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Spread update: not much to worry about

Expanding on the theme of my prior post, here is a quick look at the current state of swap and credit spreads. As is the case with most "risk assets," we see a modest correction in credit markets. US swap spreads have moved up, but from very low levels to levels that are easily within the range of "normal." As the second chart shows, the rise in US swap spreads has pretty much followed the rise in euro swap spreads, suggesting some degree of contagion from Eurozone credit concerns; after all, if a large European bank should go belly up, it would surely be of concern to its US counterparties. But as my friend Mike Churchill reminds me, euro swap yields (as shown in the third chart), have been falling consistently throughout the developing Greek crisis. In other words, the rise in euro swap spreads has been driven mainly by a collapse in government yields, which is more a sign of investors seeking safety than it is of investors fleeing the market in general. Funding costs for most qualified borrowers have been declining all year, so the rise in swap spreads does not pose any threat to economic activity.

Meanwhile, 10-yr US swap spreads are trading at a mere 6 bps (vs. 28 bps in Europe), which is still quite low from an historical perspective. Consequently it would appear that the market is thinking that this is a near-term problem, not an enduring or structural problem.

Corporate credit spreads have also moved up, as shown in the fourth and fifth charts, but so far the correction doesn't appear to be significant or particularly disturbing. If we assume that swap spreads continue to be leading indicators for spreads in general (as I have been arguing since October '08), and given that swap yields are still declining, then there is little reason for alarm. The market is certainly uneasy, but that seems more likely due to a case of nerves rather than to anything concrete.

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