Monday, June 14, 2010

Swap spreads and implied volatility are subsiding



The first chart shows 2-yr swap spreads, and the second shows the Vix index. Both are good measures of the level of fear and uncertainty plaguing the markets. From the looks of things, the negative impact of the Euro debt crisis on the U.S. economy is fading. Not surprisingly, stocks (below) appear to be finding a bid. Even European stocks are doing better on the margin (last chart). I continue to believe that the Euro debt crisis, while not inconsiderable, is not the end of the world by any stretch, and the market may be coming around to agree with that view. The important thing is that it is not degenerating into widespread uncertainty, as happened with the subprime mortgage crisis. If the problem is limited to writing down the value of Greek debt (and possibly that of a few other countries), then the global bond market is plenty big enough to absorb the hit. Relatively large debt writedowns have occurred with some frequency throughout history (I'm reminded of the Latin debt crisis in the early 1980s), yet economic disaster did not necessarily follow.


11 comments:

rwburcik said...

How does the recent negative downturn in the ECRI Weekly Leading Indicators inform your thinking?

dr. j said...

Scott: Your thoughts on the many recent articles that have focused on the possibility of municipal defaults?

John said...

RW,

I think your question is a good one. I, for one, am always interested in leading economic indicators. The recent decline in the ECRI bears watching.

Several bearish bloggers have made much of this. Below is a response from Lakshman Achuthan, of the ECRI in response...

"...at the very least ECRI itself would need to see a 'pronounced, pervasive and persistent' decline in ECRI's US long leading index before it makes a recession call".

In short, it is one weekly number that seems to be signaling a not so robust recovery. Scott has had many posts showing similar readings, so my guess is it won't change his thinking much....but we'll let him answer that.

rwburcik said...

John,
I had already seen Mr. Achuthan qualifing thought but I am still looking forward to Scott's response. Also, let me add the 2 month decline in copper prices of about 15% to my query.

Family Man said...

John
It looks that we managed to spot an inflection point in risk taking in our blogging a couple of days ago.
Good exercise and has thought me a bit.

John said...

RW,

As would I.

BTW, Scott discussed the copper and other commodities decline on a June 7 post. There was also some interesting comments. The post title was 'commodity prices have not collapsed'. You might want to check that out.

John said...

Fam,

Indeed we did. Lets hope it continues.

Family Man said...

And one more, market is in fundamental mode, which means it reacts to fundamental valuations, which is very positive, why?
On May 25, the Emerging Markets P/E ratio hit -1 standard deviation, from long term value. And as it is visible investors decided to start buying.
That means that there is no fear of a new armagedon(fi collapse of trust in gov debt, and domino effect).


Scott, one very important question.

On USD swaps provided by FED.
It is becoming more clear, that FED is providing quasi constant USD swap lines to other CB. It should release a lot of liquidity hoarded by CB in order to secure USD based local banks funding.
What is your take on this re USD valuation, should it strengthen USD a lot/modestly/just a little?

Scott Grannis said...

I think the dollar has benefited of late because of Euro debt fears. Dollar is up because it is the world's safe haven currency in times of great fear. But now that Euro fears are subsiding and systemic risk indicators are backing off, the dollar no longer benefits. Call it the return of the risk trade if you will. I think the dollar has seen its highs for awhile at least.

Scott Grannis said...

Re: muni defaults. I would be very surprised if we don't see a significant number of municipal defaults. This would be very painful for muni investors, but very healthy for the economy from a long-run perspective.

rwburcik said...

John
I read Scott's blog post on copper the day that it appeared. I was simply pressing Scott given that he now has additional copper data at his disposal. The "Humble student of the markets" is highlighting the apparent down trend in copper (and other commodity) prices on his blog so I only wanted to get Scott's latest take on this topic.