Euro swap rates extended their recent rise on Friday and widened over benchmark bond yields as concerns ahead of next week's European Central Bank meeting combined with month-end pressures in the bond market.
Euro swap rates and bond yields have pushed higher in recent sessions as investors repositioned for the likelihood that the ECB would raise borrowing costs earlier and higher than previously expected, with the next hike now priced in for May.
ECB President Jean-Claude Trichet kept up the hawkish rhetoric that has investors expecting strong signals at next week's meeting of a rate rise the following month.
Meanwhile buying of bonds to square the books for the month end, after recent issuance, led them to outperform swaps.
"People are extending in bonds while they are not doing the same in swaps so probably there is a slight bias toward appreciation in bonds and not in the swaps side," said Alessandro Tentori, bond strategist at BNP Paribas.
"You have this bearish environment, which tends to widen swap spreads. Then you had month-end, quarter-end. So it can be that there is an impact on bonds which is not fully reflected in swaps."
The 10-year swap spread widened out to 20 basis points from about 19 basis points on Thursday.
In European afternoon trade, gains in rates on euro interest rate swaps ranged from 1.0-2.0 basis points at the front end to more than 3.0 basis points at the ultra-long 30- and 50-year sectors before pulling back a bit.
Longer maturities were seeing the biggest boost as expectations for higher rates continued to crawl out to the long end of the curve after the short end of the market had already adjusted to a quicker pace of rises in benchmark borrowing costs.
Trichet underscored the hawkish sentiment, saying euro zone interest rates were historically low and supported economic growth, while the central bank was doing its bit to help the 12-nation region by keeping prices and inflation expectations stable.
At the very short end of the curve, dealers said euro overnight index average (EONIA) rates were discounting with near certainty a May hike, but there were no strong signs of serious betting on a move at next week's meeting.
"The market is not looking at April for a move. It is fully priced into May," said a trader in London.
"We've got another 25 basis point hike priced in by the end of August but it is split between the July and August meeting at the moment."