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Long Term Swap Rates


ezekiel
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I've been looking at www.swap-rates.com and don't understand why the interest rates fall the longer term the swap rate (or LIBOR) is for.

Is this because the bank gets a better deal because they're going to be paying more interest (since the term is longer) or is it because everyone expects interest rates to be lower in the future?

Or is it some other reason? Explanations appreciated.

Cheers

Eze

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You're right for not understanding it - on the face of it, it shouldn't happen. In normal circumstances, rates are higher the further they are in the future (as the more time goes on, the greater the chance of something nasty happening, hence greater risk, hence higher rates).

Having higher rates in the short term is not normal. Apparently the situation is called an 'inverted yield curve' by those who like to sound impressive (me included <_< ). As I understand it, this means people reckon there's more risk in the short term. Apparently it's a surefire predictor of recession. They've predicted 13 of the last 5 recessions, apparently, so there you go :huh:

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You're right for not understanding it - on the face of it, it shouldn't happen. In normal circumstances, rates are higher the further they are in the future (as the more time goes on, the greater the chance of something nasty happening, hence greater risk, hence higher rates).

Having higher rates in the short term is not normal. Apparently the situation is called an 'inverted yield curve' by those who like to sound impressive (me included <_< ). As I understand it, this means people reckon there's more risk in the short term. Apparently it's a surefire predictor of recession. They've predicted 13 of the last 5 recessions, apparently, so there you go :huh:

Oh! Learnt something new there, cheers!

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Guest tbatst2000
Oh! Learnt something new there, cheers!

There's another plausible explanation for the UK at least (I posted this in another thread):

There is another possible explanation which the article doesn't touch on and that's pension funds buying long dated gilts buy the bucket load to match their long dated liabilities. This stems from the weaknesses is many very large funds that was exposed when the solvency rules changed. The rule change effectively left a lot of funds with no room to wriggle - they either had to put the lot into bonds, particularly index linked ones (the treasury started issuing 50 year index linked ones just for the pension funds to buy), or persuade their backers to pump lots more cash in to allow them to stay invested in more volatile equities - some big companies did actually do this, most didn't and many funds not backed by anyone other than policy holders (i.e. with profits funds) couldn't. All this extra demand for long dated riskless debt may well have inverted the yield curve. This situation is unique to the UK as far as I know. Of course, cheap future rates has also let banks issue cheaper than expected fixed rate mortgages compounding problems in the housing market. Add to that pension miss-selling and people deciding to put all their money into property instead of a reasonably diversified set of things and here we are....

The conspiracy theorists could also speculate that Gordon Brown engineered the whole thing so that pension industry would buy 100s of billions of gilts at crappy rates that would allow him to keep spending more and more cash on the never-never.

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