Rates Markets Update: Swap activity dominated by interest rate speculation

Euro swap rates pushed up following increased expectations of an early European Central Bank (ECB) interest rate hike this week. Two-year swap yields rose by around 10 basis points on the week, five-year yields moved up 6bp, and 10-year to 30-year yields rose around 5bp.

“There is no credibility in the ECB waiting till after the States,” said Meyrick Chapman, interest rates analyst at UBS Warburg in London. Swap rates pushed up on the back of the increased expectations of an early interest rate hike. Two-year swap rates rose by around 10bp on the week, while five-year moved up 6bp and 10s/30s rose around 5bp.

Market participants expressed a little concern on the flattening of the curve: “The question now is not about the fair value of euro rates but about positioning. There are a lot of people who have held positions and are now going to have to exit.”

Spreads narrowed slightly over the week - 10-year spreads came in by 1bp to 22bp, while five-year spreads narrowed 1.5bp to 16.5bp.

European issuance remained fairly strong, led by the European Investment Bank (EIB) €5 billion 10-year issue, as corporates aimed to complete their funding requirements, with telecom-led jitters in the credit market.

“There has been a lot of supply recently - a lot of people want to get supply out of the way before Deutsche Telekom,” said Craig Reynolds, head of European swaps and options trading at Goldman Sachs in London. “The market is not looking forward to the next wave of issuance, after AT&T and WorldCom.”Reynolds added that he saw spreads tightening even further in the next few weeks due to subdued issuance.

Strong retail sales data on Tuesday pushed US swap yields higher, as market expectations of a rate hike increased. Retail sales jumped to 1.2% in April, the largest figure since last October. US swap spreads were narrower on the back of strong corporate issuance during the week. Ten-year swap spreads narrowed to around 51bp from 54bp last week, while five-year spreads narrowed 2bp to 43.5bp.