Something Big Is Brewing—-Debt Markets No Longer Make Sense… Junk Debt Sounds The Alarm

In the last few months we have warned of the “perversions” in US money markets (here, here, and most recently here) adding that “to ignore them at your own peril.” And now, as Bloomberg reports, it appears the mainstream is beginning to recognize that something very strange is going on in debt markets. Across developed markets, the conventional relationship between (‘risk-free’) government debt and other ‘more risky’ assets has been turned upside-down. “Everybody in the fixed-income market should care about this,” warns a rates strategist and in fact, it’s hard to overstate how illogical it is when swap spreads are inverted, as JPM warns the moves in swap-spreads “should be viewed as symptomatic of deeper problems.”

As we stated before, a negative swap spread holds no interpretative meaning, the very fact of which is the most important element.

In other words, we don’t have to figure out what the “market” is saying about a negative spread because it isn’t saying anything other than “something” is wrong(and very wrong with so many and deeper negative and compressed maturities).


There are numerous reasons for this “nonsense” – as we detailed here, and as Bloomberg adds,

“These kinds of dislocations can be expected to grow over time,” said Aaron Kohli, a fixed-income strategist at Bank of Montreal, one of 22 primary dealers that trade directly with the Fed. “The market structure and regulatory structure has evolved in a period with very low volatility. Once you take that away, it’s not clear what the secondary implications of that will be.”

As the phenomenon becomes more widespread, it adds to evidence that it’s not just a one-off, according to Priya Misra, the New York-based head of global interest-rate strategy at TD Securities, another primary dealer.

“Everybody in the fixed-income market should care about this,” she said.

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In the U.K., where the Bank of England is also debating whether to raise rates, the swap spread reached minus 0.05 percentage points on Nov. 12, the least since December 2013. The difference between 10-year Australian notes and comparable swaps fell to a record last week as speculation diminished the central bank will cut borrowing costs.

“Traditional pricing and relative-value rules are breaking down,” said David Goodman, head of global capital markets strategy at Westpac Banking Corp.

“This is not really just a somewhat esoteric story about interest-rate derivatives,”JPMorgan strategists led by Joshua Younger wrote in a Nov. 6 report. “Moves in spreads should be viewed as symptomatic of deeper problems.”

Another potential problem is that inverted swap spreads may ultimately cause investors and borrowers to lose confidence in the bond market’s ability to correctly price risk and provide capital to those who need it, according to Steve Major, head of fixed income research at HSBC Holdings Plc.

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2007 Redux: Stock Market Parties——Even As Junk Debt Sounds The Alarm

While the Stock Market is Partying …

There are seemingly always “good reasons” why troubles in a sector of the credit markets are supposed to be ignored – or so people are telling us, every single time. Readers may recall how the developing problems in the sub-prime sector of the mortgage credit market were greeted by officials and countless market observers in the beginning in 2007.

Merchants Of Debt——-Retailer Debt Up From $90 Billion To $180 Billion Since 2010

Big problems get a whole lot bigger when big debt is involved.

The prime example is energy companies, many of which borrowed record amounts of cash during the recent commodity boom only to run into trouble as soon as oil prices headed south. But another important one can be found in overly leveraged U.S. retailers, which are struggling in the face of astructural shift in consumers’ spending habits.

Macy’s, for example, the largest U.S. department-store company with about $7 billion of debt outstanding, plunged the most in more than seven yearslast week after the chain missed third-quarter sales estimates and cut its annual profit forecast. Its bonds had already dropped almost 3 percent in the year leading up to the earnings and kept on falling after that as investors worried about the company’s future viability, Bank of America Merrill Lynch index data show.


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