Wednesday, November 30, 2011
A coordinated easing move by the world's major central banks was well received by most markets today. Lower interest rates can't solve all problems, however, and they won't fix the fundamental problem of bloated Eurozone government spending, but they can take the edge off the panic by backstopping the financial markets. 2-yr swap spreads are a good indicator of the tensions in financial markets, and today they dropped by over 10 bps in the U.S. Eurozone swap spreads remain quite high, however, as do yields on PIIGS debt. The wider gap between U.S. and Eurozone swap spreads indicates an increased likelihood that the U.S. economy will be insulated from the fallout of a PIIGS default, and that is a very positive development. With lots of recent economic indicators showing marginal improvement in the U.S. outlook, any steps taken to foster continued improvement in the U.S. economy also provide some indirect support for the Eurozone economy as it struggles toward a solution. A solution which in the end must consist at a minimum of restructured debt and meaningful cutbacks in government spending. There is no painless way to fix the PIIGS' problems, but avoiding financial market panic is a good way to allow the process to proceed.
The chart above show the ratio of the Vix Index and the 10-yr Treasury yield, which is a good measure of panic (a high Vix index signals panic) and despair (a low 10-yr yield signals little or no hope for growth). We're still in red-zone territory, but it would appear that there has been some progress toward a resolution.
Posted by Scott Grannis at 10:49 AM