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A lot of talk around Libor widening into the year end - what we call the "turn". EDZ0 99.625/50 ps has seen a lot of interest accordingly. There are a few things to understand here.
First, a lot of this turn is already priced in (chart) with Sep-Dec-Mar FRA-OIS fly at ~15bps
First, a lot of this turn is already priced in (chart) with Sep-Dec-Mar FRA-OIS fly at ~15bps
Second, Dec FRA-OIS (using EDZ0 vs FFF1 as a proxy) hasn't gone anywhere itself. So the kink that we saw above was all driven by expectations of tighter FRA-OIS in Sep and March. If this were to continue, those Z0 puts won't be of much use.
Third, this implies that markets buying Z0 puts are expecting two things to happen at the same time.
1 Libor to have bottomed
2. Turn pricing to remain constant or widen
On #2, if you look at the last 5 years, I don't think the turn is necessarily under-priced right now.
1 Libor to have bottomed
2. Turn pricing to remain constant or widen
On #2, if you look at the last 5 years, I don't think the turn is necessarily under-priced right now.
Although, the GSIB surcharge is likely to be a bigger issue in 2020 if the Fed chooses not to do anything (Zoltan explains why that might happen) https://plus.credit-suisse.com/rpc4/ravDocView?docid=V7ln0S2AN-VHSK This along with a risk of defaults hitting banks should reopening be pushed into 2021 can widen the turn.
What about spot Libor having bottomed? The arguments calling for a floor for Libor basically rely on the spread to bills and bank CDS. 12.5 seems like a pretty good level historically, which implies a current floor of 25bps for Libor
But come December, OIS is expected to fall to 3-4bps as TGA gets spent. This, along with reduced bills issuance should bring 3m bills yield down to 7-8bps (MMF being a caveat). Therefore, for the Z0 puts to really come to life, we will need genuine widening in Libor-T bill spread
