Summary
Key takeaways
A critical market barometer: swap spreads measure the difference between swap rates and sovereign yields, serving as a leading indicator of risk aversion and liquidity.
Increasing volatility: since 2008, swap spreads have exhibited greater volatility, with sharp spikes during crises (such as the Covid-19 pandemic and sovereign tensions) and rapid tightening episodes (as seen in 2024). This volatility reflects stress in the interest rate markets and shifts in monetary and fiscal policy.
Persistent structural distortions: despite the theoretical arbitrage opportunities, regulatory and structural constraints limit their execution. These explain the persistance of swap spreads, which reflect structural imbalances and risk premiums in the fixed income markets.
Future outlook: the combination of rising sovereign issuance and declining excess liquidity is expected to drive up swap costs (leading to a narrowing of swap spreads). Conversely, an easing of banking regulation and the unwinding of pension fund hedging programs would likely increase bond prices (widening swap spreads).
Introduction
Swap spreads, key indicators of liquidity stress and risk aversion, play a crucial role for insurers. Beyond measuring price differentials between sovereign and corporate bonds, they directly influence hedging decisions, asset-liability management (ALM) strategies and insurer returns under Solvency II.
In recent years, their heightened volatility has drawn market attention and raised strategic questions: what drives these fluctuations? What are the underlying forces at play? Most importantly, how should they be interpreted to guide future hedging and investment decisions?
In this article, we explore the fundamental mechanisms of swap spreads, analyze past and recent trends, and shed light on the structural forces likely to shape their trajectory in the years ahead.
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