Written by Fernando Martin| January 19, 2019

What Are Treasury Swap Rates?

The US Treasury Swaps work just like any other interest rate swap, but are pegged to the US Treasuries rather than another index (i.e. LIBOR). The Treasury contract would be an agreement between two separate parties to exchange one stream of payments (i.e. treasury bill) for another over a set period of time. The parties to a typical swap contract are 1) a business, financial institution or investor on one side and 2) an investment or commercial bank on the other side.

Interest rate swaps, including treasury swaps, can be used for many disparate purposes. Businesses can convert their debt on floating interest rates to fixed interest rates or investors may speculate on the long-term interest rates relative to short-term interest rates through active trading. Commercial Lenders also sometimes use the treasury swap rates similar to an index in order to calculate commercial interest rates by adding a “spread” (explained at the bottom of the page). Treasury swaps tend to be an accurate reflection of the open market’s expectations for future treasury rates, making them a useful tool for fixed-income market participants such as speculators, investors, and banks.

What is the Treasury Swap Curve?

The treasury swap curve is a graphical representation of the treasury swap rates plotted across the different maturities (see chart below); this makes it very easy to compare the rates to each other and check for trends across the different maturity dates. Because swap rates incorporate investors’ expectations for future US Treasury rates as well as the open market’s perception of other factors (i.e. liquidity, supply & demand, the credit quality of US banks, etc.), the swap curve is an extremely important interest rate benchmark.

What is a Treasury Swap Spread?

The difference between the US Treasury Yield and the corresponding swap rate is called the “swap spread.” More specifically, the Treasury swap rate – corresponding Treasury yield = the swap spread. For example, if the current market rate for a 5-year treasury swap is [Swap5Y]% and the current 5-year Treasury yield is [CMT5Y]%, the 5-year swap spread would be [Swap Spread]%. 

Can Treasury Swap Spreads Be Negative?

Historically, the swap curve is typically similar in it’s general upward slope to the equivalent US Treasury yield curve and the spreads tend to be positive across different maturities, reflecting the higher credit risk of banks (i.e. swap contract issuers) versus sovereigns (i.e. US Government). However, other factors including liquidity and supply and demand can cause the swap spread to go negative, as seen in the charts below:

Some of the reasons that the swap spreads went negative in 2016 include:*

• China selling off a large portion of the US debt (treasury bonds) they were holding in order to bolster their own declining currency.

• The decrease in Fannie & Freddie portfolios with the Federal Reserve Bank being the largest securitized bond holder.

• Strong corporate bond sales.

• The regulatory requirement for central clearing of most interest rate swaps (except for swaps with commercial end users), which removed counterparty risk from swap contracts.

Why Are Treasury Swap Rates Important to Commercial Real Estate?

Treasury swap rates are often used as a benchmark for pricing the interest rates on non-recourse, securitized loan products such as CMBS, Fannie, and Freddie mortgages as well as some bank products. They can also affect the overall commercial loan market by pushing interest rates up or down through influencing a lender’s cost of funds or by creating (or removing) competition from other non-recourse lenders. Typically interest rates follow the same direction of moves in the treasury market (unless a bank is tied strictly to the Prime index).