Friday, November 7, 2008

Are swap spreads forecasting a huge corporate bond rally?

Swap spreads tend to be leading indicators of the price of risky assets, especially in today's market. That's because the financial crisis we're struggling through is dominated by credit risk and more specifically counterparty risk. Big money is afraid to trade because of the risk that their trading partner might be the next institution to succumb to a government takeover or fall victim to plunging prices on subprime-related assets. High swap spreads represent the level of fear that is gripping the market. Markets have been frozen as a result, with liquidity all but nonexistent. With some institutions still being forced to sell assets into an illiquid market, prices have been severely depressed, and yields have soared.

Things are improving on the margin, however. Swap spreads have come down meaningfully, but are still abnormally high. As this chart shows, short-maturity swap spreads have been a good leading indicator of the distress in the junk bond market. In the past few days, yields on junk bonds have finally started to come down from the stratosphere, following the lead of declining swap spreads. If both these trends continue, high-yield bond prices are set to soar.

6 comments:

The Therapist Is In said...

Scott,
Wanted to email you outside the blog to ask why I get a popup every time I log in to CBP site? Some kind of lottery US Lottery thing, just wondering if you are aware of that from others?

Scott Grannis said...

I'm unaware of anything like that, and it doesn't happen to me. Maybe it's because I have blocked popups on my browser? Or because I'm using a Mac?

Ciagins said...

Scott,
I enjoy your blog very much and thank you for doing it. I've been a "fan" since the Our Piazza days.

I also get the popups. Firefox blocks them when I open your blog, but when I click on "Comments" I get a popup in spite of the blocker.

Thank you for an outstanding blog!
Patricia Moore

Scott Grannis said...

I'm using Firefox (with popups blocked) and have never seen a popup. I wonder where it is coming from? Must be from Google, as the blog is hosted on Blogger.

drg said...

I am using a Mac and have popups blocked, yet also get that annoying ad popup. Ah well, I guess that is the price of the internet.

Still very worth putting up with that to read your blog. I enjoy it very much.

Scott Grannis said...

hmm, this popup thing is a mystery to me. I've looked at the blog on other computers and have yet to see a popup!

Anyway, thanks to drg and Patricia for the nice comments!