About the Spread Between 2yr Treasuries and 3mth LIBOR

Wanted to follow-up on an item I read about last week that a couple of my friends on Twitter brought to my attention:

If LIBOR continues to creep up and reaches, say, 75 bps, it no longer will be economical for banks to own US 2-year notes. In that case the US Treasury market will be in trouble. That’s when you head for the bomb shelter.

via Inner Workings » Blog Archive » …unless LIBOR hits 75 bps, in which case head for the shelter.

As if we needed any more arcane spreads to monitor, here’s the 2yr Treasury – 3mth Libor spread.  This chart has 20 years of daily spreads.

Couple of things to note: first, like other term structure-based spreads, spreads tighten in good times and widen in bad times.  This makes sense because as the economy gets worse, short term rates are lowered in an effort to stimulate the economy again.  Then as things improve, short-term rates get tightened.  Second, over the last twenty years it seems this spread has been in a range of roughly +/- 150bps.

But the current recession hasn’t been like the others.  I drew in that blue line to denote that despite the credit easing by the Fed (let’s be clear: monetary policy based on raising/lowering interest rates is really credit tightening/easing, read this), spreads have not widened like they have in the past.  They’ve remained tighter, even stubbornly so.  Also, negative dips have become bigger, so it gives one the sense that spreads here will not behave the way they have before.  It also shows me we’re going to have a flatter curve, which is something others have been forecasting as well.  Flatter curves, thinner spreads.  Not a recipe for a robust banking sector.

So what does it mean?  At the least, there’s another spread to keep watch over.  Second, as a friend of mine pointed out:

The convexity issue is concerning.  I’ve been saying for a little while now that convexity in rates was dangerous, mostly because of where we are in absolute rate levels.  So the possibility of a new trend taking shape here of lower highs and lower lows I think is a bad sign.  The days of increasing marginal utility for our money supply and credit system may be drawing to an end.  Added credit is not helping and may very well be making things tougher than they already are.

Also, the sovereign debt calendar really picks up in July.  France, Germany and a large part of the continent all have paper to roll, and all of the problems we were dealing with before are still there.  So behavior of this spread will be key over the next few months.

As Han Solo would say “I have a bad feeling about this…”

Indeed, so do I…



Filed under finance, government, macro, Markets, Monetary, risk management, Way Forward, You're kidding

4 responses to “About the Spread Between 2yr Treasuries and 3mth LIBOR

  1. Pingback: About the Spread Between 2yr Treasuries and 3mth LIBOR | rssblogstory.com

  2. Pingback: Monday links: value added Abnormal Returns

  3. Pingback: Treasuries Fluctuate With Stocks Before Note, Bond Auctions | Currency Trading Exchange Guide

  4. Pingback: (AFX UK Focus) 2010-06-02 15:10 TREASURIES-Bonds slip as stock rebound curbs safety bids | Credit and Loan

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s