Rates Markets Update: Swap flows increase on economic news

Dollar-swaps saw big flows this week following a US Treasury announcement on Monday that it plans to borrow $120 billion to cover its budget shortfall. Ten-year swap spreads had come in from 57.5 basis points at the start of the week to 52bp midweek, pushing out to 54bp by the end of the week. Five-year swap spreads narrowed by 5bp, ending the week at 53bp.

The overall narrowing in spreads was spurred by JP Morgan Chase and Deutsche Bank saying they would generally not be renewing corporate commercial paper lines. This led to expectations of increased long-term corporate debt issuance, which contributed to the overall narrowing in spreads.

The other major trend reported by US swaps dealers was a resurrection of trades versus Libor in arrears. Rather than fix the floating rate at the start of the contract, this involves setting rates at the end of specific points in the future, usually every six months. Such trades are advantageous to the party paying the floating leg if interest rates do not rise by as much as is indicated on the yield curve.

“The yield curve is already steep,” said James Mather, head of interest rate derivatives trading at Royal Bank of Scotland in New York. “Corporates are betting that Libor isn’t any higher [in six months] than now, and are using these trades to make a quick pick-up.”

Euro interest rate swaps reacted sharply to news from the European Central Bank (ECB), which restated its hawkish stance on inflation this week. ECB president Wim Duisenberg’s comments implied the central bank might raise interest rates earlier than expected to counter growing inflation in the eurozone. 2-, 10- and 30-year swap rates rose by 9bp, 7bp and 5bp respectively.

But many dealers were critical of Duisenberg. “I can’t believe Europe is in better shape than the US. It was a foolish interpretation of the economy by Duisenberg," said Christophe Coutte, director of euro swaps at Deutsche.

Euro swap spreads narrowed slightly in the week by around 0.25bp along the curve.