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U.S. swap spreads widen, three-month Libor rises as risk aversion spreads By Reuters


© Reuters. FILE PHOTO – A trader is working at New York Stock Exchange (NYSE), Manhattan, New York City. August 19, 2021. REUTERS/Andrew Kelly/File Photo

By Gertrude Chavez-Dreyfuss

NEW YORK (Reuters) – Spreads on 10-year U.S. interest rate swaps over Treasuries hit their widest in more than six months due in part to worries about the potential fallout of Chinese property group Evergrande’s financial troubles to the global economy.

Another sign of worry in money markets is the rise in three-month Libor to 12.5basis points. This was a four week peak according to Refinitiv Data, and may be a result of stress within the banking system.

Evergrande has struggled to raise money to pay many of its investors, lenders and suppliers. China’s financial sector could face greater risk if the $305 billion of debt it owes is not settled, regulators warned.

Analysts said that interest rate spreads are often regarded as indicators of market risks. Higher spreads indicate that market participants will swap their risk exposures. It also suggests greater risk aversion.

Spread on U.S. 10-year swaps over benchmark Treasuries increased to 5.25 base points from 4 late Friday. Late Monday, the spread stood at 3.25 basis points.

U.S. 10-year options measure the price of changing fixed rate cash flows to floating rate ones for a term of 10 years.

According to Dan Belton of BMO Capital, Chicago fixed-income strategist and economist, “Wider Swap Spreads indicate an expectation that Libor will move higher.”

And Libor is generally viewed as the fear gauge. “When there is financial market distress, Libor tends t to widen, and swap spreads tend o follow,” he said.

Because of excess cash in banks, Libor has fallen this year due to the Federal Reserve’s quantitative ease program asset purchases. However, Libor’s performance has improved over the past week and a quarter.

Belton said that larger spreads could be explained by technical factors.

Many of these moves have been technical, and a lot has to do the Libor Transition. Belton stated that interest rate swaps still reference Libor. However, in the next two years it will be SOFR (secured overnight funding rates) plus a fixed spread.

While global banks continue to use Libor in order to quote U.S. dollars-denominated derivatives or loans for now, soon they will have to switch to SOFR.

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