Main menu

Swap spread update


This chart updates the status of 2-yr swap spreads in the U.S. and the Eurozone. The situation is getting pretty intense in Europe, now that Italy is being put to the test. U.S. markets have finally reached the point (i.e., swap spreads above 35-40 bps) where they tell us that some market participants are starting to get worried that Eurozone troubles could spread to the U.S. The level of US spreads is still relatively tame, however, and all the recent indicators continue to suggest the U.S. economy is doing Ok, but Italy is such a big potential problem that it is hard to ignore. It wasn't too hard to shrug off a Greek default, but even the hint of an Italian default is enough to send shivers through the markets. I don't think we'll see an actual default, but when markets get like this then they can easily draw blood. Italy is going to have to do something meaningful to staunch the bleeding.

Markets in general are doing their best to send a message to countries with bloated governments: if you don't clean up your act, we are going to punish you. Markets can usually get their way, so I wouldn't be anxious to bet on an end-of-the-world-as-we-know-it scenario.

PIIGS update




Having been somewhat out of touch earlier this week, but nevertheless quite aware of all the sudden, new-found agonizing over whether Italy will soon join Greece as a major defaulter, I wanted to get things in perspective. These charts give you an up-to-date look at the status of the risk of major Eurozone sovereign debt defaults, which so far is concentrated in the 5 PIIGS countries. The top chart makes it obvious that Greece is a lost cause. The bottom two charts take Greece out in order to focus on the other four of the PIIGS.

There's been a lot of talk about how Italy's sovereign debt yields, and spreads to Germany, yesterday crossed the line into "no-man's land" (e.g., yields over 7%), meaning that Italy's debt burden has now become unsustainable and the market has thus effectively made an Italian default highly likely. These charts don't support that view. The cost of insuring against an Italian default is still less than that of Ireland and Portugal, and Italian 5-yr CDS are still below the average of high-yield corporate debt.

Of course, given Italy's $2.2 trillion debt, even the hint of an Italian default could have major repercussions, so it's not entirely fair to say that Italy is less likely to default than the typical high-yield bond. Even if an Italian default is still very unlikely, according to CDS and sovereign bond yields, the expected impact of a default is very large and thus is a very legitimate source of concern.

Whether Italy, still one of the world's major economies, would ever reach the point of defaulting on its sovereign obligations is the only question that matters. In the end, this is a political issue, since there is no a priori reason to think that a developed country—even one as overextended as Italy—cannot adopt a responsible fiscal policy course of action. Adopting "austerity" is not equivalent to self-destruction, as those opposed to it try to argue. Austerity is bad for those who have been sucking on the public teat, but it is generally good for the rest of the country. I believe that the adoption of true austerity measures would be quite stimulative for a number of countries, since they would not only restore confidence in a country but would also reduce the suffocating burden of too much government spending and borrowing. The Eurozone debt crisis was brought on primarily by public sector bloat, so reducing that bloat can only be a positive.

One other point: Many are arguing that since the ISDA determined that a "voluntary" write down of Greek debt by private sector banks would not trigger a CDS payout, that CDS spreads are likely trading at artificially low levels since they are much less likely to be the insurance policy that they were originally held out to be. (I note with interest that the CEO of the ISDA has stepped down, no doubt due to this very controversial decision.) Regardless, this does not make the message of 2-yr sovereign yields any less relevant. As the 2nd and 3rd charts show, the relative risk of the four PIIGS is approximately the same, whether measured by CDS or by 2-yr sovereign yields.

Oil prices remain firm


If the price of crude oil tells us anything about the resilience and underlying strength of global demand, then it would appear that the global economy is doing just fine—no sign here of any collapse in demand. On the contrary, crude oil futures prices are up almost 30% since Oct. 4th, which also marked the year's low for equity prices.

The agonizing over Europe is over what might happen if Greece and Italy default, but to date the evidence from real-time prices suggests that day-to-day activity, around the globe, remains unaffected.

This is consistent with what I argued in this post from last July, namely that debt defaults do not destroy demand: they mainly result in a wealth transfer from lenders to debtors, and "much of the disruption that can be expected from debt problems has already happened."

Weekly claims continue to decline


Weekly claims for unemployment once again came in below expectations (390K vs. 400K). Claims have been on a declining trend since April 2009, and the current level of claims (seasonally adjusted) is 6% below its 52-week moving average (the purple line in the chart above). Progress has not been all that impressive in the past year, but we continue to see progress and improvement on the margin, and that is what's most important. Especially since markets all over the world continue to be obsessed with the possibility of a global recession/depression following in the wake of the Eurozone's sovereign debt crisis. The U.S. economy remains essentially oblivious to the problems in Europe, according to the claims data.

The employment outlook continues to improve


The Monster Employment Indices for October showed "improved overall online job availability compared to October 2010," with the overall index up 11% over the past year.


Industry Year-over-year Trends: 15 of the 20 industries monitored by the Index showed positive annual growth trends.

Information (up 27 percent) remained amidst the top growth sectors with continued demand for professionals in software, digital media, and telecommunications

Retail Trade (up 26 percent) exhibited notable expansion in online recruitment levels suggesting that some employers are fully proceeding with their seasonal hiring efforts 

Manufacturing (up 18 percent) registered an accelerated growth pace in October

Public Administration (down 30 percent) continued to record the steepest decline in October, dropping to a new low in the Index

As a counterbalance to all the gloom and doom coming from Europe these days:

The Monster Monster Employment Index Europe registered a 14 percent annual growth rate in October. The engineering sector continued to lead the index with the largest year-over-year growth while opportunities in industrial production and related sectors continued to be among top growth sectors. Germany continued to lead all countries in annual growth 

All in all, I'd say this is encouraging, and it strengthens the import of the BLS release today of job openings in September, which also registered ongoing gains.

Out of town for a few days ...

... with limited access, so blogging will probably be light for the next few days. Back in the saddle on Thursday.