Lars Toomre of Toomre Capital Markets has been actively involved in the credit markets ever since he was moved from the investment banking division to the Lehman Brothers fixed-income trading floor late in 1983. As a result, he has witnessed many the upheavals in the bond markets including the 1986 rally due to $9 per barrel oil, the 1987 stock market crash, the S&L meltdown of 1990, the Asian currency crisis of 1997 and the Long-Term Capital Management ("LCTM") crisis of 1998. During that period, Lars never witnessed a day like Thursday, November 20th 2008.
The bench-mark 30-year Treasury bond is now trading at a yield of 3.43 percent down from 3.95 percent yesterday. This single-day move of 52 basis points and increase of nine points in price rivals the incredible moves in the flight to Treasuries (at the exclusion of all else) during the 1987 crash and the LTCM crisis. Just a week ago on Thursday, November 13th 2008, this same benchmark security was auctioned by the United States Treasury Department and the stop out rate on that auction was 4.30 percent. This particular Treasury bond ended the trading day on Tuesday with a yield of 4.13 percent.
However, as stunning as the rally in the bench-mark 30-year bond has been, the performance of the 30 year swap has been even more impressive. Unbelievably, the 30 year swap rate is now 2.84 percent. Apparently it has dropped approximately 80 basis points on the day and now trades at about 60 basis points rich to the benchmark 30-year Treasury security. Yes, the 30-year swap is now trading almost 60 basis point through Treasuries!!
Remember a swap spread is the yield differential between Treasury bonds and the fixed leg of a fixed-floating interest rate swap. Also, remember that any interest rate swap has to have a bank or other financial institution standing in the middle. With the world excessively concerned over counter-party risk, how is this spread at all-time negative spreads to United States guaranteed Treasury Bonds!?! Why are investors so willing to buy the 30-year swap with all of the attendant long-term credit issues at a lower yield than the underlying 30-year reference Treasury? This implies investors are somehow reckoning that they are more likely to be paid back by a private counterparty than by the government.
To gain a better sense of this stunning 30-year swap move, this swap closed last week at approximately -15 basis points. On Monday of this week, this swap was at approximately -19 basis points. On Tuesday, it closed at approximately -27 basis points and yesterday it closed at -33 basis points. Today it closed at -60 basis points!! Ten basis points in the 30-year Treasury are worth approximately 58 32nds of a point in price (or 1.8125% in price). Since Tuesday's close, the 30-year swap has moved from 3.80% to 2.84% or alternatively has appreciated approximately 17.4% in price!!! Simply amazing!!!