How do I interpret swap spreads and what do they tell investors?

Question

AcadiFi · Accepted Answer

Swap spread = par swap rate minus on-the-run Treasury yield of matching maturity. Example: 10Y swap rate is 4.35%, 10Y Treasury yields 4.20% — swap spread is 15bps.

Historically the swap spread was interpreted as bank credit risk because the swap was priced off LIBOR (a bank funding rate). Under dual-curve/SOFR regime, the interpretation shifted:

1. Collateralized swaps have minimal credit risk — so the spread mostly reflects supply/demand imbalances.

2. Treasury supply matters: heavy issuance pushes Treasury yields up, compressing or inverting the swap spread.

3. Dealer balance-sheet constraints affect hedging capacity. Post-Basel III, repo market stress widens spreads.

4. Long-end swap spreads have gone persistently negative since 2015 (10Y and 30Y) — the swap rate sits below the Treasury yield. This anomaly reflects Treasury oversupply and balance-sheet costs to dealers carrying government bonds.

Uses in analysis:

- Relative value: if 5Y spread is historically wide, an arbitrageur might receive fixed on the swap and buy the Treasury financed via repo.
- Risk appetite gauge: spreads widen in crises (2008, 2020) as funding stress emerges.
- Liability hedging: pension funds compare swap rates versus long Treasuries when selecting discount curves.

On the exam, know that negative swap spreads are not arbitrage — repo costs and capital rules make the trade uneconomic at scale.

How do I interpret swap spreads and what do they tell investors?

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