Second quarter U.S. dollar (USD) interest rate markets were very unexciting when looking at absolute movements in both swap rates and Treasury yields. However, an interesting development arose concerning the relative movement between the 30-year points of these two curves that will likely have the attention of market participants through the end of the year. The 30-year swap spread – defined as the difference between the 30-year swap rate and 30-year Treasury yield – has widened (or become less negative) significantly since June 13th, when the Treasury released its recommendations for financial industry reform, including a proposal to remove U.S. Treasuries (USTs) from the denominator of the supplementary leverage ratio (SLR) calculation. This proposal would effectively make USTs “cheaper” for banks to hold from a capital requirement perspective.
The 30-year swap spread was -43 basis points (bps) the day before the Treasury’s announcement, meaning the fixed rate on a 30-year interest rate swap was 0.43% lower than the yield on the 30-year Treasury bond. At present, the 30-year swap spread is -29 bps. Another way of thinking about this is that 30-year Treasury yields have fallen 0.14% relative to 30-year swaps over the past three weeks. This move suggests the market believes to some extent that this proposal will be adopted. By making USTs less capital-intensive for banks to hold, demand for USTs should increase and consequently should increase prices and lower yields (bond prices and yields move inversely). In the past few weeks, there has been a lot of buying in 30-year spreads (receiving the UST yield and paying the swap rate) by market participants in hopes that this move continues wider. Researchers also have been busy trying to calculate where the 30-year swap spread could theoretically stabilize if the proposal is adopted based on banks’ new expected return on equity (ROE) for a long 30-year swap spread position that is financed with general collateral (GC) and LIBOR funding.Key Takeaway
The fact that the Treasury made the recommendation to remove USTs from the SLR denominator increases the likelihood of its adoption. However, the timing of its implementation and the size of the move already in the 30-year spread may make those entering a long spread position less confident now than they were three weeks ago. For those with a longer time horizon, a financed long position still has positive carry, even after considering the cost of initial margin and any funding haircut.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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