Borrowers shopping for a new car or making a big credit-card purchase are unlikely to notice, but a key part of the U.S. debt market that keeps credit flowing to consumers has gone negative for the first time ever.
The two-year swap spread, a benchmark component of the $1.56 trillion market for bonds that bundle up U.S. auto loans, credit cards and other forms of consumer debt, last week traded below Treasury rates.
“The two-year swap spread, which had never been negative before, sank as low as -3bps and the three-year swap spread reached -5bp on Thursday,” wrote Wells Fargo’s senior consumer asset-backed analyst John McElravey, in a recent note to clients.
Swap spreads are the difference between Treasuries and swaps with similar maturities. While the benchmarks are linked, this U.S. Treasury Department blog post explains why swap spreads, a tool used by companies to hedge fixed and floating-rate assets and by traders to bet on interest rates, can take on a life of their own.
Low swap spreads also have been a sign of healthy financial markets in the past.
Read: So what does a shrinking swap spreads mean anyway?
This Wells Fargo chart shows the two-year swap spread’s trajectory since January 2011 (in basis points), with it recently falling below zero.
Asset-backed securities, or “ABS” in Wall Street parlance, are reactive to swap spreads because the benchmark is used to price most of its bonds.
ABS are a small but important corner of the U.S. bond market due to their direct link to the real economy, where investors are entitled to a slice of the proceeds when consumers make (or fail to pay) monthly auto loan, student-debt and credit-card payments.
The financing arms of Ford Motor Co. F, -0.32% and General Motors GM, +0.39% are two of the sector’s biggest bond issuers. They tap the asset-backed market for funding by pooling loans to customers into bonds, often at low yields, which also frees up capital to keep Ford and GM making more car loans.
Investors typically demand a premium over swap spreads to own asset-backed bonds, with the premium often shrinking in bull markets and growing when things get jittery.
Last week that premium climbed slightly across the board for ABS, with one-year auto bonds adding about five basis points, according to Bank of America Merrill Lynch data.
Consumer ABS is mostly viewed as a flight-to-safety trade due to the sector’s short duration and relative stability. Unlike toxic mortgage bonds in the run-up to the financial crisis, consumer ABS defaults remained low when the U.S. economy soured a decade ago.
So why the uptick in premiums? It may be that investors called for more compensation to own consumer-backed bonds amid rising U.S.-China trade tensions that also caused more angst about a potential looming U.S. economic recession.
Another possibility: a few extra basis points were needed to offset negative two-year swap spreads and help keep overall U.S. ABS yields positive, in world awash in a plunging rates.
“Rates are lower across the board,” said Peter Kaplan, a portfolio manager at Merganser Capital Management, in reference to global rates in an interview with MarketWatch.
“But the U.S. remains pretty strong in comparison to other countries and you have a healthy consumer sector, which is a net positive for the economy,” he said, adding that consumer spending accounts for two-thirds of U.S. gross domestic product.
“Moreover, despite low rates, the U.S. bond market remains attractive to foreign investors, particularly versus opportunities in Europe and Asia markets,” Kaplan said.
Global bond yields recently tumbled to a 120-year low and a raft of stimulus from central banks around the world has left an estimated $15 trillion of sovereign debt paying yields of less than zero.
There even is a Danish bank now offering 10-year fixed-rate mortgages at a negative 0.5% rate.
See: A Danish bank is offering mortgages with negative interest rates—why you shouldn’t wish for that to happen in the U.S.
Few expect benchmark, or consumer, rates to turn negative in the U.S. soon.
But last week when the average 30-year fixed-mortgage rate hit a recent low of 3.6%, that equated to about 9.7 million home loans that qualify for refinancing, based on mortgage data firm Black Knight, Inc., using conservative underwriting standards.
Meanwhile, market players have kept a close eye on the U.S. Treasury market for signs that a domestic recession could be approaching.
Check out: The U.S. Treasury 2-10 year yield curve is about to invert and that means stocks are on ‘borrowed time,’ says BAML
The 10-year Treasury note yield TMUBMUSD10Y, +3.37% was up slightly on Tuesday, a day after it set a fresh multiyear low of 1.640%. The 30-year U.S. Treasury yield TMUBMUSD30Y, +1.26% also remained inches away from its all-time low of 2.10% in July 2016.
Moreover, if two-year swap spreads stay negative, Wells Fargo analysts said the ABS market could consider revisiting its old way of pricing bonds.
Commercial mortgage bonds, which package up property loans on hotels, skyscrapers and apartment buildings, priced off Treasuries until the late 1990s, according to analysts, who said the market only switched to swap spreads in the early 2000s.
“If it persists,” Wells analysts wrote, “this condition may once again raise the issue of moving back to the Treasury curve to price ABS.”