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We are short Municipal Bonds via the etf MUB, short High Yield Bonds via the etf HYG, and short Treasuries via the etf IEF

We have had our Hedgeyes on the action in the swaps markets over the last few days.  Below we’ve attached five year charts for both 10-year swaps and 2-year swaps.  These charts show that that swap markets are at an inflection point and, in fact, are turning negative.  Last night, 10-year swaps were at -2.25 basis points and 2-year swaps were at -17.0 basis points.

According to Josh Steiner, our Financials Sector Head:

“Essentially, what’s going on here is that the cost of swapping floating rate obligations for fixed rate obligations has soared, which has put downward pressure on the fixed payer swap rate – so much so that the rate is now actually below that of comparable duration treasuries creating a negative spread (for the 10YR).”

This of course happens for a couple of reasons.  First, it shows increasing anxiety around the Fed tightening.  In effect, one would only pay a big premium to swap fixed rates for floating rates if you thought floating rates were about to get meaningfully more expensive.  Secondly, and also per Josh:

“To a lesser extent it supports the idea that AA corporate credit is trading tighter and tighter to US sovereign credit, partly because the markets are starting to price in the downgrade of the US and partly because corporate balance sheets, especially for the financials, are much, much stronger now (i.e. they are holding significantly higher capital than at any time in the last several years with much of the credit risk already reflected).

The view that the Fed may raise rates sooner than expected from the swap markets has also been supported today by data points from the Treasury market.  The Treasury Department today sold $45 billion in 5-year notes at 2.605%, which was a higher rate than anticipated.  In addition, the buyers offered to purchase only 2.55x that amount being sold, which was the lowest level of demand in this auction since September 2009.  Moreover, indirect bidders, a group which includes foreign central banks, bought only 39.6%, the lowest level since July.

We continue to be aggressively short this Rate Run Up.


Daryl G. Jones

Managing Director

Five-year chart of 10-yr swaps:

Inflection Point In Swaps - 1

Five-year chart of 2-year swaps:

Inflection Point In Swaps - 2