UST-swap spreads (UST yields less SOFR OISs) have turned more positive over the past few months. There are a few factors at play that have driven this development. First, hedging (for higher interest rates) flows have probably eased significantly as the Fed stayed on hold over the past year. Accordingly, there would be less paying pressure on SOFR and is arguably applicable across all the tenors. In the more extreme example, 2Y UST-swap spread turned from negative in early 2023 to being largely positive since. Second, fiscal worries may be weighing more heavily on US Treasuries. Under reasonably strong economic conditions, the US economy is still running a fiscal deficit of around 6% of GDP. Accordingly, investors are building a premium for longer-tenor US Treasuries to take into account higher supply. Note that this fiscal issue remains regardless of whether a Republican or Democrat takes the Presidency. That said, the market sees Trump as a bigger risk to further fiscal looseness and with increasing bets that he will win again, bond-swap spreads are widening. Moreover, in a more volatile geopolitical environment, there is always the lingering fear that reserve managers would have to diversify holdings away from the USD. Fundamentally, a new equilibrium for swap-spreads need to be found as market adjust to an easing regime from the Fed while factoring in increased term premium for USTs (over swaps).
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