It's been a while since I have posted charts of swap spreads. I relied heavily on this forward-looking indicator of systemic risk last October and November, when I asserted that they were telling us that the worst had passed and that we should look forward to an improvement in the economy and the markets in the months to come. Swap spreads have done a terrific job over the years of reacting early to emerging systemic problems (note how they rise well in advance of recessions), and reacting early to the unwinding of these systemic problems (note how they fall well in advance of the end of recessions).
Currently, swap spreads are just about where they should be during times of relative tranquility in the markets and the economy. They tell us that the storm passed many months ago, and that conditions should continue to improve in the months ahead. Swap spreads are good indicators not only of systemic risk, but also of counterparty risk, the market's appetite for risk-taking, and the market's general liquidity.
Today they tell us that all of those important things are going to be normalizing in the future. This is undoubtedly one of the reasons that the equity market has been rising since early March, and it ties in well with the message of rising commodity prices. The U.S. economy is getting back on track, despite all the bad policies coming out of Washington these days (e.g., tariffs on Chinese tires, massive deficit spending, promises of higher taxes, increased regulation of healthcare, etc.), and despite all the concerns still out there (e.g., the coming wave of foreclosures, the 10% unemployment rate).
Here is a basic primer on swap spreads that I wrote last May that explains them in greater detail.
