Curve Flattening In Credit - Never A Good Sign

Tyler Durden's picture

Via Peter Tchir of TF Market Advisors

The credit markets here are actually deteriorating and are showing signs that there is growing default concern, rather than just pressure to reduce risk.


The red line is the ratio of BAC 5yr CDS vs 3yr CDS.  It was the first curve to flatten.  The dark blue line is the European XOVER index.  As European sovereigns weakened, XOVER started to trade flatter as concern spread to how the weaker companies in Europe would be able to fund themselves and if sovereign defaults would hurt their business.

It took MAIN longer to follow suit.  Initially MAIN was dragged down by its financial component but has continued to deteriorate as some degree of fear has spread from financials and European HY into European corporates.

The light blue line is the North American Investment Grade Index (IG16).  IG remained immune to front end curve pressure, but in late August we saw a move there too.  This index has few financials than MAIN and should be the safest of all.  Seeing any front end pressure in IG16 is definitely concerning and shows that there is more than just some momentum chasing global macro players driving spreads around.

HCA, a benchmark High Yield Issuer, was cruising along until mid September.  Now it too is finding pressure on front end spreads.  This is occurring across the board on High Yield names.  That makes sense with NewPage having defaulted recently and Eastman Kodak suddenly at risk.
The pressure on curves in high yield correlates well with the underperformance of CCC bonds.  Both of these moves suggest that there is real risk aversion.  If investors only wanted liquidity they could sell some of the bonds that have performed better.  If they weren’t hedging jump to default exposure, they wouldn’t be starting to bid up the front end of the curve.  Investors are examining their positions closely and are exiting the positions they fear the most in an economic downturn.


Could this move be purely because the curves are illiquid?  Yes, CDS  curves are relatively illiquid on single name, but for the past year, they have been illiquid because there were only offers of protection.  No one was looking to buy short dated protection – everyone had jumped onto the economy is okay and corporations have a lot of cash bandwagon.  4 months ago, the market, particularly in indices could have absorbed a big buyer of short dated protection.  Now it is moving wider on thin volumes.  You could take that as a sign only of illiquidity, but I think there is more going on here than just that.  Any time a market goes for offered without to threatening to go bid without, it is not just a function of a few errant trades.


On a somewhat related note, multiple people have commented how illiquid 5 year CDS is, or how easily it is pushed around, etc.  That is largely because 5 year CDS on many names is now moving in a direction that doesn’t suit many commentators or analysts.  In most names, the CDS is as liquid as the bonds.  For many names it is easier to move around the bonds than it is the CDS.  From what I can see, it remains easier to find an offer on CDS than to find a bid on bonds for many companies.  CDS might have 99 problems, but liquidity isn’t one.  Certainly not when comparing 5 year CDS to bonds.  On the other hand, maybe no one would be as concerned about CDS if they spoke about it in “points” rather than spread.  MS went 5 year CDS, on a 100 bp SNAC contract, went from 83.1 points up-front to 82.2 points up-front.   That is the up-front payment required for spreads of 505 and 530.  Somehow 25 bps sounds a lot worse than 0.9%.  Just something to keep in mind about the perception versus reality.  The volatility in CDS is actually relatively tame compared to the volatility in the stock – and it should be, since it is structurally senior.  I do continue to believe that the action in Morgan Stanley has as much to do with a hard landing for Asia as it does for unique exposure to European banks.

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Long-John-Silver's picture

Bank of America = Lehman Brothers 2.0

GeneMarchbanks's picture

BAC or BNP or Dexia or SocGen it's not just an American thing anymore...

trav7777's picture

yeah, between those banks and several sovereigns, it's a competition to see who goes TU first.

Like I said back when the bailouts started, they have transferred all of the banking risk to who can backstop those?

The game is over.  Debt is dead.  Debt can only be rolled or repaid by growth and growth is over.  It's not a fiscal problem or a monetary problem or even a problem with "excessive debt."  There is NO amount of debt that is not excessive when debt is expected to grow and it cannot.

Threeggg's picture

Buy calls on circuit breakers bitchez !

AMR halted for the sixth time today !

Update: Now Seven times @ $1.88 on the latest halt

PulauHantu29's picture

Very insightful. I compliment you!

Steroid's picture

Paper backwardation?

slewie the pi-rat's picture

paper products were strong in today's ISM propagan..., er,..., report...

don't be caught short, BiCheZ!

X.inf.capt's picture


hello, pi- rat, answered your post you wrote to me earlier...

yes, again, thank you.

Missiondweller's picture

Not part of Operation Twist?

DoChenRollingBearing's picture

Well, this article is beyond a bearing's comprehension (with less than two and a half neurons after all), but I can see risks ahead...

All bonds look like a bad bet to me.

Gold > FRNs > electrons on deposit at the bank > longer term bonds

I guess???

mayhem_korner's picture


What the data is saying is that the premiums on shorter-dated credit default swaps (CDS) are looking more like the premiums on longer-dated CDS's.  So buyers looking for default insurance (or just speculating on default) are saying that the likelihood of default in the near term is as high as over a longer horizon.  Not a healthy sentiment.

Sure feels like weight-bearing lally columns are wobbling today...

Dr. Richard Head's picture

The question in my mind becomes whether or not the CDS are appropriately funded to pay out (ala AIG of 2008?).  Perhaps I'm confused. 

mayhem_korner's picture


Excellent question.  I don't think there are CDS sinking funds on the books anywhere.  This is all securities "vaporware."  The whole premise of underwriting CDS's is like playing hopscotch in a minefield.

And to think these hacks took the correlation issue in the wrong direction last time by stacking highly-correlated junk mortgages and CDS's into collateralized debt obligations (CDOs).  2nd derivative of vaporware, once removed.

Snakeeyes's picture

Operation Limbo Rock - How low can Bernanke go?

Vergeltung's picture

great article. I learn more & more here everyday. thanks TD.


Mitch Comestein's picture

I think the last two months have been the Fed and Treasury's "We Need People To Buy Our Debt, screw everything else....twist" plan. 

Dr. Richard Head's picture

Can't they just continue to circle jerk the debt between the Fed and Treasury with Wall Stree primary dealers acting as the limp biscuit? It's worked since late 2008 no? 

Missiondweller's picture

Looks like Tyler was right about BAC. Looks like a mini bank run..


"Spokeswoman Tara Burke says customers experiencing slowness or can't get through should keep trying. She says the access problems are a result of the bank managing traffic volume during peak use. She declined to say whether volume has surged in recent days.

Problems began on Friday, a day after the bank said it would start charging a $5 monthly fee for customers using debit cards. Burke insists there's no connection. Burke said there's been no hacking and no customer information was compromised."


So the question is, is it a relatively small number of depositors? Or the start of something bigger?

Amish Hacker's picture

B of A is "managing traffic volume during peak use?" Whatever happened to adding server capacity to meet increased customer demand? I have a B of A credit card (to get Hawaiian Air miles) but no checking or savings accounts with them. A couple of months ago they sent me a new card, saying there had been a massive data leak, but refusing to take responsibility for their lousy security and blaming a "third party" for the breach. It was a major hassle to reset all my automatic monthly billings to the new credit card number, but there was not a word of apology from B of A.

A few months before that, they had lowered my credit limit, implying that my credit was weakening. But the lower limit was a direct result of the bank's failing balance sheet, not mine, as a phone rep finally conceded to me, without once sounding polite about it.

This latest $5 monthly fee thing is just another example of the stunning incompetence and pure desperation that B of A is sliding into. Spokeswoman Tara Burke is spinning the story, but A.P. Gianini is spinning in his grave.


Caviar Emptor's picture

What's your comment on Eurodollar futures, Tyler? 

ivars's picture

What is next for stocks- have a look here with pictures-based on prediction from february which is now spot on:

Predictions that are tested and eerie similarity of the USA and Greece stock markets.

And the conclusion for macro economic bacground that will rule 2012-2015:

Recession/deflation in the USA from q1 2012, further accelerating increase in unsustainble debt levels- default/inflation from jan 2015, loss of reserve status. 

One thing I can imagine will grow vs. other currencies during 2012-2013 will be THE USD.


Ag1761's picture

Sometime later this week I think.

Sheep on Awaking:

Walks up to the bank counter,

Good morning Miss, I've been camping out all night and I'd like to close my account please, any denomination will suffice thank you.


Counter Robot:

I'm sorry Sir, that's an internet only account. I can't access it form here, you will have to go online.



But I can't get access online, your site has been down all fucking week and those bastards on the tech support line just won't take my calls. I want my money please, now!


Counter Robot:

I am sorry Sir, you will have to access the account online, now move along please. You should have known that online access makes it easy for us to keep your little savings in the most unlikely event of a temporary liquidity crisis. We did offer you 0.0005% extra on that account so we wouldn't ever have to see your face or hear you bleep. Now move along please before I call over that nice FEMA man.


In another town:


Smart Guy, already wide awake:

Walks up to the counter (coin shop):

Good morning Mr Coin Dealer, what can you give me near spot today please.


Nice Coin Dealer:

Good morning Sir, Nice to see you again, just like every month. I can give you a special on some Silver Maples, $2.00 over spot, i've got kids to feed and stocks are getting low.

Smart Guy:

Thank you kind Sir, I'll take 100 of those please, see you next month.






RSloane's picture

There is no light at the end of the tunnel. The train is running without a guide light. The best idea is to get off the tracks.

Schmuck Raker's picture

A little help here please.

"CCC" is what?

[edit] Oh fuc* me. I got it. Never mind.

ConfusedIdiot's picture

TU so very much Mayhem. I too was scratching my head as to the point being made. CI

JW n FL's picture



Bank of America lives only to die.. load it up and sink it to the depths.

Snakeeyes's picture

Look at the relationship between flat yield curves and recession. To paraphrase Chubby Checker in "Limbo Rock," Ben better be nimble and quick, otherwise we all get screwed.

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