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U.S. 2-Year Swap Spread Reaches Widest in a Year as Stocks Drop
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U.S. 2-Year Swap Spread Reaches Widest in a Year as Stocks Drop

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U.S. 2-Year Swap Spread Reaches Widest in a Year as Stocks Drop

The spread between the rate on a two-year interest-rate swap and U.S. Treasury yields increased to the widest in more than a year as global stocks fell amid concern turmoil is intensifying in the Middle East and Ukraine.

Demand for government debt rose, driving yields lower, as prices of higher-risk assets fell after President Barack Obama authorized U.S. air strikes against militants in Iraq if they threaten U.S. personnel.

The swap spread widened to as much as 24.25 basis points, or 0.2425 percentage point, the most since June 24, 2013, from 23.25 basis points yesterday and a 2014 low of 8.94 basis points on April 23. The gap, a gauge of investor perceptions of credit risk, is based on speculation on the London interbank offered rate, or Libor.

“The war issues in Ukraine and now Iraq are behind the recent widening of these spreads,” said David Keeble, head of fixed-income strategy at Credit Agricole SA in New York. “Treasuries act as a lightning rod when anything bad goes on in the world, and the swap curve does not. The spread is also a credit spread and so is suffering from the drop in equities and flows occurring particularly out of high-yield debt funds.”

U.S. two-year note yields fell one basis point to 0.42 percent today in New York. The MSCI World Index of stocks dropped as much as 0.6 percent.

Swap rates serve as benchmarks for investors in many types of debt often purchased with borrowed money, including mortgage-backed securities and auto-loan securities. Narrower swap spreads can push borrowing costs lower even if Treasury yields are steady.
Fed Facility

While geopolitical unrest has accelerated the widening, the swap-spread increases began in June after the Federal Reserve downplayed the role of its reverse-repurchase-agreement facility in the central bank’s eventual exit from monetary stimulus, Credit Agricole’s Keeble said. That widened Libor rates relative to government yields, he said.

The Fed can temporarily drain liquidity from the market through the reverse-repo program.

Swap spreads also have widened amid speculation that regulatory changes announced last month for the money-market mutual-fund industry will increase demand for government debt by as much as $500 billion, according to Bank of America Corp.

The Securities and Exchange Commission said that in two years it will require money funds that invest in riskier assets to abandon their traditional $1 share-price floor and disclose daily changes in value.

For companies that use the money funds like bank accounts, the prospect of prices falling below $1 may prompt them to shift their cash into the shortest-term Treasuries, creating as much as $500 billion of demand in two years, according to Bank of America Corp. Increased buying will push Treasury yields lower and widen the spread if credit rates don’t move in a similar fashion.

U.S. 2-Year Swap Spread Reaches Widest in a Year as Stocks Drop - Bloomberg

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