Post by Jim Woolly -- HUGE BOND RISK NOW:
on swaps, spreads, yield curve
investorshub.com
I will keep this brief, even though a huge issue with great complexity
since last year 100's of companies have swapped their more expensive longterm bonds for shorterm money
Pimco's Gross brought this to my attention last spring
LT bonds paid out 6-9% to their corp bond holders
they replaced with 2% ST money thanks to Sir Alan GreenButtWadd
now they carry risk of ST rates rising
what they have done is to capitalize on the widening Trez spread
defined as corp bond yield minus Trez yield
sometimes, if they want less risk, they swap LT for LT instead of LT for ST
the Trez spread is now the highest since 1991 or 1930
take your pick
I heard yesterday it was around 10% on junk, and 3-4% on regular
those who issue such swaps are the same notorious gang
JPMorgan, GoldmanSux, Citicorp, BAmerica
so these guys are selling the spread
this spread risk is essentially a short of the yield spread
the bankers are carrying that risk now
the yield curve has remained sloped upward despite the decline in LT yields
ST is 1.5-1.7% or so, LT is 4.0-4.7% or so
a sloping yield curve indicates health, mild future inflation expectations
that is what we have now
if however, a recession comes at us, then the yield curve will repeat its INVERSION seen in late 2000
that was the greatest missed signal of my life
actually I noted the signal, but did not act upon it!!!
as Israel says -- "NEVER AGAIN"
the difference between the LT Trez yield and ST Trez yield is called the Bond spread
if the yield curve flattens, not necessarily inverts, just flattens, then the Bond spread will close toward zero
flattening yield curve means the bigbanks lose again
they are shorting the Trez spread, which is highly linked with the Bond spread
banks that are heavily involved with swaps to shorterm are most vulnerable to a closing of the bond spread obviously
so what happens if the Bond spread closes toward zero?
same question as
so what happens if the yield curve flattens?
corporations that swapped are nailed to the wall, suffering big losses in earnings from debt financing
bigbanks that sold spreads with heavier swaps into shorterm will suffer big losses from their shorted spreads going in wrong direction
other speculators who simply bought Trez spreads and Bond spreads make out like bandits
a doubledip recession will do colossal damage to bigbanks and to corporations who used the "Clintonesque" swap to shorterm
bigbanks have placed a very large BET that the Fed rate cutting policy will result in a positive response to the economy, with mild manageable inflation returning thru reflation, and all returning to health
a recession will further decimate bigbanks
their derivative exposure is more linked to these interest rate contracts, to bond futures of all kinds, than any other type of contract
Sinclair has made general references to this
I try here to explain it in broad stokes
my personal gut tells me that such a spread closing development would generate more than enough for a DERIVATIVE EVENT of large proportions !!!
/ jim
p.s. has anyone noticed how Clinton has become THE INVISIBLE MAN?
my belief is that his financial fingerprints have become clear, and his financial miracle has totally crumbled |
