Oct

23

See chart showing the relation between 30 yr swap spreads and 5 yr swap spread going back to 1994.

The current situation seems incredibly absurd to me– can any readers offer some insight into the economic/financial implications of this? It seems to me that the 30-yr swap spread is utterly out of whack (the 5-yr swap spread is also pretty darn low considering the distress in the banking sector; see this for more on why I think that. In fact, the 30-yr swap spread recently turned negative! (it's now hovering above zero). Consider for a moment what a negative 30-yr swap spread implies. For one, it is saying that the full faith and credit of the US Treasury isn't as good as an unsecured obligation of some shaky banks. But going beyond that, suppose the 30yr swap spread remains near zero. That would means that, if I had a $1b floating rate loan at say, 50 over libor, someone would be willing to lock me into a fixed rate for 30 years, and the rate I could lock it in at is the yield on the 30 yr treasury bond. Now, as we all know, treasuries are pretty expensive at the moment — flight to quality and all that. This statement is of course more applicable to short maturity Treasuries, but it is still the same underlying credit for the 30 yr. Now, I don't know about you guys, but with the way the fed has been printing money lately (see Federal Reserve release, +$245b in a week, and it's much worse, because as you can see, in that last week they sold a bunch of treasuries and replaced them with… crappy assets from banks), I can easily see Libor getting up to very high single digits over the next 10 years.

So what's going on here? What has caused this dislocation? Let's see what the fixed income mavens have to say about this.

Convergence trade anyone? Would be easy to put on — just pay fixed on a 30 yr interest rate swap, and then receive fixed on a 5 yr swap. You could lever it up pretty ridiculously too, as long as you had some cash put aside so you could stay in the game if this madness got even worse.


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