Interest Rate Derivatives What I tell you three times is tru...-105388137

1Srini Ramaswamy AC (1-415) 315-8117srini.ramaswamy@jpmorgan.comJ.P. Morgan Securities LLCIpek Ozil (1-212) 834-2305ipek.ozil@jpmorgan.comJ.P. Morgan Securities LLCPhilip Michaelides (1-212) 834-2096philip.michaelides@jpmchase.comJ.P. Morgan Securities LLCArjun Parikh (1-212) 834-4436arjun.parikh@jpmchase.comJ.P. Morgan Securities LLCNorth America Fixed Income Strategy08 December 2023J P M O R G A N•Yields are sharply lower over the past month on the back of accelerated Fed easing expectations, but the yield curve is not much steeper over this period. This is because of term premium, which has retraced from its late-October peaks and appears to be stabi-lizing. With term premium likely biased structurally higher in the medium term and finding a bottom locally, the timing is likely opportune for long term premium trades … •… sell the belly of the 35/65 weighted 5s/10s/15s swap butterfly to isolate exposure to rising term premium while hedging against moves in Fed expectations •With 5-year swap spreads stubbornly remaining well below fair value and at levels where they offer attractive pick up over IOR, we explore the question of why asset-swap activity by banks likely remains subdued in this sector. We think the answer is not Reserve scarcity or liquidity constraints, but simply the much-improved attractiveness of asset swapping shorter maturities on a risk-adjusted basis. As a result, we view spreads as unlikely to converge in the near term, and we turn neutral on swap spreads despite valuations that are considerably narrow in the belly. A correction will likely require renewed risk appetite from relative value players, which may have to wait until the new year. In a similar vein, we recommend adding exposure to 3s/5s swap spread curve flatteners •We recommend exiting short gamma exposure in 30-year tails, as implieds have declined and are now closer to fair value. More broadly, with December typically being the worst month for market liquidity, we recommend turning bullish on volatility and buying 1Yx10Y swaption straddles on a delta hedged basis •Synthetic swaption-based strategies designed to mimic exposure to yield curve volatili-ty are currently attractive - buy 6Mx2Y and 6Mx10Y swaption straddles (41/60 vega weighted) versus selling 6Mx5Y swaption straddles to replicate exposure to 2s/10s curve volatility What I tell you three times is trueWith next week likely to bring the third FOMC meeting where the funds rate is held steady after reaching its current level, it is worth remember the great Lewis Carroll˖s line from The Hunting of the Snark - “What I tell you three times is true˙. We expect next week to bring an unchanged policy rate, as well as a reiteration of the current tightening bias as the Fed continues to lean against expectations of premature easing (see FOMC Preview, Michael Feroli, 12/8/2023). But markets appear to be rushing to anticipate the easing cycle; since mid-November, yields have steadily declined as Fed expectations ha