Crumbling Bund-Swap Spreads Defy Convention as Yield Hunt Widens

(Bloomberg) -- Deeply negative yields on Europe’s highest-rated bonds are driving investors seeking the right mix of returns and safety into assets such as interest-rate swaps.

The premium on 10-year swaps over German bunds slid this month to the lowest level in more than a year as more traders piled into the derivatives to position for the prospect of policy stimulus from the European Central Bank. Strategists at Commerzbank AG see the spread narrowing further as investors hunting for positive returns keep loading up on swaps.

That isn’t quite the market convention. Typically, bond yields fall faster than swaps on expectations of central-bank debt purchases, widening the spreads between them. The bund-swap gap blew out in January 2015, when the ECB unveiled its quantitative-easing program, and in the run-up to that. But this time is different, as negative bond yields prompt many investors to seek returns elsewhere.

“Particularly for ultra-long bunds, the persistence of the QE premium can no longer be taken for granted as escalating negative yields push the traditional buy-and-hold and regulation-driven investor base into other assets,” Michael Leister, a Commerzbank strategist, wrote in a note.

Ten-year euro rate swaps are currently about 44 basis points above the same-tenor bund yield of -0.22%, down from 57 basis points at the end of 2018. The 30-year spread was at 40 basis points.

The rate on bunds plunged to a record of -0.41% on July 4, falling below the ECB’s deposit rate for the first time.

“Long-term investors -- like insurance firms, hedge funds and endowments -- prefer not to invest in negative-yielding assets, so maturing bond positions have to be invested elsewhere, Hans Redeker, global head of currency strategy in London, wrote in a note. “Investors have to climb the risk ladder in exchange for higher returns.”

--With assistance from Tanvir Sandhu.

To contact the reporter on this story: James Hirai in London at jhirai3@bloomberg.net

To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net, Anil Varma, William Shaw

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