of factors including markets repricing for "higher for longer" Fed funds, worries about the impact of increased Treasury supply, fears of persistently high oil prices, and technical weakness.”

• “A persistent selloff increases the risk of "breaks" similar to the UK LDI episode or the SVB collapse.”
• “The persistent bear steepening also increases the risks of a snap-back move in rates in the event of an over tightening in financial conditions.”
• “The market is currently pricing in 107bp of cuts between mid-2024 and mid-2025. Options markets are already showing signs of hedging a bimodal distribution of lower rates in late-2024.”
• “We enter SFRM4/M5 flatteners to position for a potential snap lower in rates if financial conditions tighten excessively.”
• “The trade also allows us to be directionally long 2y rates but avoiding negative carry. In addition, also offers additional staying power given declining volatility in front-end rates.”
• “The key risk to the trade is a more resilient US economy in the near-term, but we think a slew of headwinds is likely to weigh on growth momentum in the near-term.”
• They target a move to -175bp with a stop set at -70bp.