Spreads at the long end of the curve continued to tighten to record levels. Thirty-year spreads narrowed by around 1 basis point, trading flat to 10-year German government bonds - the first time this has occurred. Mike Bagguley, a swaps trader at Barclays Capital in London, said the flood of covered bonds issued by government agencies in the past 12 months or so was a major factor behind narrowing spreads.
“The covered bond market in Europe is developing to similar levels as the agency market in the US,” Bagguley said. “It is not inconceivable that it will reach the size of the [European] government bond market. This type of issuance has been crushing swap spreads as it has all been swapped to floating.”
Others said bouts of liability hedging carried out by insurance companies and pension funds in the past two years have also contributed to the narrowing of swap spreads. “It has been difficult to find confirmation as to who is responsible for this,” said Gianaluca Salford, interest rates analyst at JP Morgan in London. “However, the 10s30s [10-year to 30-year] part of the curve has steepened and then flattened on a few occasions in recent times. When the curve steepens then flattens it can be a sign of liability hedging.”
But the spread narrowing was viewed as unusual, as spreads typically widen during periods of risk aversion.