There is definitely some disturbance in swaps markets as spreads have been far more volatile lately than at any point since the dramatic shift in March. While most of the action had been concentrated in the 10-year, there has also been a noticeable change in 5-year spread volatility.
I don’t think there is much doubt that recent volatility in treasury rates and funding markets is a cause here, particularly as it relates to the dramatic steepening that took place recently. But that steepening has given way, after November 20, to more volatility and action in shorter maturities.
Beyond that, there have been notable extremes seen in a broad cross-section of markets. Perhaps most important, particularly against the backdrop of a steepening curve, has been the slide in inflation expectations. The 5-year, an important benchmark for inflation, has now dropped to just about match this year’s low, only 16 bps above the September and October 2011 crisis lows.
It’s interesting that this “disinflation” anchoring builds as interest rates in general are again moving higher. The only previous episodes of this kind of credit behavior related to growing crisis: after the collateral problems reappeared in July 2008; during the first instance of European crisis just after the flash-crash in 2010; in the months leading up to the second eruption of European crisis/US debt ceiling drama in 2011.
It’s also interesting to note that those previous instances occurred (particularly the second two) as markets were adjusting to the ends of discrete QE programs. If those are all uniformly representative of these kinds of market expectations, it looks like markets are positioned for declining economic fortunes against a backdrop of uneven to diminishing monetary influence.
With that overall context, the historic credit market selloff (and global cascade of dollar “tightening”) this summer makes much more sense. The problem now is to determine whether such a stance of uncertainty is still valid. That makes the more recent dichotomies in various markets much more interesting and perhaps important. Again, junk bonds have retraced nearly all of the selloff, while equity REIT’s have moved in opposition.
At the same time, other pieces of the credit markets have been moving toward expected tightening. That includes mortgage REIT’s and Brazilian reals (which are priced at levels that previously triggered intense central bank concern turning into action).
I would also submit that there is a fair amount of uncertainty moving back into Europe, as well. On November 11, Swiss 2-year government bond yields fell back below 0.0%, an unwelcome development reminiscent of 2012’s currency crisis (reaching a low of -0.142% on December 3).
Rather than appearing to be moving toward some stable paradigm or equilibrium, it very much looks like uncertainty has again started to grip credit markets (apart from momentum and retail chases in junk debt). To really demonstrate that, I need only show the very small movements in the eurodollar yield curve in the past few weeks. And, as you might expect, most of the recent and minor “tightening” is taking place right in the belly of the curve. You would not expect such incongruous results unless there was/is palpable concerns throughout markets – in other words, itchy triggers.
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