"If at the start this cancerous growth in the nation was not particularly noticeable, it was only because there were still enough forces at work that operated for the good, so that it was kept under control. As it grew larger, however, and finally in an ultimate spurt of growth attained ruling power, the tumor broke open, as it were, and infected the whole body." The White Rose, Munich 1942
Does this imply that the comparable LIBOR is lower than US Treasuries? If so, yikes (I think).
Purely technical, the result of govenment mandates for insurance companies and pension funds to match duration obligations, and some slightly more exotic hedging from the denizens of the trading desks?
Some also speculate that this is one or two primary dealers leveraging their interest rate derivatives. And that they are anticipating some fresh antics from Zimbabwe Ben.
I am fresh out of speculation on this, so if anyone has a cogent insight on this, I would not mind hearing it. You know how to reach me by email.
It does looks like the mispricing of risk. And as we all know, that can leave a mark. It might not be so bad if this is just a temporary thing, but I get the sense that the government's sworn commitment to subsidizing moral hazard is poking the market's animal spirits in the ass, and the risk trade is back on.
This seems to be a recurrent trend here in the Hogfather's School of Economic Mischief and Misery.
And in the meantime, Watch the Bond Market, not Bank Lending or Velocity.
Bloomberg
Ten-Year Swap Spread Turns Negative on Renewed Demand for Risk
By Susanne Walker
March 23, 2010 12:45 EDT
March 23 (Bloomberg) -- The 10-year U.S. swap spread turned negative for the first time on record amid rising demand for higher-yielding assets such as corporate and emerging market securities.
The gap between the rate to exchange floating- for fixed- interest payments and comparable maturity Treasury yields for 10 years, known as the swap spread, narrowed to as low as negative 0.44 basis point, the lowest since at least 1988, when Bloomberg began collecting the data. The spread narrowed 3.38 basis points to negative 0.38 basis point at 12:40 p.m. in New York.A negative swap spread means the Treasury yield is higher than the swap rate, which typically is greater given the floating payments are based on interest rates that contain credit risk, such as the London interbank offered rate, or Libor. The 30-year swap spread turned negative for the first time in August 2008, after the collapse of Lehman Brothers Holdings Inc. triggered a surge of hedging in swaps. The difference narrowed to negative 18.56 basis points today.
“It’s hedge-related activity related to new corporate issuance,” said Christian Cooper, an interest-rate strategist at Royal Bank of Canada in New York, one of 18 primary dealers that trade with the Federal Reserve. “As more and more institutions receive, then swap rates will go lower.”
Interest Rate Hedging
Debt issued by financial firms is typically swapped from fixed-rate back into floating-rate payments, triggering receiving in swaps, which causes swap spreads to narrow. An increase in demand to pay fixed rates and receive floating forces swap spreads wider, provided Treasury yields are stable. Corporations that issue bonds also use the swaps market to hedge against changes in interest rates that may result in increased debt service costs.
The extra yield investors demand to own corporate bonds rather than government debt was unchanged yesterday at 154 basis points, or 1.54 percentage points, the narrowest since November 2007, the Bank of America Merrill Lynch Global Broad Market Corporate Index shows. High-yield debt returned a record 57.5 percent in 2009, and another 4.3 percent this year, according to the Bank of America index data.
“There’s a lot of money on the sidelines waiting for mortgage-backeds to cheapen up,” said Cooper. “In the absence of them getting cheaper and as the end of the buyback program comes near, people are looking for high quality spread products, so a good place to park is in swap spreads.”
One of the lunch regulars, Dave the BondMan, notes to our suprise that the Rate for a Credit Default Swap, the cost of insuring against default, on a 5 Year US Treasury Note is now a full 100 basis points.
The cost of credit default insurance is a real world, market assessment of the risk of default of the U.S. Govt, as opposed to the fantastical ratings issued by Moodys and S&P.
The Yield on a 5 Year T Bond is 1.92%.
It now costs more than one half of your return to guarantee a midrange US sovereign debt note.
Now if you take the next step, and view that return on a guaranteed US 5 Year Note as effectively .92%, you would have to believe that the rate of inflation will remain under one percent for the next five years in order for there to be any real return at all (Return on Guaranteed Interest Minus Inflation).
That is probably a 'flight to safety' phenomenon more than anything else, especially if one looks out on the yield curve to the 10+ durations.
That, my friends, represents an extremely dim view of the US economic situation, and a potential bubble in Treasuries.
Source: Markit
As an aside, as someone experienced in evaluating the financing of projects and companies, we wonder what figure companies are using as the basis for their 'riskless' rate of return calculations? Are they using 1.92% or 2.92% for a five year duration?
In other words, are US Treasuries still a risk free asset? Or are they risk free only with an unusually expensive Credit Default Swap? Expensive, that is, for the reserve currecy of the world.
Usually that detail is so small its lost in the noise, but with default risk now at about 50% of nominal return, that is a significant consideration.
The Bonds held up much better than one might have expected, and the spreads between corporates and longer dated Treasuries was remarkably uniform.
Bear in mind that these are yields on this chart, and the value of the underlying bonds moves in the opposite direction to the yield.
