Relative tranquility returned to equity trading yesterday. The S&P 500 moved within a fairly tight range on Monday relative to recent history and closed down by only a small fraction vs. Friday. That’s progress next to last week’s turmoil: yesterday’s session was calm, cool and…clueless.
Clueless? Yes, if you were judging sentiment by what unfolded in the credit markets yesterday. In particular, a heightened state of fear gripped trading on the short end of the maturity spectrum. With a growing penchant to kick anything of less-than-stellar credit quality, investors rushed to safety by purchasing Treasury bills, the ultimate zone of security among paper assets. In the process, commercial paper of questionable quality took it on the chin.
The net result: the 3-month T-bill yield fell to around 3.12%, down from 3.76% on Friday’s close according to U.S. Treasury numbers. The commensurate rise in the price of a 3-month T-bill yesterday (bond prices move inversely to yields) has been widely reported as the biggest since the 1987 stock market crash. Even more striking is the fact that as recently as late July, 3-month T-bills yielded more than 5%.

Meanwhile, yields rose sharply yesterday on certain 30-day commercial paper issues backed by home loans and other financial assets that have suddenly come under fresh scrutiny. In some cases, 30-day paper was yielding 6% by the day’s end, or nearly 300 basis points over T-bills.
The spectacle of short-term paper yields moving higher while T-bill yields dropped is unnerving by itself. This, after all, is the cash market. Yes, high-grade corporate paper always carries a modest premium over T-bills in the best of times, but usually the spread is relatively modest, stable and predictable–features that evaporated yesterday in a flash.
Simply put, yesterday reminds that raising cash is still a priority. That’s another way of saying that volatility still lurks. It’s any one’s guess what comes next. But it’s a safe bet that well worn assumptions and rules drawn from history may not hold at any given moment. That’s the nature of repricing risk: nothing’s sacred.
That leaves the world to embrace the next best thing. “Nobody can actually quantify the risk right now,” Robert Millikan of BB&T Asset Management told The New York Times, “so investors are requiring a somewhat exaggerated level of compensation.”