Reuters Company News
US swap spreads suffer on weak data, credit fears
NEW YORK, Aug 1 (Reuters) - Falling stock markets, weak
economic data and persistent worries about credit quality
damaged short-term swap spreads on Thursday, despite mounting
expectations the Federal Reserve may need to respond with an
interest rate cut before year end.
Spreads had tightened early on expectations for the drought
in corporate debt issuance, caused by investors avoiding any
credit risk, could improve in coming sessions after a few debt
sales were completed this week. On Wednesday Procter & Gamble
(NYSE:PG - News) sold $500 million of six-year global notes.
Companies selling long-term debt and swapping it back to
cheaper floating interest rates has been one of the main
drivers that pushed 10-year spreads to four-year lows back in
May.
But those hopes quickly faded during the session as worries
about bank liquidity and credit quality returned, likely due to
the worsening outlook for the economy and tumbling stock
markets. The Standard & Poor's 500 index fell nearly 3 percent,
snapping a four-day rise, as poor manufacturing and
construction data cast doubt on the recovery.
"People don't want credit risk," said one head trader at a
European investment bank. "Big portfolios have gotten burned
owning spreads and betting on spreads coming in. People are
scared and want to be in five-year Treasuries and 10-year
Treasuries."
Thursday's data showed national manufacturing activity
barely grew in July, suffering a sharp drop in the pace of
growth from the prior month. The Institute for Supply
Management's July index fell to 50.5 from 56.2 in June.
It also stoked worries about the economy falling back into
recession after gross domestic product grew a meager 1.1
percent in the second quarter and other figures showed the
economy to be on much weaker standing than many had expected.
Futures contracts on the federal funds rate have rallied in
recent sessions to reflect a roughly 50-50 chance the central
bank will cut rates by a quarter percentage point before year
end.
The trader said that front Eurodollar futures essentially
trading at or below the federal funds rate was creating market
dislocation that causes "everything to go kind of nuts."
September Eurodollars traded at the 1.75 percent federal funds
rate, unusual for those contracts that offer a slight spread
over the benchmark.
Five-year swap spreads continued the bear the brunt of the
spread blow-out because that is an area where many investors
have exposure to other credits.
Traders have noted many investors paying fixed rates in
swaps against losses in other issues, like mortgage-backed
securities, agencies or corporate bonds since the sharp move
wider began last week on worries about liquidity problems at
J.P. Morgan Chase and Citigroup.
Tight conditions in the repo market -- which many investors
use to fund positions -- for five-year notes also pushed those
spreads wider by making those Treasury issues more attractive
than swaps with the cheap funding.
While repo rates typically trade close to fed funds, the
rate for five-years stood at a mere 0.20 percent on Thursday.
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Aug 1 July 31 July 30 July 29 July 26 July 25
2-YR 45-00 43-00 44-1/2 43-1/2 45-3/4 42-1/2
5-YR 68-00 66-00 68-00 67-1/2 68-3/4 63-00
10-YR 62-1/2 62-00 64-00 64-00 65-1/2 61-3/4
30-YR 51-00 51-1/4 52-3/4 51-1/4 52-00 51-00
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