Bond issuance is the most transparent driver of flows in the interest rate swap market and price action after a new benchmark bond is announced is often fascinating for traders to watch.
Among the questions swappers ask are whether the issuer has already swapped the proceeds of the bond to manage their interest rate and cross-currency risk, and could that explain recent flows. More important, perhaps: they will wonder why they were not asked to quote.
Sovereign, supranational and agency borrowers will often hedge their fixed rate liabilities on a bond for floating rate ones with interest rate swaps, though some will not.
When it comes to bonds issued in a foreign currency, it is safe to assume that most SSAs will swap what they must pay on the bond back to their domestic currency using a cross-currency interest rate swap.
There used to be a fair degree of certainty that the terms of the cross-currency swap would have been agreed before, or at the same time, the bond was priced. However, the latest burst of SSA issuance in January has shown that is no longer the case.
Several European public sector borrowers that have recently sold dollar bonds have chosen to wait until the cross-currency basis turns more favourable before swapping back to euros — some have said they are giving themselves three months before swapping, others take longer.
It is a development that shows more flexibility and sophistication in the management of public sector balance sheets.
Yet such a move by SSA issuers means the traditional playbook of expected flows in the swap market has become less clear, which might not be good news for swap traders as it is less predictable when certain flows will come to market.
But where the derivatives traders lose out, the debt capital markets bankers may win.
Cross-currency issuance has hitherto been dominated by the cross-currency basis swap market in determining borrowers' cost of funding. For issuers now happy to wait to hedge their risk, all of a sudden whatever the cross-currency levels say in a bond pricing grid no longer have the same weight they once did, meaning bond funding is more accessible for more of the time.