Halister News

(Bloomberg) -- Collapsed optionality in TLT and IEF Treasury ETFs provides low-carry directional view on any positive surprise on U.S. tax reform, given expectations have crumbled, Bloomberg strategist Tanvir Sandhu writes.

• Rates volatility has collapsed to near-record lows given range trading in yields with reduced expectations of growth, and with investors now believing the lofty fiscal expectations (highlighted here, here and here) seen following the election of Trump were overdone
• The swing in tax-reform expectations to the low side is now at risk of being surprised back to the upside, particularly with the passage of healthcare reform
• TLT (20Y+) and IEF (7-10Y) Treasury ETF volatilities have collapsed across the term structure with 3-month implieds near all-time lows, see chart here, while 25-delta call/put spread remains close to zero
• While the Fed terminal rate lacks escape velocity with inflation lacking any traction, the next upward pressure on long-dated yields requires an increase in term premium via tax reform among other factors, regardless of whether the expected path for short rates remains little changed
• U.S. economic surprise has deteriorated, with hard data failing to gain traction to scare bulls off versus stronger soft numbers, and moderation of recent macro data surveys is limiting the short- term upside for U.S. rates
• U.S. stock market is for the moment giving the administration some time on fiscal expansion given that legislation is a slow process while earnings data have been resilient
  • While the bull run may continue with recession probabilities low, the high valuations may be at risk of unwinding if data don’t strengthen and no powerful fiscal elixir is delivered
  • SPX 1-month implied volatility hit the lowest level on record last week, being pulled down by realized vol remaining stubbornly low at 7%. A growth slowdown would be consistent with lower market returns and higher volatility
• NOTE: Low vol strategies selling vol may not end well. It may not be ending just yet as negative carry invites more sellers, compressing vols further. A regime shift in vol will be best captured with long-convexity exposure combined with tactical shorts rather than tail-risk strategies betting on mean-reverting vol spikes, see analysis here
• NOTE: Tanvir Sandhu is an interest-rate and derivatives strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice

To contact the reporter on this story: Tanvir Sandhu in London at tsandhu17@bloomberg.net To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net Anil Varma