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Rates peaked in June 2006 on increased growth expectations and later reversed as the subprime mortgage fiasco hit the markets. Yields stabilized in 2008 before dropping in the wake of the deepening recession following the Lehman debacle. Yields fell as low as 2.05% in December before moving higher as deflationary fears are evaporating.

Ever since Paul Volker broke escalating inflation expectations by firm monetary policy in the early 1980s, bond yields have been declining. In every economic cycle, yields have peaked at lower points, reflecting steadily improving inflationary expectations. Yields temporarily broke the downward sloping trend-line of the late 80s but later dropped as the credit crisis unfolded. Rates reached lows in March and September 2008. The recent increase in monetary creation may lead to inflationary problems and higher rates.

The TED spread skyrocketed following the Lehman bankruptcy. However, the spread has narrowed about 400 basis points, indicating less stress in the credit market.

Overnight LIBOR rates have come down to the fed funds target and 3-month LIBOR has fallen, indicating less stress in the banking system.

After rising to a cycle high, the 2-year swap spread has subsided, indicating declining risk aversion.

The 10-year swap spread has decreased as markets normalize.

The T-bill rate has forecast lower federal funds target rates since 2006. The T-bill rate normally signals a lower fed funds target rate as long as below the target rate. The T-bill rate has recently stayed close the target rate as the Fed cut rates close to zero.  If the T-bill rate rises, it indicates the Fed is likely to increase its target rate.

The 10-year – 2-year spreads surged to a cycle high at the end of 2008. The spreads narrowed, but rose to new highs last week.

The Aaa credit spread has eased, still indicating heightened risk aversion.  

The Baa credit spread surged since 2007. Stabilized at a high level early 2009 and the spead is now narrowing as the economy recovers.

The yield curve has shifted up since the beginning of the year. 

Credit-default spreads for corporate borrowers have recently fallen from elevated levels, indicating declining stress in the credit market.

 The  home equity index have been declining steadily since 2007. However, the higher rated series have improved lately.

Commercial mortgage-backed credit spreads have surged, indicating stress in the commercial real estate market. The last few weeks spreads have narrowed somewhat.

Emerging market spreads skyrocketed following the Lehman debacle. However, the spreads have narrowed as risk sentiment improved.

Overall, treasury interest rates have risen from their lows and credit spreads have narrowed, indicating the credit freeze is easing and the economic outlook is improving.  

Hans Nilsson

New York, May 29, 2009