A few questions on swap spread
From my understanding, swap spread (say LIBOR - treasury yield of the same maturity) basically measures the credit risk of Libor fixing banks. Then a few questions arise:
1. What would be the difference between taking this spread risk and buying CDS on the basket the Libor fixing banks?
2. Why is USD 30Y swap spread currently negative?
3. In January 2009, 10Y swap spread turned negative as people are expecting Fed to cut rates and to implement QE. But these actions would also decrease treasury yields. So why was Libor more sensitive to treasury yields?
3. What factors are currently driving the US swap spreads? Are these factors just the combined list of factors that affect Libor rates and treasury yields?
Thanks in advance guys! Really appreciate it.
mm didn't look anything up so may be wrong but to get you started:
Swap spread measures overall banking vs. govt credit whereas buying CDS on basket of LIBOR fixing banks would expose one to individual credit spreads. Say there's a banking crisis initially isolated to France, then BNP, SG, and Credit AG CDS may blowout whereas swap spreads may lag behind or not move as much (of course the two are correlated, with the degree depending on severity, contagion effects, panic, etc.)
Well LIBOR has been anchored like many short-rates due to low for long and excess liquidity/reserves. Overall bank vs. govt credit has improved and swap spreads have remained tight. Reason for 30Y spreads trading negative is probably technical: corporate issuance unusually concentrated in longer-dated spectrum and receiving flows thereof can help push swap rates lower relative to treasury yields, for example.
Would question the simplification that expectations of Fed policy mechanically decrease Treasury yields across the board. For example, 10y tsys yield actually increased during that period between Jan 09 and Jun 09. One perspective is that people move out of the 10Y-30Y sector to the under 5Y sector for attractive rolldown + carry profile
All the factors that affect bank vs. govt credits matter, but some matter more than others. Technical factors affecting different parts of the swap vs. tsys curve also matter. An event that blows out front end spreads may not translate as much further out on curve if deemed short-lived by market.
Theoretically, swap spread measures the expected difference between LIBOR and repo rates, and this spread is function of credit risk of lending at LIBOR, amount of capital banks must hold against various assets and the cost of this capital (cost of equity), level of interest rates and the repo haircuts.
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