Goldman: Add 5y UST Swap Spread Tighteners On Upcoming Supply

Goldman Sachs believe that this week’s refunding announcement “should feature the start of a series of coupon auction size increases - by next summer amounting to a 28% increase in monthly duration supply compared to current levels. We estimate that this increased supply, along with upward pressure on financing costs, is likely to pressure swap spreads lower over the next year, particularly in the front and belly.”

• “Looking ahead, we project that 2- through 7-year spreads should tighten by between 3-10bp by end of this year, and by about 10-18bp by the end of 1H24.”
• “In addition to the increase in coupon free float that should drive spreads across the curve tighter, we see additional relative weakness in the belly given poor demand from commercial banks, which have traditionally been a source of support for this sector.”
• “We therefore recommend locating swap spread shorts at the 5y maturity (our model suggests that a 7y spread tightener should do just as well).”
• “A risk to this trade is that financing spreads increase at a more gradual pace than we think.”
• They recommended entering the trade at -20bp, targeting a move to -36bp, with a stop set at -12bp.