Goldman: Fed B/S Runoff Adjustments Could Flatten Spread Curves

Goldman Sachs observe that “while the rising debt level should result in tighter swap spreads across the curve, it appears to impact longer maturities more.”

• “With an earlier step down potentially translating to roughly $100bn lower net coupon issuance than previously assumed, we could see spreads fall short of our prior targets.”
• “Indeed, spreads widened notably on Monday following Logan’s suggestion that an earlier step-down in the pace of balance sheet runoff may be appropriate.”
• “That said, even with the lowered estimates, net coupon supply to the public is set to increase by around 80% from the amount last year, leaving narrowing pressure in place.”
• “However, we think this pressure will be more apparent on a relative basis at longer maturities than before, because an earlier taper (and possibly end) to QT should lead to more support from buyers like banks and foreign official sector accounts for shorter maturities; we expect 30y spreads could narrow by as much as 8-10bp over the year, whereas 2y and 3y spreads could tighten by a more modest 3-4bp.”
• “We therefore recommend adding 30y OIS spread tighteners.”
• “Although smaller increases in the upcoming quarterly refunding announcement could pose a risk to this position, we believe the large accumulation stock of debt will eventually determine the equilibrium levels of such spreads.”