Swap Spread Shows ‘Healing’ of Credit: Chart of Day

By Liz Capo McCormick

Jan. 8 (Bloomberg) -- Interest-rate derivatives are signaling credit markets are returning to levels not seen in over a year as the Federal Reserve keeps its target lending rate pinned near zero to unfreeze lending.

The CHART OF THE DAY shows the two-year interest rate swap spread narrowed to 61.25 basis points today, the least since October 2007. The spread, which is the difference between the rate to exchange floating for fixed interest payments for two years and comparable U.S. Treasury yields, is a gauge of investors’ perceptions of credit risk. Swap rates are based on expectations for the London interbank offered rate, or Libor.

“The move tighter in swap spreads is definitely a positive for the credit markets,” said Saumil Parikh, a portfolio manager at Pacific Investment Management Co. in Newport Beach, California, which oversees more than $790.3 billion in assets. “It is an important step in the sequential healing process of U.S. credit conditions and it signals immediately that there is decreasing risk in the inter-bank lending market.”

Lending conditions have improved because the Fed allowed excess reserves in the banking system to rise and set up several asset purchase and lending programs, according to Parikh.

Swap rates serve as benchmarks for investors in many types of debt often purchased by buyers using borrowed money, including mortgage-backed securities and auto-loan securities. That means wider swap spreads can push up borrowing costs even if Treasury yields are steady.

To contact the reporter on this story: Liz Capo McCormick in New York at Emccormick7@bloomberg.net