On the right is the 1 year fly curve I have been showing for a while. I thought it would be interesting to show this looks like from the perspective of the 1 year s151012 1 year flypread curve.[1]


The first thing to mention is that the very long term swap rates have gotten crushed.[2] So all other things being equal, you would expect to see a lower fly curve further out and a lower year spread curve further out. Supply and demand on the curve could cause there to be excess curvature in certain parts of the curve, as the markets figure out how to price in the longer end.


This Fed hiking cycle is going to be very slow. It will be years before we get to the target rate. So having a component of your book that carries well is attractive. The big issue for me in recommending a long end carry trade right now is that I’m not sure if the next big move in the long end is going to be a steepener or a flattener. Typically in a hiking cycle, it is a flattener. And this time around, the flattening view is helped by the huge demand to receive in longer dated swaps. But this is a much slower hiking cycle than in the past and the real possibility of a recession next year, both of which speak to steepeners.

If you were thinking flattener, the part of the curve highlighted by the red arrow looks attractive relatively. And if you were thinking steepener, the flatter 151012 1 year spdparts of the curve around the red arrow look more attractive relatively. So I am still looking for that good balance of fly vs spread relative value that makes sense in most environments. The double flys in the CA trade list are good ways to present this view, but don’t roll particularly well. I’m still looking at better ways to earn rolldown. If you have a flattening or steepening view, it would be a little easier to take a position. I’m still looking for a good blend. Stay tuned.


1 There is a labeling mismatch because the axis on the Fly graph is for the center of the fly, and the axis for the Spread graph is for the first contract of the year spread.
2 In particular relative to Treasuries, as seen in the noticeably negative swap spreads as you go further out the curve.