The 2/10 and Fed fund/10 spread will now widen, as will risk spreads.
lance lewis had some great comments on this last night
dailymarketsummary.com
Speaking of which, treasuries were higher on the back of another flight to quality, as the yield on the 10yr fell to 4.22%.
As I mentioned above, credit spreads moved to fresh new highs for the year today, and the 10yr junk spread is now just a freckle away from a new 52-week high. The last time we saw a move as violent as this one was the LTCM fiasco in 1998. In fact, this move is even more violent than that one was thus far.
In 1998, we started to see spreads slowly move up off their lows about a year before LTCM blew up. This 100 bp move (a rise of nearly 50 percent) has occurred in just under 2 months off of what were record lows in spreads.
Of course, that sort of violent unwinding is also what you would expect given the unprecedented speculation that has taken place in anything and everything that was nailed down over the past 2 years. Even worse, there is the tremendous amount of leverage that was no doubt employed over the past two years as a result of everyone believing that the Fed had their backs and would take every step imaginable in order to insure asset prices continued to rise. On top of all that, the leveraged speculation is not centered at one large fund like LTCM as it was in 1998. Instead, today it is spread around at a 1000 different funds, which makes containing it virtually impossible.
Why do widening credit spreads matter to stocks? The primary reason is that it’s a general reduction of liquidity in the financial system, very much like the Fed raising interest rates. Except in this case, it’s the market that is tightening. Not only is it a contraction in the availability of credit and an increase in the cost of borrowing, but there is an additional reduction of liquidity in the financial markets themselves as a result of leveraged players being forced to reduce positions across the board (meaning in stocks, commodities, etc) as credit market positions go against them, which then causes others to reduce leverage, which then causes others to do the same and so on and so forth. It feeds on itself.
In the past when this has happened, the Fed has eased, and FNM has ballooned its balance sheet, which has always bailed us out before things got really ugly. However, as we’ve noted, the situation is a little more precarious this time. This time the Fed is trapped due an inflation problem, and FNM’s ability to grow its balance sheet has been restricted due to new regulations. So, you can see how this tremor in the financial markets is much more dangerous than at any time in the recent past. |
