Heinz, re spreads are at panic levels ,
The value of using nominal spreads to Treasurys to judge credit market conditions has been considerably compromised by the crazy doings in the Treasury market.
This latest spread blow-out (from 70 or so in 10-yr swaps at January-end to 114 today) has been driven more by Treasurys catching a "flight-to-scarcity" bid than by spread product cheapening due to credit concerns.
Treasurys are trading in their own world now. With the exception of the short end (which can still be used to gauge the market's fundamental expectations for monetary policy), the rest the Treasury market is being driven mainly by technicals. The Treasury refunding announcement and buy-back details that were announced in late January caught so many participants offsides (i.e., with big overweights in spread product, and underweigts in Treasurys), causing a mad scramble into Treasurys -- especially at the long end. To wit, since the peak in yields around Jan 21, the 10-year note has rallied from 6.79 to 6.22, while 10-year single-A corporate yields have declined from 7.88 to only 7.67. Mortgage rates have come in by only 15-20 bps as well.
Another point to consider is the increased "specialness" of Treasury benchmarks. For example, the 10-year roll (yield on the current less the previous 10-year note) is now -17 bps -- a new all-time wide. Nominal private sector spreads are adjusting for this as well.
To be sure, liquidity conditions are quite fragile (again), although household issuers like Ford would nevertheless have little trouble selling bonds today.
The cyclical trend evidenced over the past few years remains very much in place: Net shrinkage in the outstanding stock of Treasury debt combined with 12-14% annual growth in spread product supply. Ceteris paribus, generic spreads to Treasurys for agencies, swaps, corporates, mortgages, etc. should continue to widen as long as this persists.
To look through this technical distortion, focus on private sector yields (in mortgages or corporates for example), which are in any event the necessary transmission mechanism for Fed "tightening" to have any real impact. In terms of spreads, you should focus on corporate or mortgage spreads relative to other high-quality benchmarks, such as swaps or agencies.
Regards,
JW |
