March 23 (Bloomberg) -- The 10-year U.S. swap spread turned negative for the first time on record amid rising demand for higher-yielding assets such as corporate and emerging market securities.
The gap between the rate to exchange floating- for fixed- interest payments and comparable maturity Treasury yields for 10 years, known as the swap spread, narrowed to as low as negative 2.5 basis points, the lowest since at least 1988, when Bloomberg began collecting the data. The spread narrowed 5.38 basis points to negative 2.38 basis point at 3:12 p.m. in New York.
A negative swap spread means the Treasury yield is higher than the swap rate, which typically is greater given the floating payments are based on interest rates that contain credit risk, such as the London interbank offered rate, or Libor. The 30-year swap spread turned negative for the first time in August 2008, after the collapse of Lehman Brothers Holdings Inc. triggered a surge of hedging in swaps. The difference narrowed to negative 20.5 basis points today.
“It’s hedge-related activity related to new corporate issuance,” said Christian Cooper, an interest-rate strategist at Royal Bank of Canada in New York, one of 18 primary dealers that trade with the Federal Reserve. “As more and more institutions receive, then swap rates will go lower.”
Interest Rate Hedging
Debt issued by financial firms is typically swapped from fixed-rate back into floating-rate payments, triggering receiving in swaps, which causes swap spreads to narrow. An increase in demand to pay fixed rates and receive floating forces swap spreads wider, provided Treasury yields are stable. Corporations that issue bonds also use the swaps market to hedge against changes in interest rates that may result in increased debt service costs.
The extra yield investors demand to own corporate bonds rather than government debt was unchanged yesterday at 154 basis points, or 1.54 percentage points, the narrowest since November 2007, the Bank of America Merrill Lynch Global Broad Market Corporate Index shows. High-yield debt returned a record 57.5 percent in 2009, and another 4.3 percent this year, according to the Bank of America index data.
“There’s a lot of money on the sidelines waiting for mortgage-backeds to cheapen up,” said Cooper. “In the absence of them getting cheaper and as the end of the buyback program comes near, people are looking for high quality spread products, so a good place to park is in swap spreads.”
