November 20, 2008 / 8:46 PM / 12 years ago

US SWAPS-Long spreads hit lows on hedging, duration demand

 * Fears of recession drive bid for long-duration
 * 10-year spread briefly fell into single-digit territory
 * 30-year spread posts new lows for sixth straight session
 *For up-to-the-minute bond news, please click on FINEWS
 By Richard Leong
 NEW YORK, Nov 20 (Reuters) - Long-dated costs to exchange
U.S. fixed-rate interest payments for floating-rates stumbled
to all-time lows on Thursday, as investors scrambled for
long-duration investments on fears of a deep global recession.
 Growing losses in stocks, corporate bonds and real estate
securities forced insurers and pension funds to buy more assets
like interest rate swaps that earn stable, long-term income so
they can meet future liabilities, analysts said.
 "The consensus view for a global slowdown and lower
inflation makes long duration assets very attractive. There has
been good demand to receive long-end swap rates, as a result,"
Morgan Stanley's head of global rates research, James Caron,
wrote in a research note on Thursday.
 The long-end of the swap curve has also been distorted by
hedging of exotic products like non-inversion notes and Power
Reverse Dual Currency Notes (PRDCs).
 Dealers borrow heavily to create these "exotics" so a
dramatic shift in currency rates or shape of the swap curve can
ignite radical changes in hedging them.
 "A lot of these instruments are highly levered," said Larry
Dyer, interest rate strategist at HSBC Securities in New York.
"You have a massive amount of optionality. You can see a lot of
positions swing."
 Thirty-year dollar swaps traded at a 50 basis point-plus
yield discount to 30-year Treasury bonds on Thursday.
 But this yield inversion should not be taken either as a
sign of better credit conditions, or that swaps, a benchmark of
corporate borrowing costs, have achieved a higher credit status
than Treasuries, according to Morgan Stanley's Caron.
 The 30-year swap spread over Treasuries set a record low
for a sixth straight session. It was quoted at minus 56.50
basis points in late trading, below minus 34.25 basis points
late on Wednesday.
 The yield spread on 10-year swaps over benchmark 10-year
Treasuries set a record low of 5 basis points in early trading
before it retraced to wider levels when the stock market
recovered some of their initial steep losses.
 Meanwhile, short-dated swap spreads tightened marginally as
players preferred short-dated Treasuries over comparable swaps,
analysts said.
 The two-year swap spread was last at 102.25 basis points
versus 104.50 basis points late Wednesday. It was quoted as low
as 100.25 basis points earlier.
 Other than hedging and duration demand, some analysts
attributed the unprecedented yield discounts of long-dated
swaps over Treasuries reflected traders' anticipation of the
vast supply of U.S. government debt supply to hit in the coming
months.
 "Over the past 10 years or so, it is an inescapable
observation that the swap spread has correlated very, very
closely to the federal budget deficit," Calyon's fixed income
strategists wrote in a research report.
 The U.S. government is expected to borrow heavily to fund
its $700 billion bank rescue program and a ballooning budget
deficit. On Thursday, the U.S. Treasury Department said it will
sell a record $36 billion in two-year notes and a hefty $26
billion in five-year debt next week.
 (Editing by Leslie Adler)









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