Primer: swap spread frameworks: Swap spreads frameworks for relative value

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US Rates

Primer: swap spread frameworks

Swap spreads frameworks for relative value

31 July 2026

We describe four swap spread frameworks. Our focus is UST spreads to swaps, but the

frameworks can apply across other currencies. We look at: 1) traditional regression

(commonly used spread factors), 2) PCA (factors with maximum explanatory power), 3)

term-premium (short-term factors), 4) dynamic factor model (growth + inflation + jobs

factors). The residuals can bring a dislocation that corrects, or may remain as a regime

shift, unexplained by the model’s factors. As linear models, the frameworks apply to

swaps and Treasury rate curves separately or directly to spreads with the same results.

Exhibit 1: UST swap spreads currently appear fair in most frameworks but the Macro one

Results for UST swap spreads as of 30-Jul – residuals based on the four frameworks

Framework

Traditional regressions

PCA

Term premium

Macro factors

2y

fair

5bp too tight

5y

fair

2bp too tight

14bp too tight

10y

fair

1bp too tight

16bp too tight

30y

3bp too wide

fair

1bp too tight

19bp too tight

Source: BofA Global Research

BofA GLOBAL RESEARCH

Traditional regressions: user factors

We look at some typical regression variables like USTs outstanding, level of rates,

slopes, vol, Fed holdings etc. US Swap spreads recently are explained by dealer balance

sheets, funding conditions, rate levels and vol. Regressions allow easy exploration of

spread drivers. Today, we find 2y spreads fair and 30y spread 3bp too wide (Exhibit 1).

PCA framework: statistical factors

PCA is a statistical method for extracting factors from historical data. This avoids trial

and error process of regression. The algorithm finds 2 uncorrelated factors (time series)

that maximally explain data variance in the sample period. For rates and spreads, PCA

finds “level” and “slope” factors which best re-create the spread curve across maturities

each day. Currently, spreads appear fair across the curve, with near zero residuals.

Term premium framework: market factors

This framework again uses 2 factors, but they are tradable points selected at the front

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