Potential steps by the Federal Reserve to facilitate regulations on capital for US banks that will allow them to hold more Treasury securities have released a burst called spreading swap spreads in the bond market.
This is a bet that increases demand for US treasury that will encourage their results lower and closer to a competitive risk -free asset class called interest rate swaps. Analysts say this trade has been successful this year.
Trade has become popular since the November 5 election on the expectations of President Donald Trump’s administration will encourage deregulation, especially making capital adequacy rules less limiting banks.
“The market has utilized the possibility that more loose regulations will free some capacity for banks to have more bonds, especially at stress,” said Steven Major, Head of Global Research on Fixed Income at HSBC in Dubai.
“The initial position of a hedging fund is at the view that the regulations will be adjusted. There is more. “
Spread Swap is the main component of the interest rate derivative market of more than $ 500 trillion. They stated the differences in the basis between the fixed interest rates from the exchange of interest rates related to the current level of financing that were secured (SOFR) and the treasury results from the same maturity.
Investors and companies use swaps to protect the risk of interest rates or exposure to US treasury, allowing them to exchange cash flows with fixed interest rates at floating rates, or vice versa.
Spread Swap is currently negative in all curves, which means the results in the treasury are higher than swaps (USDSrois = TWEB). But since the beginning of the year, spread has become less negative, or in bond language, widening, which means the treasury has become a lower trend.
Spears Swap five years US (USDSR5YOTS = TWEB) has widened since January about five points (BPS) to minus 29 basis points on Tuesday. The distribution reflects the difference between the current five -year treasury results at 3.925% (US5YT = RR) and a five -year swap level at 3,6201% (USDSROIS5Y = TWEB).
At the end of the curve, the 30 -year -old Swap Swap (USDSR30YOTS = TWEB) has increased by 8 bps to minus 78 bps.
Balance of balance
Last month, Chairman of Fed Jerome Powell told the Congress that it was time for the US central bank to ease the additional leverage ratio (SLR), which directed banks to withstand capital to investment regardless of their risks and effectively prevent these institutions from holding the treasury.
The Fed was forced to temporarily put aside the SLR after the finance department market confiscated in March 2020, but let the relief ended a year later.
Cutting SLRs will significantly free the additional capacity for banks in their balance sheet, allowing them to add low risk free assets such as treasuries without having to allocate capital to cover the potential loss.
The clean effect of the new powell comment on the SLR is to encourage lower results, as a result widening spread swap.
Exchange spread throughout the curve has been negative for years, and this has to do with the loan structure between two risk-free assets.
“Credit risk between treasury results and SOFR SWAP tariffs is identical,” said Srini Ramaswamy, Director of Implementing and Head of Derivative Strategy at JP Morgan in San Francisco. “The results of the treasury are higher and it has to do with activating the principal.”
Ramaswamy quotes the five-year SOFR exchange rate, for example, which is effectively an average level that can be obtained by a loan at the repurchase market or repo every day for five years.
Treasury notes five years, on the other hand, representing lending money to the US Department of Finance five years at once.
“You provide flexibility when you lend money for five years to the Ministry of Finance, so the compensation is higher, which is contrary to a one -day loan at a time in SOFR exchange,” Ramaswamy said.
And with a recent transition to SOFR risk-free from Libor, or London Interbank offers tariffs, there is no more premium for credit risk embedded in swap rates that lift them higher above the results of treasury in the past.
Big banks as a result recommended the SWAP distribution to take advantage of the towering deregulation.
Barclays, in the research record, recommend the exchange of widening exchanges in the stomach of the curve, in particular, the spread of seven years, where banks prefer to have a treasury. He believes that changes in SLR can open the key to additional banks for treasury because these financial institutions grow their assets.
Securities TD, on the other hand, see more opportunities at the end of a longer curve, especially in the 30 -year sector, where the spread remains historically or more negatively.
“We believe that widening has more space to run because the regulator makes progress,” said Gennadiy Goldberg, Head of the US Tariff Tariff Strategy.
Source: Reuters
