Fed Balance Sheet and Swap Spreads

This report examines the potential impact of Federal Reserve balance sheet reduction options and regulatory changes on US interest rate swap spreads. The author concludes that while these factors are fundamentally bullish, their impact is likely already priced into the market.

Key Takeaways

• 1.The Fed is exploring 15 regulatory and balance sheet options that could reduce the balance sheet by an estimated USD 1.15-2.125 trillion.
• 2.While regulatory changes are generally bullish for swap spreads, the market has likely already priced these expectations in.
• 3.Swap spreads are currently driven by volatility, rates, the curve, Treasury supply, funding, and regulations, with an inverse correlation observed between swap spreads and volatility since the onset of the Iran war.

Table of Contents

• Fed balance sheet and swap spreads
• 2. Fed policy options to reduce the balance sheet and estimated effects
• 3 Ample reserves help front end spreads
• De-regulation supports intermediate to long end spreads
• Composition & duration matter
• Drivers of swap spreads

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