Thursday, February 2, 2012
I've been highlighting the importance of swap spreads as good leading indicators for over three years, and three weeks ago I noted how euro basis swap spreads (a measure of the difficulty that Eurozone banks are having in obtaining dollar liquidity) were pointing towards improvement in swap spreads. Well, things are really picking up. Eurozone 2-yr swap spreads haven't been this low since last October, and U.S. 2-yr swap spreads are back to August levels.
It really does look like the world may be exiting the Eurozone sovereign debt crisis, thanks mainly to the improvement in liquidity conditions in the Eurozone financial system. I caution that the fundamental problem in the Eurozone—bloated government spending—remains unsolved, but at least the world can deal with the problem if financial markets are able to function with some semblance of normality. That's the key. In a worst-case scenario, PIIGS defaults might erase some $2 trillion in capital, but that's a only a drop in the $100 trillion global capital market bucket. If financial markets can spread the risk around, we can deal with a loss that size. But if financial markets are frozen, it's like what happens when someone yells "fire" in a theater and the exits are blocked: panic.
Posted by Scott Grannis at 8:52 AM