Mackenzie: Investors caught out by historic swaps dislocation

"...When the 10-year swap rate fell earlier this month to just 2 basis points above the "risk free" yield on the 10-year Treasury note, many in the swap market believed that this was an opportunity to pay fixed rates in swaps and sell Treasuries - this resulted in a rapid increase in trading activity...

Since the historic inversion between the 10-year swap and Treasury yield, the market has only repaired some of the dislocation, leading some traders to suspect that not all losses have been cut.

Yesterday, the swap rate of 3.82 per cent was 5bps below the 10-year yield of 3.87 per cent.

Given the relationship between outstanding Treasury debt and swaps, the negative relationship can endure for some time, say analysts.

A decade ago, 10-year swaps rose to a historic high of 140bps over the 10-year yield when the budget surplus was rising.

But also keeping swap rates below yields is the assumption, now being questioned, that the longer swap rates stay below Treasury yields, an arbitrage opportunity exists because Libor is higher than general collateral for Treasuries..."