As the US yield curve continues its downward trajectory, swap spreads are experiencing a similar trend – widening and steepening. According to UBS Securities and Treasury (UBS S&T), there are several factors contributing to this movement, including a lack of resistance in the 5-year 30-year cash market around the 106 level and duration struggling to maintain Wednesday’s bullish rally. While the desk still believes the move has further to go, the room is becoming thinner, particularly for spreads. In fact, an additional 1/1.5 basis points in long spreads could lead to levels not seen since 2023.

To position themselves for this potential move, UBS S&T recommends a focus on positive-carry structure, such as receiving 3-year 2-year/5-year 2-year and 8-year 2-year/10-year 2-year forwards. This approach allows for profitability from a persisting flattening or a combination of longer forwards in a more neutral stance, such as 3-year 2-year/5-year 2-year/7-year and 8-year 2-year/10-year/15-year 5-year.

The desk’s analysis suggests that the current trend in swap spreads is unlikely to reverse anytime soon, with several factors contributing to the widening and steepening of the curve. These include a decrease in inflation expectations, a decline in central bank stimulus, and a shift in investor sentiment towards riskier assets. As such, UBS S&T believes that it is crucial for market participants to adapt their strategies to these changing market conditions.

The widening and steepening of US swap spreads is a significant development that could have far-reaching implications for the fixed income market. By focusing on positive-carry structure and maintaining a neutral stance, market participants can position themselves to profit from this trend while minimizing risk exposure. As UBS S&T notes, “the room is getting thinner,” so it’s essential to stay ahead of the curve in today’s rapidly evolving fixed income landscape.