In the first two months of this year there has been a dramatic
reconfiguration of market variables in the US, including interest
rates, credit spreads and the yield curve. Both a result of and
contributing to these seismic shifts in the financial landscape has
been business completed by mortgage portfolios to hedge negative
convexity. Dealers have been rocked on their feet by the scale of
volatility buying, and the fear that if rates back up, the mortgage
holders will unwind the positions and sell convexity, making any
general market sell-off much more severe than would otherwise be
the case.
At the beginning of December, five-year swap yields were around
6.5% while 10-year swap yields were at 6.7%. The five-year swap
spread was around 105 basis points over US treasuries, and the
10-year swap spread was close to 120bp.
At the end of February, much has changed. Five-year...
