Rates Markets Update: US swaps widen on Middle East fears

The US interest rate swaps market broke a trend this week as spreads slowly widened after several weeks of consistent narrowing. Five-year dollar swap spreads widened by 5 basis points to 62bp over Treasuries in the same maturity, while 10-year spreads widened by around 3bp to 66bp, due to uncertainty in the Middle East and the timing of potential US interest rate increases.

Investors sought the relative safety of US Treasuries due to concerns that the current tensions in the Middle East could escalate. According to James Mather, head of interest rate derivatives trading at Royal Bank of Scotland in New York, the widening of spreads showed there was a greater risk premium in the market. “The trends in the market are showing us that the world is a more risky place.”

But Gagan Singh, vice-president and head of derivatives strategy for North America at JP Morgan, said he expected spreads to trade in a narrow range despite this week’s slight rebound. Singh said any substantial widening would only occur if the Middle East tensions significantly worsened, or if the Federal Reserve delayed a likely decision to tighten interest rates from May to June.

Euro swaps saw a mixed week, with spreads generally following the US market. Two- and 10-year spreads were wider by around 4bp, while five-year spreads widened about 4bp at the start of the week but then came back in by the end of trading today. “Corporate issuance has been dry this week. There has been no big activity on the swaps side,” said Christophe Coutte, director of euro swaps at Deutsche Bank, adding that although volatility had risen, volumes remained thin.

The Easter holiday break was cited as the main reason for the lack of bond issues. Bond issuers often engage in interest rate swaps at the time of fund raising.

The euro swaps market is expected to remain relatively stable this year, dealers said, although a Lehman research note said a moderate widening of spreads is likely in the medium term as the expectation of interest rate rises grows.