Swap Spreads

December 15th, 2016 8:53 pm | by John Jansen |

This is an interesting piece on 30 year swap spreads by my friend and former colleague Steve Liddy. I am reproducing the graphs which he includes but they do not translate well to my low rent retired guy hobby blog. That is entirely my fault and not his.


Via Steve Liddy:

When Lehman Brothers collapsed, in 2008, and the rate markets plunged long end swap spreads collapsed with them. Previously swapped hedges, with a  then bankrupt entity had to be reset, in a market where risk tolerance and balance sheet usage were being taken away, then by the banks themselves. Add to that the increased long end UST issuance needed to fund the various government bailout programs and you had yourself all time low 30y swap spreads. In the process of this wave of receiving, the friendly neighborhood RV hedge fund got stopped out on all the ‘cheap balance sheet’ trades that had consistently paid out a nice annuity. And, well the mortgage player…we all know…so no natural long end payor.

Twice since there have been periods where long end spreads rallied sharply:

-In ’09 with the announcement of QE1, that was short lived as ‘traders’ all believed all that liquidity would cause an inflationary nightmare, and were taken to task once the extreme FED actions did not lead the economy back..oh yeah, that euro crisis
-So, for 2yrs, roughly between 2/2010 and 2/2012 Bond spreads bounced around between -20 and flat
-Then in early 2012 the Op Twist talk began, officially becoming policy in 9/2012 and the heavy long end buying continued with QE3, until finally ending in 10/2014
-Since then swapped corporate issuance, Asset-Liability receiving needs and nobody to take the other side drove swap spreads to the recent all-time lows
-Along the way, RV funds did dip toes in the water attempting to buy Strips and Long End paper on asset swap, but they were simply not ever really able to force a true move wider

Well, now with elections results making the idea of a more aggressive FED, and possible inflationary pressures (forgive me while I laugh..inflation..so funny-unless you’re sending a kid to college) rates are backing up…at a time when the world is long a ton of fixed income, especially long end IG. Well here’s the problem, now regulatory issues prevent The Street from warehousing any large inventories, so how is a poor asset manager going to shed their duration? Could there be a new natural payor here? Watching the ultra-bond contract get pummeled has left the low coupon 2045/46 sector in tough spot. Liquidity is poor, DV01s are big and screen bids seem to be good for 5. Oh yeah..its year end, so that should toss a little gas on this fire.

If I were seeing selling, I’d be paying in swaps, even here at the recent ‘wides’. Every duration survey known to man has accounts long their IG bogey, and that has spilled over into duration. They can’t sell bonds..at least not that many bonds until ‘The Donald’ and his people come in and change the rules.

30y swap spreads

3.00% 11/45 vs spot 30y swaps…I still think this will be the out…maybe Mr RV comes back?

Good luck and enjoy the evening…Steve

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  1. One Response to “Swap Spreads”

  2. By Steve Liddy on Dec 16, 2016 | Reply

    If you’re ‘dying to see the graphs’ https://www.linkedin.com/pulse/has-natural-payor-swap-spreads-come-out-hibernation-stephen-liddy?published=t

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