Dutch pension funds have postponed billions of euros worth of swaps, triggering a huge spike in the 10-year/30-year swap curve. And, dealers reported, hedge funds and bank prop desks were latching on, prompting 30-year spreads to jump sharply to 15.4 basis points at the start of last week, from 14.3 bps the Friday before.
Pension funds are holding back flow due to reports a planned pension fund reform may be delayed because of a lack of parliamentary time. De Nederlandsche Bank, the Dutch financial regulator, has denied the reform will be delayed, but dealers reported hedge funds and prop desks made the most of market uncertainty by pounding the long end of the curve with flattening trades to grab the volatility. "In this market, EUR10 billion of real money will be followed by EUR20 billion of hedge fund trades," said one dealer.
Tim Bond, interest rate strategist at Barclays Capital in London, said pension funds will be holding back from diving into long-dated instruments not just because of uncertainty over the reform, but also because bond yields are at historical lows. The reform, scheduled for Jan. 1, 2006, will link funds' liabilities to the long end of the yield curve. With long-dated bond yields at all-time lows, pension funds themselves are demanding a delay to the reform, which as currently timetabled would push them into entering swaps at unattractive rates. Since March, 30-year yields have tumbled to 3.45% from 4.40%.
One institutional sales official explained the Dutch pension fund market is the second largest in Europe after the U.K., but the scale of the market blowout is a surprise. Meyrick Chapman, fixed income strategist at UBS in London, agreed, "It's been a very adverse reaction." But, he noted there's a consensus that whatever Holland does the other countries in Europe will likely follow. Dutch funds will have to move EUR45-75 billion into the long end of the curve before the legislation comes into effect, estimated Chapman.
Long-dated swaps volatility is likely to continue, predicted traders, with pension funds going hot and cold on the instruments in sync with the progress of the reform. The long-dated curve will flatten as the funds pile in, and steepen if reports of delays resurface. The sales official noted until there are more flows out to 30 years the back end of the curve will continue to be hyper sensitive to reports of pension fund activity, because the funds are so sizeable and because long-dated swaps are not as liquid as shorter dates. Thirty-year swap rates stood at 14.3 bps last Thursday.