The euro swap spread is on the move again… but this time heading south
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Article Type
Market Updates
Topic
Credit
Published
November 29, 2024
Read time
10 mins
Authors
Peter Spijkman, CFA
Luca Ferramosca, CFA
Oliver Warren, FIA, PhD
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More than two years ago, in March 2022, euro swap spreads reached all-time highs. We now see spreads at record lows and turning negative for the first time. What’s brought about this 180° turn? And what are the implications for Dutch pension funds’ hedging strategies, particularly during the implementation phase of the new pensions contract?

 

Executive summary

  • Swap spreads – the difference between swap yields and equivalent German government bond yields – are at historic lows and have turned negative at some maturities, making euro interest rate swap yields less attractive relative to euro sovereign bond equivalents. 

  • Many Dutch pension funds have increased their interest rate hedges to protect their funding positions ahead of transition to the new pensions contract. This may have been a contributor to the lower swap spread. As Dutch pension funds complete transition and reduce their hedges, we may see some normalization in the spread. However the extent of this impact will be dependent on the hedging strategies the pension funds adopt post-transition and how they are implemented.

  • The swap spread development does not have a direct impact on pension funds currently using swaps to hedge long-dated liabilities discounted with the euro swap curve. There is a potential opportunity to add value by exchanging swap exposure for euro sovereign bond exposure. However this has some potential hurdles, including basis risk, maintaining the required leverage, and also the immediate and ongoing costs of implementation.


 

Disclosures

Authors

Peter Spijkman
Senior Investment Strategist
Peter Spijkman, CFA, joined Aegon Asset Management in 2012. He is a senior  Investment Strategist, focused on providing advice to institutional clients on their strategic asset allocation given their investment objectives and risk attitude.
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Luca Ferramosca
Portfolio Manager
Luca Ferramosca, CFA, is a portfolio manager with a focus on sovereigns. Prior to his current role, he worked as an institutional sales analyst at Aegon AM. 
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Oliver Warren
Senior Investment Solutions Consultant
Oliver Warren, FIA, PhD, joined Aegon Asset Management in 2016. He develops solutions for institutional investors across a wide range of regulatory frameworks with a particular focus on Liability-Driven Investment and Defined Contribution.
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