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Crescenzi: Big Signal in Swap Rate

The two-year swap spread, which measures the difference between two-year swap rates and two-year Treasuries, has plunged 24 basis points to 125 basis points today, its lowest level since September 19th and 40 basis points below the peak set on October 2nd.

The drop is important because it indicates that market participants are betting that credit spreads will narrow. As a refresher, swap rates gauge the interest rate that a debt obligor (or speculator) pays to swap out of a floating-rate obligation into a fixed-rate obligation. Debtors do this particularly when they are unsure about their funding costs, a concern expressed wildly of late. (Crescenzi talks about other credit market signs with Jim Bianco and Kevin Ferry. See video)

If swap rates appear to be trending lower, U.S. corporations might begin selling debt before credit spreads fall, by selling fixed-rate debt and entering into swap agreements to swap their fixed-rate obligation for a floating one. This would be good news for the economy given the paltry amount of corporate bond issuance that has occurred of late.

At 125 basis points, the 2-year swap spread is still elevated. For example, in contrast, the 10-year swap spread is trading at just 52.5 basis points today, a relatively normal level, even in prosperous times.

The contrast obviously reflects the time frame involved, with market participants betting that the credit crisis and its affects will pass in due course, well before the 10-year time frame, but not necessarily before 2 years. The 2-year swap rate therefore indicates that there remain significant concerns regarding the outlook for corporate cash flows, and this will probably be the case until the economic climate appears set to improve.

Check key spreads and Libor data here.

More: Click for Latest Economic coverage ...

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Tony Crescenzi
Tony Crescenzi

Tony Crescenzi is the Chief Bond Market Strategist at Miller Tabak + Co., LLC where he advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. Crescenzi makes regular appearances on financial television stations such as CNBC and Bloomberg, and is frequently quoted across the news media. He is also the author of the forthcoming book, "Investing from the Top Down," "The Strategic Bond Investor," and co-author of the 1200-page book "The Money Market."Crescenzi is a contributor to RealMoney.com."