What is a swap spread?
A swap spread is the difference in the interest rate between an interest rate swap and government bond yield of the same maturity (for instance, a United States Treasury security). It is used as a measure of the difference in credit risk between a corporation and a sovereign bond.
Key takeaways
A swap spread measures the difference in interest rates between an interest rate swap and a government bond yield of matching maturity, serving as an indicator of credit risk differences between corporations and sovereign bonds.
U.S. swap spreads have been declining since the 2008 financial crisis, with 10-year and 30-year swap rates now lower than Treasury rates, potentially indicating higher future government funding costs according to some commentators.
Historically, swap spreads primarily reflected corporate credit risk since sovereign risk was stable, but the 2008 financial crisis altered this dynamic when European sovereign bonds like Greek bonds priced in government default risk.
Today, swap spreads are influenced more by technical and structural factors such as the adoption of swap execution facilities and centralized clearing of swap transactions, which significantly reduces traditional credit risk in the swap market.
Where have you heard about a swap spread?
Swap spreads in the United States have been moving lower ever since the 2008 financial crisis. In fact, in the 10 and 30 year sectors, the swap rate is lower than the Treasury rate. Some commentators argue this means there will be a higher future cost in funding the government.
What you need to know about a swap spread.
Historically, the swap spread was used as a measure of corporate credit risk. As sovereign risk barely moved, any move in the swap spread was, by definition, due to changing perceptions of the credit risk of corporations. The 2008 financial crisis changed that dynamic, with some European sovereign bonds – notably Greek – pricing in a chance of government default. Today, the swap spread moves on more technical and structural factors. An example is the move towards swap execution facilities and centralised clearing of swap transactions, which removes much of the credit risk normally associated with the swap market.