The rate on 10-year interest-rate swaps fell to the lowest on record relative to Treasury yields as balance-sheet constraints on bond dealers and corporate debt issuance undermined prices on U.S. government debt.
The 10-year swap spread reached negative 17.6 basis points Thursday, the lowest in Bloomberg data beginning in 1988. A basis point is 0.01 percentage point. The gap turned negative for the first time in three years in September. The spread reached record negative levels in other maturities as well, including the five- and seven-year.
Slumping Treasuries contributed to the narrowing of the spread. Yields on 10-year U.S. notes reached 2.26 percent Thursday, the highest since mid-September, as bets mounted that the Federal Reserve will raise interest rates as soon as next month. Investment-grade corporate issuance may tally about $30 billion this week, putting further pressure on Treasuries. On top of all that, regulations enacted after the financial crisis have curtailed the amount of risk banks can take, leading them to scale back trading and lending.
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"This is more of a Treasury-led move as all the on-balance sheet products are becoming more costly to dealers," said Priya Misra, head of global interest-rate strategy in New York at TD Securities, one of the 22 primary dealers that trade with the Fed. "Treasuries are an on-balance sheet product so they are getting more costly relative to swaps."
Swap rates serve as benchmarks for a variety of debt purchased with borrowed funds, including mortgage-backed and auto-loan securities. Narrower swap spreads can push borrowing costs lower even if Treasury yields hold steady.
Swap rates have traditionally exceeded Treasury yields because the pricing of swaps is based on the London interbank offered rate, which involves credit risk.
–With assistance from Alexandra Harris in New York.
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