Hello all.Is anyone familiar with Yield Curve Inversion trades?i.e from the dealer's point of view...Receive 6mLibor * (% of time where 30yswap>2yr swaps)Pay fixed KThe structure matures in 10 years and in callable in 5yrs.Could someone comment on ...1.which clients would put on this trade?2.when would a dealer accept this clearly negative carry trade? it it the gamma profile that would make it attractive?and most importantly...3.What is a natural set of "Hedging Instruments" to calibrate to? If we had to build a replicating portfolio what would be some natural candidates.Thank you all in advance for your insights.

I have not seen this precise structure, but I have seen swaps tied to yield curve inversions.This particular one may be a bit of a sucker bet. When the yield curve is steep, as it has been since 9/11, swap spreads over treasuries tend to be low and roughly the same in at all tenors. But when the yield curve flattens or inverts, swap spreads over treasuries go up, and much more on the long end than the short end. So when the treasury curve last inverted, in summer 2000, the swap curve did not.The more common yield curve inversion instrument is similar to an option to pay the lower of short-term or long-term rates. The natural counterparty to this someone with interest-sensitive products who competes with both fixed-rate and floating-rate payers. People in mortgage-related businesses, who have to respond to borrower shifts from fixed to floating rate loans, could use these to stabilize their cash flows in all markets.This swap is a little odd because the counterparty doesn't want to pay anything at all in an inverted environment. It's hard to think of anyone who has such an on-off exposure to whether the 2-year swap rate is a couple basis points above or below the 30-year rate. I'd say this can't be stabilizing cash flow, so it must be someone looking at total valuation. Still, this seems an odd way to do it. My first guess is someone stuck in the "don't pay in inverted yield curve" feature to lower the fixed rate far more than economics would dictate. Hence the "sucker bet" suspicion.Dealer's don't care about negative carry, as long as they're getting paid appropriately. I don't think the gamma profile is important, because I don't think the yield curve inversion feature is very important. The dealer would do this because it can book a lot of P&L.There are no liquid market instruments that would give a good overall dynamic hedge to the inversion feature. You'd have to price this using some macroeconomics tied to a model, that model would be calibrated with liquid caps and floors. For hedging you'd have to evaluate the short-term outlook and hedge accordingly. When conditions were right for an inversion, you could probably hedge pretty well in the short term using some interest rate options. When conditions were not right for an inversion, you might just buy some deep out of the money options and hope for the best.