Friday, October 17, 2008

Gradual improvement in spreads

2-year swap spreads are down to 126 bps this morning, as this chart shows. They've got to fall a lot more before we're out of the woods, but at least we see gradual improvement. The TED spread is also coming down gradually; this morning it's 385, down from its recent high of 463. This means the big money feels slightly better about lending to each other.

Meanwhile the VIX index remains at a lofty 71, and the equity market seesaws up and down violently (which is why the VIX is high).

Fear keeps all these indicators high. If you knew that stocks wouldn't make new lows you would buy every dip and sell every high, or, equivalently, you would sell put and call options all day long since that is how you bet that the VIX (the implied volatility of options) will decline. If you knew that counterparty risk was not something that could bite you at any time you would "buy" swap spreads and earn a much higher return than you can get on Treasuries.

We wish this nightmare would end faster, but there's nothing wrong with building a solid base of support, which we are in the early stages of doing.

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