US swap spread narrowing set to continue

US swap spreads narrowed during the year’s first week of trading. But despite anticipation that the Fed will soon discontinue cutting interest rates, spreads will continue to be tight over the next few months, according to economic research from JP Morgan Chase.

January could prove a bumper month for corporate debt issuance. Last Thursday, Goldman Sachs and Lehman Brothers raised $2.75 billion and $1 billion on the bond market, respectively. And yesterday, Credit Suisse Group said it plans to raise $1.5 billion from a sale of 10-year notes, while US financial services company Washington Mutual plans to raise $1 billion from a sale of five-year notes.

The steep US Treasury curve means an issuer can currently exploit the differential between short- and long-term rates by swapping its fixed-rate liabilities into short-term floating-rate cash flows. A poll conducted by UK information provider Reuters last Friday found that 20 out of the 24 primary dealers of US government securities surveyed, expected the Federal Reserve to edge the Fed funds rate to 2% or higher by the close of 2002, up from a current 1.75%.

Issuers are likely to continue swapping until the Fed reverses its current easing policy, at which point there will be increased pressure on spreads to widen. However, swap spreads should “narrow substantially” over the next few months, according to JP Morgan Chase's economics research, with five-year and 10-year spreads narrowing to around 50 basis points and 60bp, respectively.