Swap spreads – a very sensitive barometer of economic cycle risk – are saying systemic risk is low and outlook for 2013 is for an improving economy.

Swap spreads are the expression of the direction in interest rates.  They are derived from a massively liquid market for treasury and money market securities.  Scott Grannis of Califia Beach Pundit (here) provided the following chart and commentary.  Jeb Terry, Sr. October 16, 2012

Swap spreads are excellent leading indicators of economic health, as the above chart demonstrates. (Here is a primer on swap spreads.) Swap spreads can be thought of as the price that market participants must pay to reduce their exposure to risk. When swap spreads rise, it’s because investors are becoming more worried about the future, the market is becoming more risk averse, liquidity is drying up, and/or the economic fundamentals are deteriorating. As a result, it becomes more expensive to get rid of unwanted risk. Swap spreads have risen in advance of the last three recessions, and they have declined in advance of the last two recoveries. The decline in swap spreads in late 2008 led me to predict improving conditions in 2009. Today, swap spreads are about as low as they get, and that suggests that systemic risk in general is very low, and therefore the health of the economy is likely to improve over the next six months

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