Blatant Warning, Not Casual Dismissal

For everything that has gone wrong over the past year or so, there was and is a benign interpretation to accompany each negative factor. Oil prices were “transitory”, longer run inflation expectations didn’t matter because “professional forecasters” remained steadfastly devoted, and no matter which market has gone highly askew it’s just “normal” worry. All of these nonthreatening rationalizations trace back to the backward nature of economics; getting more so the louder these current contradictions. Because Janet Yellen assures us that tomorrow will beher tomorrow, nothing you see around you now to the contrary can actually matter.

Commentary is thus adjusted by that so current observations are skewed under that perception – a perception that dominates not on merit but credentials alone. This answers a lot of our current woes.

One of those negative factors, increasingly so, was and is swap spreads. As spreads have decompressed all across maturities, itself highly unusual, more and more they turned negative in 2015. A negative swap spread is meaningless in a vitally important market where prices are supposed to hold relevant significance. On its face, a negative swap spread suggests that the market is pricing more risk in UST’s than private derivative counterparties. That is, of course, not what is happening; instead, a negative swap spread only denotes great financial imbalance within the deeper bowels of bank balance sheet construction.

Even recognizing such imbalance, there were no end to the similarly benign excuses as to why swap spreads would signal such grand disarray, but yet still not spoil Yellen’s victory parade. Repeatedly negative spreads were deduced to nothing more than corporate bond issuance and, what would really make Yellen’s version, “selling” of UST’s everywhere:

“There is a rebalancing of holdings by central banks and there is still a massive supply of Treasuries that has no end in sight,” said Ralph Axel, an analyst in New York at Bank of America Corp. “We see recent signs that China is selling and overall all central banks, including the Fed, are no longer the big supporters of Treasuries as they had been in recent years. This is narrowing spreads as it cheapens Treasuries.”

There’s a third component to the negative spreads: Companies are piling into the debt market to lock in low borrowing costs. They frequently swap the issuance from fixed to floating payments, which causes swap spreads to tighten.