Swap Rates Below Bond Yields? What Does It Mean?

US interest rate swaps, popular derivatives that track government bond yields, have experienced a spectacular collapse this month with an array of reasons being suggested by traders.
This market emerged during the 1980s and has become a fundamental part of finance. Like bonds sold by companies, swap rates have historically traded at a premium over Treasury yields - seen as the risk-free rate for pricing other types of debt and derivatives.
Now dealers and users of US swaps, such as hedge funds, asset managers and companies, are watching the swap rate relationship to underlying Treasury yields, known as a spread, become increasingly negative. Last week, the 10-year swap rate at one stage was quoted 18 basis points below the 10-year Treasury yield. The current swap rate of 2.225 per cent trails that of the Treasury benchmark's yield of 2.33 per cent by 10.5 basis points.

Why is a negative relationship prevailing?
Analysts at Deutsche Bank say the recent swap spread tightening reflects "tighter macro prudential regulation, higher capital requirements and reduced dealer balance sheet capacity".
Also playing a role is swapping activity from companies selling debt.
Companies and institutional investors exchange floating rates of interest for fixed rates via a swap contract. When a company sells fixed-rate debt, it can use a swap to offset the payment of a bond coupon and pay a much lower floating rate - three-month Libor.
Such activity pushes... Read more