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Swap spreads collapse, what does It mean?

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  • Thu, Mar 25, 2010 - 02:47am



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    Swap spreads collapse, what does It mean?

I never thought I would see what this chart is showing. 10-year swap spreads have suddenly, for the first time ever, dropped below zero. They are now -7.25 basis points. Since swap spreads are traditionally a proxy for AA bank credit risk, this means that the market prefers to own 10-yr AA bank debt rather than 10-yr Treasuries. (For my short primer on swap spreads, see here .)

I’ve several explanations for the recent plunge in swap spreads, but not one that is compelling. The latest one is that corporations are rushing to issue lots of fixed rate debt and then swapping it back to floating; that is equivalent to a surge in demand to receive fixed in a swap transaction, which is itself equivalent to a surge in demand for long-term corporate bonds. But no matter what, the fact that swap yields are lower than Treasury yields can only mean one thing: Treasury bonds are no longer considered to be the most default-free instruments on earth.

  • Thu, Mar 25, 2010 - 12:20pm

    Peak Prosperity Admin

    Peak Prosperity Admin

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    Re: Swap spreads collapse, what does It mean?

I’m curious which came first: Chicken or egg? Did the swap spreads go negative BEFORE the Portugal downgrade or after? My instinct would have been that the swap spreads were probably depressed in reaction to the Portugal news, but something I saw on ZH seems to imply the reverse.

In any case, I agree that the masses are finally waking up to the obvious: Lending money on an unsecured basis to an insolvent borrower that has the legal ability to monetize and thus dilute the repayment currency really isn’t the safest investment on earth afterall…



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