TD Securities Recommend 2-Year Swap Spread Tighteners

Late Wednesday saw TD Securities note that “swap spreads (roll adjusted) have tightened in recent days on the back of renewed bank concerns. We think 2-Year swap spreads are likely to tighten further for the following reasons:”

• “Bank/FDIC selling of assets: We expect more sales of assets from at-risk or failed banks. Debt ceiling: We think that brinkmanship into the X-date will result in balance sheet constraints, which should cheapen Treasuries to swaps. Reserve scarcity: After the debt ceiling is raised/suspended, a rise in TGA could bring reserves below minimum levels. This should move repo rates higher. Likely increase in auction sizes: We expect Treasury to increase auction sizes at the August (or November at the latest) refunding, which will add more supply and cheapen Treasuries. QT: The Fed is expected to continue QT for now, which should cheapen Treasuries to swaps.”
• “Note that swap spreads don't seem very correlated with the level of rates. That reduces the macro risk in this trade. The biggest risk to this trade is if FRC raises capital or the debt ceiling gets resolved quickly, which should help richen Treasuries to swaps. Given headline risk and recent spread tightening, we initiate half the risk and look to add to the position on any widening.”
• The recommendation came with the spread trading at +2.7bp, targeting a move to -10bp, with a stop set at 8bp.