A key measure of the difference between long-term US borrowing costs and private borrowing costs neared parity for the first time in four years on Monday as a massive Bank of Japan stimulus program left investors searching for higher-yielding assets.
The 30-year swap spread, or the cost of exchanging 30-year fixed-rate interest payments for floating rates, was quoted at minus 4.75 on Monday. The spread was last that slim in early January 2009.
The US Treasury market was relatively quiet, with long-dated bonds selling off modestly late in the session as US stocks recovered. The move in swap spreads comes in the search by Japanese investors for yield abroad as the Bank of Japan's stimulus plan took the return on government debt there to record lows last week and the yen to multi-year lows against the dollar.
The trend toward lower yields and a weaker yen began last year, but last week's announcement of a $1.4 trillion stimulus program by the Bank of Japan sped those moves up.
Traders are now speculating that some dealers must close out their current 30-year swap positions, which they use to hedge investments known as power reverse dual current notes (PRDC) they sold earlier to investors. The notes were popular before the credit meltdown, but an estimated $40 billion to $50 billion remain outstanding. The notes let yen-based investors take advantage of higher US interest rates as Japanese rates go down.
As a result, the movements of the yen have become especially important for the long end of the Treasuries curve, said David Keeble, global head of interest rate strategy at Credit Agricole in New York.
Once the yen hits 100 per dollar or so, the notes are triggered and called, he said. The yen traded as low as 99.37 per US dollar on Monday.
"If there's uncertainty you just don't really want to receive on the 30," Keeble added. Big moves in the yen - which has fallen against the dollar in the wake of the BoJ move - get longer-dated swap spreads jittery as a result, Keeble said.
"We're in for a little volatility," he said. Like the US Federal Reserve's bond purchase programs, the BoJ's quantitative monetary policy aims to lower long-term borrowing costs and stimulate spending and investments. Moreover, the depreciation of its currency should help Japanese exporters by making their goods cheaper abroad.
Prices for US Treasuries dipped slightly on Monday after last week's rally.
Benchmark yields hovered near the lows for the year set on Friday in the wake of very disappointing data on the US jobs market and the Bank of Japan's plan to buy $1.4 trillion in assets. The two factors forced traders to downgrade their outlook on the US economy and revise up their view on foreign appetite for dollar-denominated debt.
"The market is taking a bit of a breather and digesting the two big surprises from last week," said Michael Brandes, global head of fixed income strategy at Citi Private Bank in New York.
Benchmark 10-year Treasury notes traded down 9/32 in price on Monday for a yield of 1.744 percent, from 1.7145 percent late on Friday.
Prices for 30-year bonds slipped 22/32 to yield 2.910 percent from 2.8766 percent late on Friday. As part of its own stimulus, the US Federal Reserve on Monday bought $1.399 billion in Treasury inflation-protected securities.
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