Interest Rate Derivatives Schrodinger’s Cut-110319067

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 Strategy13 September 2024J P M O R G A N•A rate cut at next week’s FOMC meeting is all but certain. But the magnitude is almost maximally uncertain, as markets are currently in a “Schrodinger’s Cut” state with rough-ly 50-50 odds of a 25bp or a 50bp rate cut. Thus, when one of these outcomes gets real-ized next week, front end yields are likely to finish either reasonably higher or lower depending on the outcome. Therefore, we favor asymmetric ways of gaining exposure to lower as well as higher front end yields …•… initiate conditional exposure to a flatter 1s/3s swap curve in a selloff using 3M expiry ATMF payer swaptions … •… and initiate exposure to a steeper 2s/10s swap curve in a rally using 3M expiry receiv-er swaptions, financed by selling 24% of the risk in 3Mx7Y receiver swaptions•Buying the factor weighted USZ4 CTD basis, which currently trades near zero net of carry to early December, is another attractive way to gain exposure to more aggressive Fed easing, as the basis contains an embedded call option on forward delivery-month repo rates•We also favor buying the factor weighted WNZ4 CTD basis as an attractive way to gain bearish exposure. This basis is currently trading near 1 tick net of carry, which is histori-cally low because of reduced wildcard optionality. But in a selloff, rising odds of CTD shifts to lower-coupon CTDs should widen the current CTD’s basis, giving rise to asym-metric bearish exposure•Near-term policy uncertainty is back to elevated levels on the eve of the FOMC meeting, and remains supportive of a long vol bias in our view. But one key risk to this is the potential for Fed messaging to improve policy clarity, which could cause a broader reduction in risk premia. Given that risk premium in swaption volatility appears cheap to risk premium in equities, we recommend buying 1Yx10Y swaption straddles versus longs in S&P500 E-Mini futures•We remain neutral on swap spreads on an outright basis across the curve Schrodinger’s CutGlobal developed market central banks have already been easing in recent months. The Bank of Canada (last week) and the ECB (this week) have cut rates twice so far this cycle, and the Bank of England once. Next week, it is all but certain that the Fed will join the chorus. But the question remains as to whether the magnitude of the rate cut will be 25bp or 50bp. The odds of a 50bp cut have fluctuated considerably in recent weeks, ranging from a low of 10% to as high as 45% (Figure 1), in response to economic data (such as a firm CPI report and Friday's soft import price data) as well as nuggets of information (such as the WSJ and FT reports