Rates Vol Lab: Trading the asymmetric tail risks

Research evidence excerpt

Rates Vol Lab: Trading the asymmetric tail risks

Rates Vol Lab

27 July 2026 Citi Research

Trading the asymmetric tail risks

Mike Chang Near-term tail risks on front-end rates are likely to be asymmetric, and we see scope for the

currently balanced upper-left vol skews to re-steepen (payers higher/receivers lower). We

recommend monetizing rec skew and vol by owning costless 3m2y receiver ladder as a “safe”

way to position for a Fed on hold. We also highlight short 3m1y 1x2 payer spread as a tactical

hawkish hedge.

Upper-left payer skews to outperform receivers on conflict

Despite the surprisingly soft CPI data earlier this month (core CPI MoM was slightly

negative), the market is once again pricing for the possibility of rate hikes in the

upcoming FOMC meetings, primarily due to the re-escalation Middle East conflict

and the steady increase in oil price. Aside from a brief reprieve on the soft CPI, the

market implied probability of a July Fed hike has broadly tracked the oil futures

price and retraced back to around 36% (Figure 1). Correspondingly, upper-left vol

has also drifted higher along with the increased expectation of a more active Fed.

We continue to believe that this week’s FOMC will be too soon for a rate hike and

the Fed has the luxury of simply staying on hold given the recent benign jobs and

inflation data.

With that said, we are cognizant of the market’s current sensitivity to tail risks,

which are clearly asymmetric with the right side of the rates distribution having the

potential to open sharply on further hawkish repricing. In contrast, dovish repricing

would likely result in much more constrained rate rallies given that the first step is

to price out the rate hikes, which implicitly means that the Fed would become even