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What A Negative Swap Spread Really Means (Spoiler Alert: Nothing Good)
Submitted by Eugen von Bohm-Bawerk via Bawerk.net,
SWAP spreads recently took a nosedive and are once again trading at negative levels, even for shorter maturities. As can be seen from the chart below, treasury yields, here represented by the 10 year maturity, rose during QE policies programs contradicting the very raison d’être spouted by the central bankers. Interestingly enough we also see the same pattern in SWAP spreads. As QE programs were enacted SWAP spreads started to move upwards, just to rollover as the central bank program was getting close to a conclusion.
Source: Bloomberg, Federal Reserve, Bawerk.net
Also, note that the exact same pattern in yields occurred during the taper period with the all too familiar plunge in the immediate aftermath as the program ended. In addition, SWAP spreads also drifted downward as one would expect. However, something changed in 2015. Yields started to move upward, while SWAP spreads collapsed and even became negative.
This market perversion suggest that Wall Street is a safer counterpart than the very institution that underwrites the whole fractional reserve fraud in the first place. To price in a higher risk premium on the US government than on US banks is a contradiction in terms so there need to be another explanation behind this puzzling market phenomenon.
One reason, which seem very popular among the mainstream pundits, relates to new banking regulations post-GFC. It has become more expensive for banks to make markets compared to what it used to as higher capital requirements means holding “inventory” of bonds are costlier. In addition, banks are now required to maintain a total loss absorbing capacity (TLAC) which equate ?safe? government bonds with other more risky paper. Overall, globally systemically important banks, here represented by US Primary Dealers have reduced their bond inventories dramatically since 2008 to reduce their cost of capital. Initially, before the TLAC proposal, they also changed the composition. Corporate bonds fell precipitously from 2008 while a net short positon in TSYs became a net long position (front -running QE).
In times of stress, corporates may want to hedge large positions while the main conduit, the global banks, are nowadays unable to respond accordingly. Pricing in the SWAP market then reflect the demand / supply mismatch driving the TSY spread negative.
Source: Federal Reserve Bank of New York, Bawerk.net
By isolating the holdings of corporates, we see how dramatic the change has been in the post-GFC period (note that there is a break in the time series from 2013, which exaggerates the effect, but the shift is remarkable nonetheless).
Source: Federal Reserve Bank of New York, Bawerk.net
In addition, we know that foreign exchange (FX) reserve managers have been net sellers for quite some time now. It is safe to assume these are mostly US treasury securities being sold to prop up various Emerging Market currencies, of which China is the most notable. The next chart depict a moving average of monthly change in FX reserves of those countries that as recently as last year used to be large accumulators. From this it is clear that there have been significant selling pressure in the TSY market, and with the Fed now being a neutral bystander this has led to lower prices (higher yields) which have helped intensify the SWAP spread perversion.
Source: Bloomberg, Bawerk.net
To substantiate this argument we look at Primary Dealers holdings of TSYs, and it is clear that they have had to be more active in the market when FX managers started to sell in earnest in July. Funding this position must have had an impact on repo market, as witnessed in the rising GC collateral rate, which in turn have propagated into TSY markets, id est helped raise rates relative to SWAP markets.
Source: Federal Reserve Bank of New York, Bawerk.net
As a side note, it is interesting to witness Caterpillar’s retail sales and how it tracks the ebb and flow in FX reserves. See how, in particular, Asia/Pacific retail sales track their changing FX reserves. As a supplier to the construction- and its consequent commodity boom Caterpillar has been highly dependent on global ?dollar? funding; a system which paradoxically fed on itself. As ?dollar?, funding became ever more available, first through fractional reserve expansion (pre-Lehman) and subsequently by QE (post-Lehman) final sales demand for manufactured goods rose almost uninterrupted, leading to an unprecedented expansion in Chinese fixed asset investments, which in turn incentivized commodity producers to expand their output. These surpluses where promptly recycled back into the very same pockets of those expressing demand for their products in the first place. This virtuous cycle of higher demand feeding the global ?dollar?-funding scheme obviously benefited the likes of Caterpillar.
Source: Caterpillar, Bawerk.net
The other side of this structure was debt accumulation, both private and public. ?Dollar? recycling means the producing nation accumulate claim on the consuming nation’s capital stock and future output. In addition, as Emerging Markets took over what used to be highly paid jobs from the spoiled western worker, wages would eventually start to converge, meaning stagnate and ultimately falling in the west. Lower incomes could thus not keep pace with the relentless surge in leverage so the demand was clearly unsustainable. QE unfortunately prolonged the process for almost a decade even though the market tried to correct the capital consuming process several times.
Now, that demand is clearly falling we find ourselves with massive overcapacity of manufacturing capacity and commodity output. Inventories, both in manufactured goods and commodities are breaking record levels every day now. We are “swimming in oil” in North America, Europe and China while desperate producers keep churning out a product no one wants. The story is no different in coal, gas, iron ore, steel, cement, cars, glass, trucks, heavy-duty equipment etc. A massive inventory liquidation is underway which will lead to a new global recession in 2016.
This is the real reason why SWAP spreads are negative. The complete unwind, or even reversal, of global wholesale ?dollar? funding put extreme pressure on corporations (which overwhelm the market for hedging) as they realize they can no longer roll over debt to maintain their overcapacity. With a scramble for real dollars (note, a ?dollar? is a claim on dollars for which no dollars actually exists) the dollar exchange rate is surging; both compounding and reflecting the problem at hand.
Source: Federal Reserve Bank of St. Louis, Bawerk.net
Historically, large and sudden shift in the value of the global reserve currency is synonymously with global turmoil. We guarantee you that this time is not different. We are heading straight into a massive deflationary inventory liquidation with mass defaults across the globe. This is what a negative SWAP spread is really telling us.
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FX Market ? I get the Fucked part what does the X stand for
Fuckin Xcrewed.
Ponzified Central Xchange.
Reminds me of the "Roaring 20's" and the subsequent "Crash of '29", that's the 1920's and 1929 for the historically challenged. Another fine example of the "stability" created by the corrupt parasites at the Federal Reserve.
I'm sure that whatever the FED does on Monday will fix this.
First words out of their mouths after the meeting...raise, don't raise, QE7, Yeller breaks wind.....markets go up
Good article. I've been trying to get my brain around swap spreads since the first ZH article and this helps. Still not there totally, but getting closer.
1937 all over again if the Fed persists in raising rates is what I take from the article. Blowing more and more air into a burst balloon is the only option they've got, since they're obviously not going to allow a reset. Been doing a good job of it since 2008, but the balloon's been springing more and more leaks as the years have passed.
Yes, but do not gamble with funds you cannot afford to lose. If a default is good for the other side of the CDS issuer's book, then you migh "win".
This helped me
http://seekingalpha.com/article/3703626-swap-spreads-for-dummies
great article -thank you very much!
Can't imagine why the Feds have that Expedited Closed Door Meeting on Monday, November 23.
Planning the Thanksgiving Day Massacre.
The anti dalla , for turkeys
To try to figure out how to insert "patient" back into their statements while simualtaneously announcing QEinfinity is back.
Or they are putting out a hit on Ryan, seeing if anybody "knows a guy"
Of course the Federal Reserve was created and has been maintained by bribing those fine, upstanding and stalwart boot-licking lackeys in the White House and Congress.
An officer in the United States Air Force cannot accept so much as a free can of Coca-Cola at a program review meeting with an aerospace contractor. They rightly and properly have to pay the current value of 50 cents, or whatever for any drinks, and the value of any meals. But, parasitical politicians can accept bribes in any amounts because they exempted themselves from the bribery laws. Which group has done and continues to do greater harm to the Republic?
Maybe the National Association of Realtors? They often act as a money laundering and deposed dictator relocation service. And they get to skim 6% off the top for themselves.
Deflation and mass defaults will happen. What will happen to the issuers of the US Treasury bonds, the US government? http://www.counterpunch.org/2015/10/28/united-states-treasury-swap-spreads/
What a fucking joke. The very same people that sell this garbage control all sides of the equation. You are a fucking idiot. If GS or JPM stand to lose should a default happen, a default will never happen.
Look around this world asshole. Defaults no longer happen, war (civil or otherwise) happens. You have to live in a pretty civil society with robust economy, just laws and accountability for the system to handle defaults and bankruptcies.
Sorry asshat, that society no longer exists. Just ask Joh Corzine.
Excellent article. Thanks ZH.
Good article
What it means is very simple mathematically but could be highly consequential in the real world, ie:
The negative swap rate means that the bond market (very broadly speaking, ie including all interest-rate financial assets and derivatives), is forecasting a lower interest rate on US Treasuries, the global foundation financial asset.
In terms of investing consequences/opportunities, if this collective interest-rate market forecast turns out to be true, then buying treasuries now at current prices would result in capital gains as reality catches up to the forecast, ie treasury prices rise and yields/interest rates fall. This would happen if the FED implements another cycle of QE.
In terms of economic consequences/opportunities, the forecasting signal implies that the global economy is going to slow down even more, possibly into a global recession, and if that happened, then the FED would surely launch another cycle of QE, plus whatever other money-creation & injection scheme they can invent.
one thing is sure. this stock market rally is costing uncle sam a fortune in higher interest rate payments.
nice work. that actually explains a lot. the pd net positions chart could account for the lack of volatility lately. with no net positions the pds have no interest in doing the pump and dump. i think this doom porn article is actually bullish come to think of it. yeah, that's the ticket!
QE4 to the rescue.Everyone deep down inside knows that all the QE programs since the great financial crisis are being rotated amonst different governments in order to buy time.It's Japan,the U.S.,Europe,England and now China.Even China said "they've done as much as they can to help out the United States".It's a huge life support system that simply buys all the big world crooks time in order to keep the present economic order going,that's all.They don't want the economic order of the world to change.You first have to understand that all western governments and their central banks are all essentially insolvent.There's a few years left at best and that's exactly the reason why you are seeing them slam gold down while central banks that are smart accumulate hard assets.You see this individually when the average guy sees silver and gold drop the demand really picks up while western governments empty their vaults in a last ditch effort to keep that last bit of confidence left in their paper fiat currencies.How much longer can it last,we don't know but we do know that governments are losing their tax base because of demographics and endless war costs that are helping to bankrupt all of them.Their basic line of thinking is that they can print as much paper currency as they want and it doesn't matter.The whole financial system especially banking is governed by Keynesian philosophy which has failed.It is what they've done since moving off of the gold exchange standard.The ultimate last solution that they will try,and it will come,is jumping from the deflationary spiral downwards to hyperinflation directly in a desperate act to help out all the corrupt politicians.The politicians will always take the easy way out guaranteed and that will blow up too.Like they say,land,fine art and gold to be safe.
I think this chart, "pretty well" summarizes Swap Spreads.
H/T to the Tylers.
I thought there was a trade in there somewhere, unfortunately, the Fed can keep spreads wider for much longer than you can remain solvent.
LoP you clearly don't understand the credit market. I've been short corporate debt for months.
The divergence in debt vs equities, on the short end has been very profitable, as risk premiums rise, bond prices DROP.
ie; being short corporate debt.
Roll the Guillotines MFer's. ha
No, I have picked up many nickels in front of steamrollers before. Paid for some great vacations with it too.
I picked up a nickel on my walk home from the beach this morning. It was face down, and I'm sort of superstitious.
This is a true story. 2012d series. Tin foil zinc crapola.
If real defaults were actually allowed, yes, it could be profitable. However, I am betting that corporate america gets another bailout soon. Back door or otherwise. The escalation in "terror" is already signaling a bailout for MIC companies.
Okay, here's my scenario, based on macro charts. I think we'll see another round of QE going into q-2'3 2016.
How it's implemented ,is another question entirely?
So YES, I agree with your comment.
Thanks. What are your thoughts on the Real? IMO if the USD:BRL goes above 4, then America and Canada will have to worry about more than just mexicans.
I'm flat until the first of the year. I don't trade 3rd world risk.
LOL! I thought you might have brass balls. My bad. I look at Chicago, detroit, L.A. and see plenty of "third world risk". I have a nice plantation in the states and another on an island in the south of Brazil. Sorry, plenty of "third world" shit in 'merica. Fuck, Chili has Ski resorts that put Vail to shame.
Every time I fly through JFK all I see is "third world"...
Do you have dual citizenship LoP? lol
That's a whole lot of mental masterbation considering that there is no spoon motherfuckers.
Allow me to simplify; when fraud is the status quo, possession is the law.
I agree with almost everything you say in "principal"
If the cow needs to be milked, in the curds & whey, and the meat needs to be smoked, by all means, use all the tools at your disposal for wealth preservation.
More to the point, the central banks control all sides of the credit markets, period. I am speaking more to the point of CDS and bets on bets on bets...
There is no real collateral at risk here because shoulld any of this actually blow up (but it won't because the very same people who lose get to decide if a default has actually occured) the world would errupt in war, everywhere. Or at least in major cities around the world. Whether or not your "bet" actually pays out would then be the least of your worries.
You're incorrect. Cental banks do in-fact control monetary policy, but have very little control over F/X policy, which is why the SNB who blew up the F/X markets 10 months ago is black listed.
F/X dwarfs all market trading, on a daily basis. I'm not sure you entirely understand swaps LoP.
Swaps are an agreement between parties to fix a rate over an agreed time period. [ with a little premium> 1-1.5 basis points]
Swaps theoretically provide liquidity. If an central bank suddenly changed policy the SWAPS market would blow-up, as secondary traders would have to reprice their money market portfolios.
"SNB who blew up the F/X market" --- ONE bank blew up the entire "market"...
LOL, good luck when they all go.
nickels and steamrollers, yeah I think I understand just fine. As a producer of food, your paper promise or debt note won't be accepted. We will do just fine.
I am interested in your thoughts on the Real however. We have done a lot of business with and in Brazil.
Yes, the SNB did in fact "blow up" the entire F/X market.The markets, all of them are just electronic trust funds. Just like the bank that you buy seed from every year.
LoP you should stick to peanuts and corn, because your understanding of finance is in fields of corn,and small villages.
How I divest, re-invest, my paper procedes is non of your business.
You're just a pinhead sharecropper looking for an argument, to feel important.
What I get from this. Reset is a must and Hold Physical Gold.
ummm.. can't we just say something simple like "investors are sick and tired of lending money to the government" and get rid of all the useless chart porn?