Is the U.S. Government Single-A Rated?

Negative swap spreads cannot be a good omen for the financial markets.

Interest rate swaps are the most vanilla and widely used over-the-counter derivatives in the world. They are an effective tool in helping institutions hedge interest rate risks. When a company or bank issues floating rate debt but needs a fixed rate profile, it can easily swap the floating rate payments to fixed payments. When a pension or insurance company has long duration (10+ year cashflows) and it cannot find any attractive long duration bonds to invest in, it can simply buy short cash bonds and overlay long interest rate swaps to hedge away that long interest rate exposure. Interest Rate Swaps are critical components of the derivatives and fixed income markets.

With that as the backdrop, when something looks strange in the interest rate swap markets, I tend to pay attention. Back in July of 2009 I asked whether it made sense that 30-year interest rate swaps were trading at an interest level that was below 30-year government bonds. In fact, 30-year swaps spreads have traded as low as -60bps (-.6% to treasuries) and have bounced around the -17 bps to -4 bps level for most of 2009 and until recently. (Click to enlarge)

30-Year Swap Spreads are plunging once again