M&G: ‘Bizarre’ US swaps market is big opportunity
The weight of US corporate debt issuance is creating an unusual phenomenon that is ripe for exploitation by traditional fixed income investors, according to M&G.
Speaking at an M&G fixed income conference last week, manager Ben Lord said there was a “huge issue” in the US because 30-year Treasury bonds offered a yield 50 basis points higher than their corresponding derivatives.
The swap rate, which should trade above US Treasury yields, had been pushed lower by companies issuing corporate debt, Mr Lord said.
The manager said US corporates had sought to hedge out the interest rate risk they take on when issuing debt by buying swaps.
As the volume of US debt issuance increases – meaning more hedging by corporates – a mispricing between derivatives and physical bonds has occurred.
Asset managers have been shy to take advantage of this opportunity. But Mr Lord, who co-manages a range of bond funds at M&G, said the moment might be nearing.
“Lots of US companies issue bonds but do not want to have 30-year fixed rate exposures,” the manager said.
“Given lower liquidity and other regulations, it does not seem that the real money community is willing to take the other side [to synthetic investors] and express an aggressive view to start normalising the bizarre levels we are seeing.”
Other market commentators have suggested the selling of US Treasuries by foreign central banks is another factor behind the widening differential.
Mr Lord added: “It is probably the time to start taking the other side in some shape or form, but not going the whole way. We are watchful.”
This view was echoed by Richard Woolnough, manager of the firm’s Optimal Income, Strategic Corporate Bond and Corporate Bond funds. He said a similar scenario had previously occurred in 2000, when corporate borrowing reached elevated levels.
Issuance already stands at a record $815bn (£536bn) this year as US corporates rush to issue debt ahead of a potential interest rate rise.
Mr Lord noted the past two months had seen US five- and 10-year swaps trade at negative rates, well below the yields on equivalent US treasuries.
“It is a big deal, but there is an opportunity; it depends on where the bottom is,” Mr Lord said.
A similar situation in the UK was less of an opportunity and more a feature of the market, the manager noted.
“We have got used to swap rates being below government bond rates in the UK because of pension fund demand,” he added.
By contrast, the manager said the situation of a 50 basis-point spread in the US was “very dramatic”.
This meant an investor could buy a 30-year US Treasury note and hedge the interest rate with a fixed-rate swap, and get paid 50 basis points for 30 years.
“Fifty basis points for 30 years is not negligible in this environment,” Mr Lord said.
“Corporate credit is paying 250 basis points. Buy some of that and pay for the fixed interest rate swap and you’re now getting 300 basis points, and holding a duration-hedged 30-year corporate bond.”
