Submitted by Jeffrey Snider – Alhambra Investment Partners
Before the financial disconformities of 2013 can be allowed to rest in the annals of financial history, I think there is still one more piece that needs to be analyzed in the context of where we are now. Convention about liquidity disruptions is again leading back to Dodd-Frank and Basel, rightly so, but that isn’t enough to fully capture the decayed state of systemic liquidity in 2014. As I said yesterday on this topic, that includes the one-way trade that was “induced” by QE3 in September 2012, as clearly shown by the dramatic compression in swap spreads.
An interest rate swap is relatively straight-forward by itself and can thus provide, at times, relatively straight-forward analysis. To “take fixed” simply means that you pay a floating rate in exchange for receiving a fixed rate payment from some counterparty. Since this is a private transaction but benchmarked to the relevant UST rate, an interest rate swap “should” trade (it is quoted at the fixed rate payment) at a premium to the UST rate because there is risk involved. In fact, that was such a durable and iron-clad convention that it was once believed impossible to ever see a negative swap spread – that wouldn’t make any sense in this convention since the US gov’t is always viewed to be “risk free.” Continue reading