Halister News

(Bloomberg) -- Even after the Fed’s Dec. rate hike, swap spreads are “still meaningfully below zero” and spread-to-rate correlations are far off from returning to positive, especially since the “global reach for yield is still in force,” Nomura strategists led by George Goncalves write in note.

• Swap spreads “no longer the perfect tool” to protect fixed income portfolios in times of stress; “nor are they good signals that risk-off pressures are forming”
• Front-end spreads: proof of “new world” for spreads is fact that there was “no significant widening” of 2Y spreads during recent risk-off episode after Brexit
  • Also, better correlation between 2Y spreads and 2Y OIS/UST spreads, so 2014-2015 spread widening periods were a function of “strong demand for cash bonds” as a result of LCR requirements
  • Balance sheet availability has become “more precious,” leading to spikes in GC repo during quarter-end and times of stress, which may be putting tightening bias into Libor/GC spread and “transmitting into front-end swap spreads”
• Intermediate spreads: Since Fed hike expectations have been pushed back, an opening of an IG issuance window may play a role before “summer slowdown”
  • 5s10s spread curve around “most stretched levels” under a new regime and may be opportunity for steepening into summer
  • Don’t rule out possibility that foreign central banks come under pressure and start defending their currencies via UST selling, which exacerbates spread tightening
  • Belly spreads “more at risk,” since the last round of EM FX-based selling impacted front-end paper and the next “overweight” bucket for central banks is 3-7yr sector
• Long-end spreads: “Key structural factor” impacting 30Y spreads is that private defined benefit pensions have become risk averse, shifted to receiving swaps for conservative strategies
  • May be challenging for funds to reallocate to stocks and/or take off received swaps positions, as their “worsening funding status” may lead them to “more prudent investment strategies” for liability management
  • Funds may be comfortable holding onto existing swap receiver positions, though “real risk” is that there’s a skew for further tightening if “another shock hits the market”