Economic Policy Review
Negative Swap Spreads
Volume 24, Number 2
October 2018

JEL classification: G12, G13, G28

Authors: Nina Boyarchenko, Pooja Gupta, Nick Steele, and Jacqueline Yen

Market participants have been surprised by the decline of U.S. interest rate swap rates relative to Treasury yields of equal maturity over the past two years, with interest rate swap spreads becoming negative for many maturities. This movement of swap spreads into negative territory has been attributed anecdotally to idiosyncratic factors such as changes in foreign reserve balances and liability duration management by corporations. However, we argue in this article that regulatory changes affected the willingness of supervised institutions to absorb shocks. In particular, we find that increases in the required leverage ratio may have changed the breakeven level of the swap spread at which market participants are willing to enter into spread trades. We present a stylized example of these economics, illustrating how a higher leverage ratio can help explain these historic movements in swap spreads.

Available only in PDF
Press Release
AUTHOR DISCLOSURE STATEMENT(S)
Nina Boyarchenko
The author declares that she has no relevant or material financial interests that relate to the research described in this paper.

Pooja Gupta
The author declares that she has no relevant or material financial interests that relate to the research described in this paper.

Nick Steele
The author declares that he has no relevant or material financial interests that relate to the research described in this paper.

Jacqueline Yen
The author declares that she has no relevant or material financial interests that relate to the research described in this paper.