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Giant Bank Bond Sales Help Explain Big Dip in Treasury Yields

Stephen Spratt, Liz Capo McCormick and Edward Bolingbroke
·2 min read

(Bloomberg) -- Bank of America Corp. and JPMorgan Chase & Co. did more than just bolster their cash stockpiles last week as they smashed records for U.S. bank bond issuance. They also spurred hedging that helps explain the mystery behind a sudden lurch lower by Treasury yields.

Rates on 10-year notes dove to 1.53% on Thursday, a level last seen a month earlier, despite positive economic news that day that many expected would do the opposite. The yield is barely above that on Tuesday at 1.56%, down for the day as stocks and oil decline.

Trading in the derivatives market probably explains much of this. The swap spread -- or gap between 10-year U.S. yields and interest-rate swaps -- shrank for six straight days through Monday, putting it at the tightest level since August. That suggests a burst of hedging.

On Thursday, just as Treasury rates were hitting lows, JPMorgan was selling $13 billion of bonds, the most ever by a bank. That record fell a day later when Bank of America sold $15 billion. Goldman Sachs Group Inc. and Morgan Stanley also offered debt. Investors often want fixed-rate bonds, but some banks prefer to pay floating rates to better match their income steams. To square this, banks exchange their fixed-rate payments for floating via interest-rate swaps, which can pressure rates.

Financial “issuance is the most likely driving factor behind the huge tightening move in swap spreads,” BMO Capital Markets strategist Dan Krieter wrote in a note Tuesday.

While the drop in swap spreads appears near its end given the pipeline of new bank bond offerings is now slim, the flurry of activity did help Treasury bulls win a little relief in what’s been a tough year. In 2021 through April 19, Treasuries losses amounted to about 3.5%, according to Bloomberg Barclays index data.

With the pressure from swaps appearing close to finished, the ramp up in U.S. vaccine distribution and business re-openings raises the odds of Treasury holders remaining in the red, which could drive yields higher again. For now, BMO sees 10-year yields likely in a holding pattern around 1.6% through the Federal Reserve’s policy meeting next week.

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