The recent US midterm elections have led to a significant shift in the fixed income market, with volatility compressing across various asset classes. According to UBS Securities and Treasury (UBS S&T), the risk premium is compressing, with oil prices declining and bond yields, particularly those of Italy, tightening. This decrease in volatility has been led by the front-end of the curve, with gamma and the top left of the volatility smile trending lower.

The front-end of the volatility curve has been the driving force behind the recent volatility compression. Fast-money accounts have been sellers of outright volatility, chasing calendar steepener trades and selling the top left of the volatility smile via receiver ladders. This has resulted in a stabilization of skew, with a positive correlation between rates and volatility returning. Spread option gamma has also stabilized, with 1-month 10-year 30-year options looking broadly neutral.

The desk at UBS S&T prefers to remain short volatility with a small long-gamma bias, long long-dated calendar steepener trades, and flat skew. They are also covering short curve gamma on the 0% strike. This strategy takes advantage of the current market conditions, where the front-end of the curve is leading the volatility compression.

In conclusion, the recent post-election volatility shift in the fixed income market has been driven by the front-end of the curve, with gamma and the top left of the volatility smile trending lower. This compression has led to a stabilization of skew and spread option gamma, with the desk at UBS S&T preferring to remain short volatility with a small long-gamma bias and long long-dated calendar steepener trades.