Swaps spreads highlight credit stresses
The fall in high oil prices and recovery of stocks and the dollar over the past month might suggest the year-long global financial upheaval is easing, but that's not the picture painted by interest rate swaps.
HSBC bad debts hit 8.7 billion poundsThe gap between 10-year swap rates and 10-year yields on German government bonds is wider now than for most of the 12 months since an implosion in financial instruments linked to the U.S. mortgage market froze up global money markets.
That spread, a key indicator of credit risk and banks' willingness to lend to each other, and an overall barometer of financial market stress, shows that the cost of borrowing is still nominally and relatively expensive for firms and banks.
In short, it suggests the financial system remains under extraordinary pressure and mirrors the persistently wide spreads elsewhere in the fixed income and money market universe: many euro zone government bond yields over yields on top-rated German paper, and those of London interbank offered rates (Libor) over Overnight Index Swaps in money markets.
"This tells you that there has been credit differentiation everywhere. Spread widening is here to stay," said Meyrick Chapman, rates strategist at UBS in London.
On Thursday the 10-year euro swap spread was almost 50 basis points.
Only for a brief period, before U.S. investment bank Bear Stearns was rescued in March, has that spread been meaningfully wider in the past year at just over 60 basis points.
The long-term average 10-year European swap spread going back to 1992 is about 29 basis points, peaking in September 2000 at 71 basis points and troughing at a "stupidly narrow" 5 basis points in the middle of the decade, Chapman at UBS noted.
BANKS' CLEAN UP TIME
An interest rate swap is an agreement between two counterparties which often involves the exchange of a stream of a fixed payment for a floating payment linked to an interest rate, usually Libor.
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