Swap Rates vs. Treasury Rates

Following on my previous post regarding swap rates falling below treasury rates, this is a phenonon not only evident in the U.S. market but also in the UK. In Europe, the relationship is “normal.” Read the following excerpt below from a report published in today’s FT.

For the first time since swaps emerged in the mid-1980s, the 10-year swap rate traded below that of the "risk free" 10-year Treasury yield. Analysts say this reflects how government debt issuance has altered the dynamics between "risk-free" yields and swaps, which reflect borrowing costs for non-sovereign borrowers.

In the UK, swap rates have been below those of 10-year gilt yields since January. The yield on 10-year gilts was at 4.03 per cent yesterday, up from a low of 3.91 per cent earlier this week. The peak yield so far this year was 4.27 per cent in February. In Europe, however, swap rates are 20 basis points higher than 10-year yields.

"If we get clarity on what the UK will do on deficit reduction once the election is behind us, then the market and gilt yields could stabilise," says Mike Amey, UK portfolio manager for Pimco. Since the UK budget on Wednesday, the negative spread, or inversion, has widened with swap rates trading nearly 20 basis points below gilts for 10-year maturities compared with a negative spread of 10bps just before the government statement on public finances.

In other words, huge issuance is already creating unexpected distortions and stresses in the market. It is far from clear that we have seen the last of them, given the amounts that still need to be raised.