Oct 09 2008
More market craziness – negative swap spreads
It’s not showing it now, but 30-year swap spreads reached negative levels earlier this morning. That’s the last row on the graphic below. That sort of thing is highly unusual, to say the least.
Basically, what this means is that the fixed side of a 30 year swap (remember that a swap is an exchange of a fixed interest rate stream with a floating rate one) is trading at just about level with the rate of a 30-year Treasury Bond. Given that the credit quality of the swaps are generally AA-, and of course Treasury debt is AAA, this sets up an interesting question. Why so tight? One of my colleagues has suggested it’s the market looking at the banking system (the swappers) and saying they will basically be owned by the Treasury at the point. 
If you look at the front end of the curve (short dated stuff), you’ll see the money market issues in play.
Here are some other posts which might interest you:
- CME Expanding the Price Increment on Bond Futures
- The Fed buying notes and bonds concerns me
- Is the Treasury Issuing Enough Debt?
- Playing for a rise in interest rates
- Dollar Carry Traded by Germany
Do you have any theories as to why yield on the 30-year Treasuries is so low? Or why it has been dropping over the last week or two?
Thanks
Gary – The quick answer is flight-to-quality. The second answer is recessionary expectations. My feeling is that the latter is the larger contributor right now. The Fed couldn’t get long rates down, but now the market is because there’s a concern about the US (and global) economy which had been mostly lacking until relatively recently.