Credit Rate Spreads as Indicators

Vince Farrell of Soleil Securities Group sent me his take on what key credit spreads are indicating about the financial landscape and economic prospects. For a little background, a ‘spread’ is trader talk for the difference between two financial instruments, in this case the interest rates offered different debt instruments. As with most spreads these have a historical ‘normal’ range and their trend away from or back towards normal are used to measure optimism or pessimism in hearts and minds of those who create or invest in the referenced instruments.

Vince finds that while most of the credit spreads he follows are wide by historical norms, they are narrowing and the trends are positive for the credit markets and eventually the economy. Here are his comments:

The TED spread – the difference between three-month dollar LIBOR and the three month Treasury bill – is about 96 basis points today. The normal spread is 50 basis points or so but this is vastly improved from the almost 500 basis points that was touched in September when Lehman failed. This is a measure of fear in the short term money markets and the fear hasn’t completely gone but, as I said, is much improved.

The spread between the thirty-year fixed rate mortgage and the 10-year Treasury bond is about 235 basis points. The historic spread is about 170 basis points and this, like the TED, is much better.

The difference between the jumbo mortgage interest rate (30-year mortgages for over $417,000) and the 10-year Treasury is around 400 basis points. This still has a way to go, as the long term average is closer to 250 basis points. This is a loan a bank would make knowing it can’t be sold to Fannie or Freddie (too big), can’t be securitized (that market isn’t there), so it would stay on the banks balance sheet. To me this is a critical mark for judging if the credit markets are truly improving.

The TIPS spread – the difference between the 10-year Treasury and the 10-year Inflation Protected Treasury – is about 110 basis points. That would be read as the expected rate of inflation for the next 10 years. It was close to 0 not long ago and I am greatly relieved the market has backed off that deflation scenario.”

You can catch more of Vince’s insights and analysis on CNBC where he appears regularly. He is the CIO of Soleil Securities Group who provide research, brokerage, marketing and investment banking services to institutional and corporate clients.

Giovanni Isaksen
Ashworth Partners Ltd.

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