Rates Markets Update: Swaps ride out terrorist scare

Interest rate swap spreads continued in a narrow range this week, despite a slight widening caused by the fear that the crash of a small plane into a Milan office building on Thursday was the work of terrorists. Initial fears led to 10-year US dollar spreads widening by around 1-1.5 basis points to 63.5bp. However, spreads came back in, settling at around 62bp, once the fear passed.

Dealers in the US claimed poor liquidity in the swaps market had prevented spreads from widening further on Thursday’s news. Apart from a slight widening last week, swap spreads have been steadily narrowing since the start of the year, with volumes showing a consequent decrease. Five-year swap spreads have dropped from a high of 80bp at the start of the year to their present level of around 56bp.

The other main development in the markets this week was Alan Greenspan’s testimony to the US Congress on Wednesday suggesting that the US Federal Reserve will continue to hold interest rates steady until June at the very earliest, following the recent pick-up in the US economy. Ten-year swap spreads came in by around 2bp following the news to 62.5. James Mather, head of interest rate derivatives trading at Royal Bank of Scotland in New York, said it was likely interest rates would remain unchanged until August. However, he added that the swaps market could see a big increase in activity should the Fed pursue a more aggressive policy and hike rates in June.

The euro swaps market had another quiet week, despite a couple of big bond issues in the market. The news from Italy hit the euro market late on Thursday, just prior to the day's close, and too late for dealers to react. Theoretical spreads, which are used to proxy actual data, did, however, jump by around 7bp immediately after the attack. Two-year swap spreads widened from 105 to 114 on the news. The market opened Friday at the same level, however, as dealers had time to uncover the truth about the incident.

The next few weeks are likely to see an increased amount of bond issuance in Europe. However, says Christophe Coutte, director of euro swaps at Deutsche Bank, it is unclear as to how much swapping activity this will lead to, as most corporates are holding their fixed positions, in the expectation that short-term rates will rise.

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