Wednesday, February 29, 2012

Treasury yields and credit spreads divergence is not sustainable

There is a great deal of discussion in the market about the dislocation between US equities and treasuries. It is somewhat surprising that people are only now starting to focus on the issue - the divergence has been visible for quite some time and was discussed here.

But another divergence which is quite striking exists now between corporate bond spreads and treasury yields. The chart below compares the investment grade CDX (index CDS) with the 10-year treasury yields.

The treasury market continues to trade with a built in "Europe risk premium". Some managers hold treasuries as a hedge against European surprises - a strategy that has worked quite well recently (as opposed to equity index puts). But this divergence is not sustainable in the long term and treasury yields should start rising later this year.
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