Swaps traders last week put some EUR8 billion (USD6.8 billion) notional through the euro interest-rate swaps market in anticipation of the spread between corporate and government bonds widening. The heaviest action revolved around going long Euro-BOBL or Bund futures and paying fixed in five or 10-year swaps, according to Peter Hartmann, director and swaps trader at Dresdner Kleinwort Wasserstein in Frankfurt.
Analysts believe spreads will widen now that the heavy flow of corporate debt issuance from the first half of the year has dried up, explained Rory Byrne, fixed-income strategist at Schroder Salomon Smith Barney in London. He predicts the 10-year spread will widen to around 45bps and then remain in a 35-45bps range. Ten-year swap spreads hit a two-year low on June 12 of minus 35 basis points.
One trader said a typical trade would be to enter a EUR2 billion 10-year swap and 20,000 Bund futures (notional EUR2 billion). If the spread widens 15 basis points the trade makes EUR21 million, he continued.
Banks, hedge funds and bond investors were also jumping into these positions to hedge corporate bond portfolios. Investors have lost appetite for corporate bond issuance, especially telecom debt, and therefore it is hard to sell so professionals are hedging through the swap market. Investors who anticipate an upturn in the bond market but are bearish in the medium term may also prefer to put this hedge on as it is cheaper and quicker than selling a bond portfolio and rebuilding it when they are more bullish. However the swap curve is a reflection of the credit quality of a double A financial institution rather than the telecom market so the hedge is not perfect.
