TD Securities strategists Gennadiy Goldberg, Molly Brooks and Jan Nevruzi argue that proposed Basel III endgame and related US bank capital changes should ultimately support wider US swap spreads, particularly at the long end. They note that deregulation is set to lower capital needs for GSIBs and smaller banks, boosting balance sheet capacity and likely improving liquidity in Treasuries and repo despite near-term geopolitical volatility.

Deregulation seen supporting wider spreads

"Swap spreads have recently tightened on geopolitical-driven volatility and deteriorating Treasury liquidity alongside shifting rate cut expectations. However, deregulation momentum should create a widening tailwind in spreads once markets refocus on balance sheet capacity and regulatory relief."

"Swap spreads have tightened sharply in the wake of Iran war volatility as investors rapidly penciled out rate cuts and sent Treasury yields sharply higher alongside deteriorating liquidity conditions. We expect geopolitics to remain in the driver's seat in the near-term, but a renewed focus on deregulation should help push swap spreads wider — especially in the long-end of the curve."

"Capital needs are expected to decrease by 7.8% for smaller banks and 4.8% for the GSIBs, allowing banks to devote more capital to other activities. While banks will almost certainly want to devote capital to higher-ROE businesses, we expect at least some of the additional capital to find its way to the Treasury and repo markets."

"Similarly, we expect proposals to ease Liquidity Coverage Ratio (LCR) and Internal Liquidity Stress Test (ILST) rules in the coming months to create a widening tailwind for swap spreads."

"However, with banks obtaining significant relief from the proposals as a whole, we expect balance sheet capacity to increase overall, allowing spreads to widen."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)