U.S. Interest Rate Swap Spreads Tighten Amid Stock Sell-Off and Recession Fears
U.S. interest rate swap spreads tightened on Monday as investors hedged against lower interest rates amid a sharp stock sell-off and recession concerns. Learn more about the market movements.
New York, Bollywood Fever: Spreads on U.S. interest rate swaps over Treasuries tightened or turned more negative on Monday as long-term investors hedged their exposure in the swaps market to position for lower interest rates, reflecting concerns over the sharp sell-off in stocks.
In late trading, the spreads were mixed. U.S. swaps measure the cost of exchanging fixed rate cash flows for floating rate ones over a specific time frame.
A swap spread is expressed as the basis-point difference between the fixed rate of a swap tied to the Secured Overnight Financing Rate (SOFR) and the Treasury yield of the same maturity. This spread also considers the cost of financing a long or short position in Treasuries.
In general, a tighter spread means the cost of funding Treasuries is higher compared to swaps. During the session’s peak meltdown, when stocks sold off sharply and U.S. Treasury yields dropped, swap spreads were tighter across the curve, likely driven by hedging flows, analysts said.
The spread on 10-year U.S. swaps over 10-year Treasuries fell to as much as -45.75 basis points (bps) on Monday, down from -44.30 bps late on Friday. It settled at -44 bps as Treasury yields sharply rebounded from their lows, with some maturities even higher. U.S. 20-year swap spreads went as low as -78 bps and were last at -76.75 bps, tighter or more negative on the day.
“Very often what you’ll see is that very large declines in equities lead to receiving needs in swaps, which … move swap spreads as well,” said Gennadiy Goldberg, head of U.S. rates strategy at TD Securities in New York. Receivers in swaps, or the counterparty receiving a fixed-rate payment, benefit if interest rates fall and lose if interest rates rise.
“That’s because variable annuity (VA) and fixed index annuity (FIA) accounts will behave more in a fixed income fashion once equities go sharply lower. They could be positioning themselves and hedging more than they usually are, which tends to tighten swap spreads during periods like this,” Goldberg added.
Major U.S. stock indexes fell sharply on Monday, with the Nasdaq down more than 3%, as U.S. recession fears spooked global markets and drove investors out of risky assets. Recession worries followed softer-than-expected economic data last week, including Friday’s U.S. payrolls report.
Meanwhile, U.S. Treasury yields rebounded from one-year lows as panic eased slightly after data showed a recovery in the U.S. services sector index.
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