Halister News

(Bloomberg) -- Steepening of bund volatility skew in favor of calls reflects increasing Brexit risk premiums and investors positioning for increased bond scarcity (see chart here), Bloomberg strategist Tanvir Sandhu writes.

• USTs, bunds and gilts remain well-supported into the U.K. vote on EU membership as “leave” poll gyrations increase and downside risks are far too large on being wrong
• Pool of bonds Bundesbank can buy is shrinking and increased buying of what remains amplifies bullish flattening
• EUR swap spreads set to extend widening trend as bund scarcity concerns are most directly expressed in ASW
• As pension funds’ funding ratio deteriorates, increased receiving interest is most likely at the long end of swap curves
• As returns get squeezed out of curves, pension funds and insurers with large liabilities are being forced to increase their DV01 further out the curve
• Widening duration gap between liabilities vs assets amid falling yields spurs demand for duration for asset-liability matching
• Yields on German bonds maturing up to and including Jan. 2022 are now below ECB’s deposit rate of -40bps, making them ineligible for purchases
  • With ECB running out of German paper, they will either have to change the depo rate or issue limit restrictions
• German supply set to turn strongly net negative (adjusted for QE) over summer, which will further weigh on yields; average maturity of assets purchased under QE has been increasing, adding support to long-dated paper: see here
• Downside options may come into play where a vote to “remain”, in line with betting odds, will see an unwind of Brexit premiums in bunds and renewed Fed hawkishness weighing on global bonds
• Bund futures contract may ultimately approach roll gap at ~166 before ~168, corresponding to yield of ~-20bp, as mentioned here and here in April
• Comparison of July skew today vs 5 days ago:
  • 25d skew at 0.57 vs -0.23
  • 15d skew at 0.93 vs -0.31
  • 10d skew at 1.22 vs -0.33

• NOTE: Tanvir Sandhu is an interest-rate and derivatives strategist who writes for First Word. The observations he makes are his own and are not intended as investment advice.