Monetize High USD payer skew through payer ladders

Strong anticipations of Fed tightening exacerbated demand for protection against higher rates on the long end of the curve. This resulted in elevated levels of payer skew , which can be monetized through payer ladders. We favor the 10y tail to express this view, with several factors supporting higher long term rates  : we expect the Fed to start unwinding its balance sheet as soon as May , with monthly caps grandually increasing from $60bn towards $100Bn , which will inject term premia into the curve. We expect the current Fed rhetoric to raise the level of market implied neutral rate, now slightly above 2% towards the Fed’s 2.5% objective and 10y rates are strongly correlated with the level of the terminal rate. The 6M maturity features one of the most elevated payer skew for the 10y tail, which allows for a large zero cost bandwidth. Despite strong tightening pressures, the long end the curve is soft capped by the Fed , which doesn’t want a sharp deterioration in financial conditions to trigger a recession. We don’t expect the creation of material inflation risk premia into the curve on a 6m horizon. Foreign investors c ould also provide some stabilization should the USD long end of the curve underperform s too much its G10 counterparts . The strategy is not exposed to a recession scenario and to further deterioration on the Russian invasion of Ukraine . Risk s of the trade include a loss of credibility of the Fed in its ability to tame down inflationary pressures which would lead to a change in the Fed operating framework or an extremely agressive balance sheet reduction with massive s ales of Treasuries , which seems unlikely at this point given Powell’s comment at the March FOMC . A 6Mx10Y payer ladder (ATMF +5 , ATMF+ 30 , ATMF+ 50 ) through SOFR swaptions features a 70 bp bandwidth .