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 Strategy09 February 2024J P M O R G A N•Yields are higher this week on the back of strong data and Fed-speak that continues to signal a desire to see sustained disinflation before eventually cutting rates. But options market implied distributions point to a significant weighting on a tail risk scenario that could bring aggressive cuts •With such a tail scenario being dramatically different from baseline easing expectations, policy uncertainty remains considerable, and is creating a supportive backdrop for ele-vated day-to-day volatility. But rates are also rangebound and mean-reverting, because of which realized volatility based on less frequent sampling (such as biweekly) is much lower. While we acknowledge this headwind, we nevertheless remain bullish on volatil-ity on the back of heightened policy uncertainty and lingering tail risk •With forward OIS rates still below modal expectations for the path of the Fed, carry trades on the swap yield curve remain an attractive proposition, but we prefer imple-menting them conditionally in a selloff to mitigate the downside in the event that tail risks worsen and trigger a sharp rally … •… buy 3Mx2Y payer swaptions versus selling 3Mx3Y and 3Mx5Y payer swaptions (30% and 75% risk respectively) •Given the potential for tail risks to escalate, and also given our Treasury strategists� bull-ish view on the market, we also find value in asymmetric ways of creating bullish expo-sure … •… buy H5 and Z5 3M SOFR futures contracts versus selling U4 SOFR futures and pay-ing fixed in 10Y swaps •Thanks to low coupon issues at the short end of the basket and high coupon issues at the long end, the June Treasury futures ultra-long bond contract is characterized by interest-ing dynamics. The current CTD, the Aug �49, could switch to the long end of the basket - the Nov �53s - in a rally, which would bring about duration shortening rather than lengthening. We discuss the impact of high coupons / conversion factors at the long end of the basket, versus low coupons / conversion factors at the short end. A CTD switch to the Nov �53s, which is already nearly equi-cheap, would not be material in the tradi-tional sense, but would significantly lower wildcard optionalitySoft landings, TouchdoWNs, and Safety in the End ZoneWith strong Claims and ISM data this week coming on the heels of last week's strong employment report, it has been a week of steady increases in yield levels across the curve (Figure 1). Market focus continued to center around infla...
