A dovish surprise at next week's FOMC may relieve some of the pressure from the first two factors; if dollar strength dissipates and risky assets bounce back (it would require a substantial rally for our measure of needs to move out of receiving into paying territory). However, it may paradoxically increase tightening pressure on spreads if issuance picks up. Despite the fact that risky assets are well off their peaks, volatility in credit spreads appears to be declining. Further, issuance has historically exhibited mean reversion.
In the US, limited delivered volatility, in the absence of any key data releases, meant that implied vols across most of the surface were largely unchanged. We've devised strategies suitable for reducing volatility circumstances, very short expiry vols (such as 1m), however, rose, likely in anticipation of the FOMC meeting next week. For example, USD 1m*10y rose c.3.5bp/y, while USD 3m*10y was close to unchanged.
In EUR, underlying rates continued to trade in a tight range over the course of the week, which likely led to selling of gamma by investors. Vols on long tails therefore came off, even as those on shorter tails were close to unchanged. EUR 1m*10y fell c.1.5 bps/y, while EUR 1m*2y was only c.0.5bps/y lower.
In the UK, vols came off somewhat over the course of the week, particularly in short expiries, which fell as the BoE MPC rates decision and minutes release on Thursday did not lead to any major surprises. GBP 1m*30y fell c.2bp/y, while GBP 1m*2y was c.1bp/y lower.
