US 30-year swaps spreads hit records

IFR 2084 23 May 2015 to 29 May 2015
4 min read

The spread between the US 30-year swap rate and Treasuries widened last week to the most in nearly three years, amid imbalances in US interest rate markets that are unlikely to end any time soon, according to analysts.

The fixed rate that investors demand in exchange for making 30-year floating rate payments was 2.71%, some 29bp tighter than the sovereign, and the widest spread since May 2012, according to TradeWeb pricing. The spread has widened from 9bp at the beginning of March and close to flat at the beginning of the year.

“It is not unusual for the spread to be negative but it is surprising that it’s this negative,” said Priya Misra, head of US rates strategy at Bank of America Merrill Lynch. “There is not really a good explanation for it, but there are a number of potential contributing factors.”

Trading desk speculation around the causes of the move include a potential unwind of a curve trade by large hedge funds and record levels of corporate issuance of longer-dated bonds, leading to exceptional demand for swaps.

Meanwhile some bankers said the spread may be the result of capitulation trades from investors who had bet on higher rates, combined with a lack of liquidity at the long end of the yield curve. The latter point is a particular concern analysts say, because it is caused by imbalances in supply and demand that are becoming entrenched in the US swaps space.

“The issue over the medium term is that there are plenty of counterparties looking to receive a fixed rate at the long end, for example pension funds and insurers who wish to match their longer-dated liabilities, but there is a declining constituency of people who want to take the other side of that trade,” said Amrut Nashikkar, an interest rates derivatives strategist at Barclays in New York.

“The natural payers in the market are the mortgage hedging community, but there has been a sharp reduction in demand from that quarter because of Fed purchase of mortgage-backed securities,” Nashikkar said.

As the Fed lightens up its balance sheet in the coming months the swap payer community may return, Nashikkar said.

Other dynamics

However, there have been other dynamics at work which mitigate any early reversal, for example, recent corporate issuance. Long-dated issuance has been unusually strong recently, as corporates including Qualcomm, Apple and AbbVie came out of earnings blackout with jumbo acquisition and share buyback financings.

In the first three weeks of May, more than US$33bn of bonds 20-years in maturity and longer came to market, compared with US$22bn for all of April. The avalanche of offerings follows a record month for April and the biggest month of all time in March.

Another cause of the record spread may be a jump in demand for low strike receivers in the options market, where investors pay a premium on a bet that rates will be lower than are implied for some point in the future. The low strike swaption buys the right to receive a fixed-rate on the strike date, and has been a popular play as the US Fed has prevaricated over the timing of its first post-crisis rise in interest rates.

From a dealer point of view, the best way to hedge its side of the option trade is to receive in the swaps markets, again increasing demand and pushing the spread wider.

Meanwhile, some analysts speculate that a contributor to the spread move is a combination of failed tightening trades and illiquidity at the long end.

“People may have trade to fade wideners as part of curve trades and then given up as the spread continues to move out,” says Misra, “We heard a big hedge fund may have unwound a position and with the long end being pretty illiquid we have seen moves of a point a day, which is kind of gappy.”

30-Year US swap spread