3 Hidden Signs of Surging Credit Stress

I’m here with a major warning — a warning about hidden signs of surging credit stress. In fact, I haven’t seen these kinds of dangerous credit market moves since the weeks and months leading up to the great credit crisis.

The comments above and below are excerpts from an article by Mike Larson (moneyandmarkets.com) which has been edited ([ ]) and abridged (…) to provide a faster and easier read.

[Below are 3 charts outlining the]…rising credit risk and/or rising funding costs for corporate borrowers…

The first chart shows the 3-month LIBOR. The abbreviation stands for the “London Interbank Offered Rate,” and it’s a key benchmark of the cost of short-term borrowing for banks and corporations.

You can see from the chart that LIBOR has been rising quite a bit lately. It’s now the highest since the tail end of the credit crisis in 2009. You would expect to see LIBOR rise when the Federal Reserve is hiking interest rates, or talking about doing so.

Chart #1: 3-Month LIBOR

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The second chart shows the “TED Spread,” or the difference between LIBOR and the yield on credit-risk-free three-month Treasury bills…

You wouldn’t expect LIBOR to rise faster than yields on 3-month T-bills unless increasing credit stresses were building behind the scenes. Sure enough, T-bill yields have only climbed around 30 basis points since the beginning of October 2015. LIBOR has risen roughly 50 points during that same time frame. In fact, [though,] the TED spread is now at its widest since 2011-2012. That was when the U.S. debt ceiling debacle and European debt crisis were roiling the credit markets. If it widens by just a few points more, it’ll be the greatest spread we’ve seen since the tail end of the great credit crisis.

Chart #2: 3-Month TED Spread

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The third chart shows the “LIBOR-OIS” spread, the difference between LIBOR and the overnight indexed swap rate. This one is a bit more complex but you can think of the OIS rate as a benchmark for tracking how much banks are charging on very short-term lending to each other.

…I charted the LIBOR-OIS spread over a longer-term time frame for a reason. Go back to the far left of the chart [above] and you’ll see an initial jump higher in this spread in mid-2007. Then you’ll see it climbed steadily until the fall of 2008. That’s when it went vertical as the credit and stock markets “blew up” as Fannie Mae, Freddie Mac, Lehman Brothers, AIG, and other companies either went broke or required massive bailouts.

We saw an initial jump in this spread in late-2015, and it has done nothing but rise since then. It’s getting closer and closer to taking out the late-2011/early-2012 peak, and that bears very close watching. That’s especially true when you consider that other “something is wrong” indicators — like the value of the Japanese yen against the U.S. dollar — are climbing in lock step with these credit risk spreads.

Chart #3: LIBOR-OIS Spread

Click image for larger view

Now I should point out that some on Wall Street are offering up a counter-argument. They’re pointing to new money market fund regulations as the driver of this move. Essentially, the regulations are causing some investment funds to buy less short-term corporate debt and more short-term government paper [BUT,] if that were the case, then

• why would the move be so long-lasting and persistent?
• why would there be a corresponding sharp move higher in the Japanese yen?
• why are they coming at the same time as multi-billionaires and noted market experts are preparing for major market turmoil and
• why would the moves “fit” so well with other indicators of rising credit stress, and my thesis of deflating “Everything Bubbles” ?

The fact is I also recall vividly the same kind of excuse-making and happy talk coming from Wall Street back in 2007-2008 when spreads like these began to widen. They said stock investors should ignore them but, if they did, they got crushed in the ensuing market chaos.

I’m not going to sit here and tell you I have all the answers — no one does. What I am saying is that these indicators have flagged looming trouble in the past — and they’re getting more and more disturbing in the present- so be on alert!

Disclosure: The above article has been edited ([ ]) and abridged (…) by the editorial team at munKNEE.com (Your Key to Making Money!) to provide a fast and easy read.

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