Negative Swap Spreads - Trouble On the Way?
If you missed "Will negative swap spreads be our coal mine canaries?" by Gillian Tett (Financial Times, March 30, 2010), it's a worthwhile read, especially given the pervasive use of triple A-rated sovereign bond yields as a proxy for the "risk-free" rate of return. A writer known as Bond Girl makes a similar observation in "10-year swap spread turns negative" (self-evident.com, March 23, 2010), adding that plausible explanations take the form of temporary and structural, respectively.
Consider the following:
- Pension funds and other long-term investors are driving up demand to receive swap fixed payments as part of their asset-liability management strategies.
- Some investors worry about the viability of governments to pay interest and debt on time.
- Corporate debt issuers seek to hedge these liabilities.
- Mortgage risk techniques are in flux, especially as the Federal Reserve Bank is no longer an active buyer of mortgage-backed securities. Read "Large-Scale Asset Purchases by the Federal Reserve: Did They Work?" (Federal Reserve Bank of New York, March 2010).
As if risk managers were not already challenged to deal with moving regulatory targets and market volatility, a negative swap curve adds to their concerns.
Editor's Note: On the topic of sovereign debt, a summary of Dr. Lucjan Orlowski's analysis of the Greek debt crisis and the likely impact on the U.S. dollar and euro will be posted shortly.
