More Swap Spreads Speak?
Nattering about the USD/JPY FX pair carry...
As a result, repo rates can rise (circa 1.7 to 2.4 or +70bps since May 2018) and swap spreads on 5 and 10-year USTs can go negative or below that of corporate funding.
It's not just the inverted US Treasury yield, Eurodollar futures and swap rate curves indicating how messed up the financial plumbing system is...
30,10 and 5 yr Swap Spreads - note the 30 and 10 year are negative, the 5 is above the 10, and the 5 and 10 are above the 30. This is an inversion.
Note: the 30 year spread has been negative mostly since the GFC. This condition is mostly due to ins cos and underfunded pension funds having to match the extending durations of their liabilities as long duration government yields declined.
When a swap spread turns negative, this means swap rates have dipped below yields on corresponding duration USTs. Does this mean that the swap has less risk than a UST? Corporations can borrow for less than the government, so it's the end of days? As a result, the US government will be BK in under five years? Or none of the above?
The latter is the correct answer, and suggests that there must be other risk factors involved. For USTs, this is an overreaction which is symptomatic of counterparty risk for the execution of the swap leg of the trade, costs of the trade, or limits to arbitrage, any of which can make holding the trade to maturity infeasible.
These conditions can be affected by dealer balance sheet constraints (capital holding costs), inability or unwillingness as in less participants or market makers, which effects the markets ability to absorb supply or inability, viz. negative swaps spreads are also a sign of illiquidity. Ruh-Roh?
More to come in The Sluice Is Down!!! Ruh-Roh? Stay tuned, no flippin.
Recommended reading:
Swap Spread Spike Signal?
Swap Spreads For Dummies?
Negative Swap Spreads FRBNY
Of late, the seeming relationship between the USD/JPY FX pair has been, (+/-) USD up, US markets up, JPY down, Nikkei down and vice versa for both; (-/+) USD down, US markets down, JPY up, Nikkei up.
When certain parties, offshore and otherwise, can't get the GW's they need in the market, with no lender of last resort or backstop for them, they must resort to selling USD assets at any cost to order to obtain them.
- Capitulation To The Dark Side?More Nattering about Swap Rates and Swap Spreads...
The credit risk profile of a swap spread is different from a bond, and when bonds or HQLA are in short supply, it would seem to be the easy way out. Pay me now or pay me later? Forward swaps artificially create present "liquidity" for a future price.
Why all this negative swap spread action? T-bills compete with government repo and reverse repo. Perhaps at the moment, banks want to maintain or shrink their balance sheets, as opposed to making loans in the repo market, read limited supply and capital constraints. Are Swap rates and spreads speaking? Swap Spreads Speak?Moving West... At the same time, in order to hold more T-bills, dealers are requiring increasing amounts of short term on the run collateral (a liquidity issue we have Nattered about ad nauseum) or wholesale funding in the repo market.
As a result, repo rates can rise (circa 1.7 to 2.4 or +70bps since May 2018) and swap spreads on 5 and 10-year USTs can go negative or below that of corporate funding.
It's not just the inverted US Treasury yield, Eurodollar futures and swap rate curves indicating how messed up the financial plumbing system is...
Note: the 30 year spread has been negative mostly since the GFC. This condition is mostly due to ins cos and underfunded pension funds having to match the extending durations of their liabilities as long duration government yields declined.
What makes negative swap spreads puzzling is that, when the swap spread is negative, a pure “carry” yield can be earned by paying the fixed rate on the interest rate swap, receiving the floating rate on the swap and holding long a Treasury bond of the same maturity. If interest rates were the only risk factors in this trade, holding to maturity would represent an arbitrage opportunity. - Negative Swap Spreads FRBNYWith mid to longer duration swap yields below Treasuries and negative, what does that say about: the forward expectations of those future corporate streams? Or the demand, supply, market making ability and price for the swap instrument or hedge?
When a swap spread turns negative, this means swap rates have dipped below yields on corresponding duration USTs. Does this mean that the swap has less risk than a UST? Corporations can borrow for less than the government, so it's the end of days? As a result, the US government will be BK in under five years? Or none of the above?
The latter is the correct answer, and suggests that there must be other risk factors involved. For USTs, this is an overreaction which is symptomatic of counterparty risk for the execution of the swap leg of the trade, costs of the trade, or limits to arbitrage, any of which can make holding the trade to maturity infeasible.
These conditions can be affected by dealer balance sheet constraints (capital holding costs), inability or unwillingness as in less participants or market makers, which effects the markets ability to absorb supply or inability, viz. negative swaps spreads are also a sign of illiquidity. Ruh-Roh?
More to come in The Sluice Is Down!!! Ruh-Roh? Stay tuned, no flippin.
Recommended reading:
Swap Spread Spike Signal?
Swap Spreads For Dummies?
Negative Swap Spreads FRBNY
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