Unravelling the mystery of the negative US swap rate | FT Alphaville

Unravelling the mystery of the negative US swap rate

Readers might remember how back in March 2008, Bloomberg ran a story that declared:

Treasuries Riskier Than Bunds, Default Swaps Show (Update1)

March 11 (Bloomberg) — The risk of losses on U.S. Treasury notes exceeded German bunds for the first time ever amid investor concern the subprime mortgage crisis is sapping government reserves, credit-default swaps prices show.

Readers might also recall that analysts have been suggesting that the current  shenanigans in the 10 year US Treasury swap rate, which turned negative for the second time ever in July, are more likely down to supply issues than shifting risk perceptions.

In other words, this is not about the swap-spread indicating that Treasury yields are no longer a reflection of the true cost of risk-free borrowing — in their eyes.

But does that wash?

First, consider the degree to which German bund yields fell on Wednesday on supposed fear of a double dip recession in the US. After the Federal Reserve decided to keep its bond holdings steady, yields on 10-year German debt did, after all, hit record lows.

But also consider the following chart. It shows the US yield curve in white, the US swap rate in yellow and the German sovereign curve in red:

As can be seen the German bund’s premium to the US Treasury becomes increasingly pronounced at about the same part of the curve as the swap rate begins to go negative.

The correlation becomes more glaring still if you break down the implied forwards, which reflect forward interest rates for a given market as implied by the current term structure of interest rates.

(H/T Sean Corrigan at Diapason for the chart.)

Furthermore, you’ll see from this chart how the negative swap rate only really began to recover as the European sovereign crisis began to peak in March. It then subsided back into negative territory when European sovereign fears began to soothe:

What’s our point?

Simply that the bund may have become the real global risk-free rate from about 10 years onwards. In the 2 to 10-year both appear relatively evenly risky. While due to the intervention of Federal Reserve in the near end of the market, no risk whatsoever is seen the Treasury securities market up to 2 years of duration.

All of which — going back to the orginal bund versus treasury Bloomberg story — also happens to tie in perfectly with what the sovereign CDS market is telling us.

Note below to what degree Germany CDS retraced their steps into more risky territory from about April onwards, and are only just about now reaching parity:


Related links:
Swooning canaries, exploding debt
– FT Alphaville
The negative swap time-warp
– FT Alphaville
Coming to America, Greece-style – FT Alphaville