Interest rate swap?

[jj1929]

There is news on Bloomberg.
"The cost of exchanging fixed for floating interest-rate payments for two years climbed to a record high as investors sought to lock in rates. The spread between the rate on a two- year interest-rate swap, used to hedge against and speculate on interest-rate swings, and the Treasury two-year note yield, reached 110.06 basis points, the largest since at least November 1988, when Bloomberg began compiling data."
http://www.bloomberg.com/apps/news?pid=20601087&sid=aYYI8yE9Hme0&refer=home

I charted the 2-year swap and find that its downtrend is bearish for stocks and its uptrend is bullish for stocks. But I don't know why its trend has such implication. In addition, I have got only 8 year data and I don't know whether the above conclusion can stand the test of time.

When I charted the spread between the 2-year swap and 2-year T-Note, I don't find any hints to develop a trading strategy for stocks.
I don't know whether higher spread is bearish for stocks and the reasons why.

 

[Timmy]

jj - good post, well done.

A couple of questions first, the top graph, that's the interest rate swap price, right, US data I assume given the article was from Bloomberg in the States? The bottom chart, which stock index is that?

Initial thoughts from me, and I am no expert but am willing to at least get the discussion started. The article you quoted says at the start: "The cost of exchanging fixed for floating interest-rate payments for two years climbed to a record high as investors sought to lock in rates."

Why would investors want to lock in rates? Because they think rates will rise. So. as the spread widens (which will be represented on your top graph as the line rising - well done on the graph BTW, where did you get the data?) this indicates expectations of rising interest rates.

Economic theory holds that, in general, low rates are good for the stockmarket, and high rates are not so good for the stock market. Thus, as the line in the top graph rises, so the stockmarket should fall - but this is not the relationship you have noted. This, however, is because it is only a very general relationship, really just a starting point, there are many other factors at work, as well as leads and lags. For example, rates in Australia have been rising for years now, but the stock market kept rising (until October/November 07) as well - this has been due to other factors at work (commodity prices).

I have some ideas on the relationship between the swap and stock index prices, but if you could clarify what the bottom graph is that would be a good start please?

 

[jj1929]

The first chart is the spread between the rates of 2-year swap and 2-year T-Note.
The second chart is the rate of 2-year swap.
I got the data from the following:
http://www.federalreserve.gov/releases/h15/data.htm
Rate of 2-year T-Note:
http://www.federalreserve.gov/releases/h15/data/Weekly_Friday_/H15_TCMNOM_Y2.txt
Rate of 2-year swap:
http://www.federalreserve.gov/releases/h15/data/Weekly_Friday_/H15_SWAPS_Y2.txt

 

[Timmy]

OK, thanks for that jj - yes the lower graph had me scratching my head, I thought it was a stock index of some sort...