FxWirePro: Trading run through on inflation-linked swaps, USD CCY swaps, and swaptions

Though Treasury Secretary Steven Mnuchin said this week that he is seriously considering 50-or 100-year debt, we continue to think the scope for adding either maturity point is limited. While internationally, the outcome of the French presidential election remains a very large tail risk.

Last week yields initially rose on the back of Yellen’s semi-annual testimony before Congress, as well as a higher-than-expected CPI report, which led us to pull forward our projections for this year’s rate hikes to May and September versus June and December.

Buy 5-year real yields: With inflation risk rising, the more structural drivers of low real productivity growth still very much in place, and attractive near-term carry, we recommend buying 5-year real rates.

Receive in $300mm notional of a 1Mx5Y forward starting swap (start date 3/28/17, maturity 3/28/22, coupon 2.028%) versus paying fixed in $293.9mm of a 1Mx5Y inflation (US CPI) swap (start date 3/28/17, maturity 3/28/22, zero coupon) at a current spread of   -18.1 bp.

Stay positioned for an underperformance of USD swaps in a sell-off by selling 3Mx5Y AUD versus USD payer swaptions.

Stay long $100mn notional 3Mx5Y ATMF USD payer swaption (notification date 5/10/17, maturity date 5/12/22, strike 2.048%, premium 75.8bp) versus selling A$152mn notional of 3Mx5Y ATMF AUD payer swaption (notification date 5/10/17, maturity date 5/11/22, strike 2.595%, premium 60.4bp).

This trade is constructed to be premium neutral at inception and has a forward risk weight of 85%. P/L since inception 5.7 bp.