Convexity hedging and its impact on US swap spreads

The active management of agency bond portfolios has become the driving force behind moves in US swap spreads. The Royal Bank of Scotland’s John Wraith explains

While there is a huge diversity of factors that can impact on the level and direction of swap spreads in interest rate markets, some clearly have more importance than others. Over time, the dominant influences change with other developments in underlying markets, and the key to anyone exposed to changes in swap spreads must therefore be to keep abreast of the nature of major influences on spreads at any given time.

In the US over the past few years, the behaviour of negative convexity hedgers