Another Post on Swaps????

I admit it... I've posted WAY too much about swap spreads, but in my last post on the subject of the 30 year swap spreads (defined here), I received this comment:

Not sure why this is considered good or bad. Seems indifferent to me as banks are basically an extension of the Fed balance sheet and federal government for all intents and purposes now. This doesn't have any impact on credit to the real economy. Just filling in holes of the banks balance sheets.

How's this for importance? For the past 8 years (I could only find data going back 8 years) 30 year swap spreads have followed equities with alarming regularity (I smoothed the changes by averaging the change over the past month):


HOWEVER, over the last month, 30 year swap spreads have rallied significantly more than the equity market.



Will swap spreads lead the market higher or should we view this recent rally in credit markets as short-lived? Or should we ignore it altogether. Interesting post at Infectious Greed about just that. According to Paul:

The risks of financial history are higher than ever though. We have more data, better analytical tools, and more people crunching the data, so we can expect to see data on pretty much anything we want to see. There will always be someone tearing apart something to find something interesting, so something interesting will be found. My friend James Altucher has always been great on this subject, ripping holes in pretty much every data-driven rule of thumb by which people claim to trade and/or find market tops and bottoms. They mostly don’t work.

Agreed.

A Continued Good Sign in Credit Markets

Swap spreads continue to "normalize". Don't understand and want to? Go here and/or here:

30 Year Swaps Flat to Treasuries

We've detailed the odd occurrence a few times at EconomPic of the 30 Year Swap trading through Treasuries (implies that banks can borrow at a lower rate than the U.S. government). This has whipped back over the past few weeks and today has traded a 0 bps to Treasuries.



I won't declare victory in credit markets just yet, but it is a good sign.

Who Wants to Receive 2.5% / Pay LIBOR for 30 Years?

This is an update of a previous post (for full details of the technical factors go to that link).

Across the Curve details:

Swap spreads moved wildly. The 2 year spread narrowed 6 basis points to 82. Three year spreads tightened 7 ¼ basis points to 76 ¾ basis points. Five year spreads narrowed 1 ¼ basis points to 70 basis points. Ten year spreads moved wider 17 basis points to 17 ½ basis points. Thirty year spreads widened 20 basis points to NEGATIVE 22.

While a ~50 bp rebound in this measure over a few days is BIG, at some point in the near future I expect a much more violent rebound towards zero as the realization that paying a floating rate and receiving 2.5% over 30 years has a ton of risk and the flight to short-term Treasuries unwinds.

Curve: Swaps vs. Treasuries

A post on the FT from back in 2006:

Much as in other derivatives markets, swaps are becoming preferred among many investors as a means of increasing exposure to interest rate moves rather than direct investment in cash Treasuries, which is narrowing the differences between the behaviour of both markets.

When the US Treasuries yield curve inverted during 2000, swap spreads, a measure of the difference between the rate available from the swap market and the Treasury yield, widened, led by longer-dated maturities.

The wider spread pushed swap rates higher and prevented the swap curve from inverting.

We are truly in unprecedented times. The last time 10-30 swaps inverted was back in 2000, when Treasuries were even more inverted. Now, 10-30 Treasuries are more than 50 bps steep.

Up is Down... Down is Up

Swap spreads are currently trading through Treasuries on the long end of the yield curve. Not just a few bps, but 30+ bps.

What does this imply? It "implies" that investors are willing to lend to a counter-party (bank, hedge fund, etc...) at a lower rate than the U.S. government. While this isn't the reason for the inversion (I detailed back in October some technical factors that caused this), it still shows how distressed this current environment is.

How strange is this? Well back in October when the spread first inverted, we get this from the FT:

“Negative swap spreads have been considered by many to be a mathematical impossibility, just like negative probabilities or negative interest rates,” said Fidelio Tata, head of interest rate derivatives strategy at RBS Greenwich Capital Markets.

In this environment, nothing is impossible.

Two Year Swap Spreads State "WE WANT A BAIL OUT NOW"

Per Bloomberg:

The spread between the rate on a two-year interest-rate swap and Treasury yields surged to a record on concern that U.S. lawmakers may delay a Treasury department proposal to bailout the banking system.

The rate charged to exchange fixed for floating interest rate payments for two years above Treasury yields, dubbed the swap spread and viewed as a gauge of credit concerns, climbed to 166.38 basis points from 139.25 yesterday.