Sunday, February 21, 2010

Credit Markets Are Showing Serious Warnings Signs

Bond vigilantes are battening down the hatches across the world, "bringing the most dramatic credit rally for a century to a shuddering halt". So says the U.K.'s Telegraph today, in an article today by Ambrose Evans-Pritchard.

Gavan Nolan, an analysts with Markit's, says that the Markit iTraxx Crossover index, which measures yields on lower-grade debt, jumped by almost 130 basis points since mid-January to 514, or nearly 34%. In addition, the main index of investment grade bonds has jumped by a third to 93. "This is the biggest move since the financial crisis in early 2009". "The index is a leading indicator so it is a warning signal. This is being driven by volatility in sovereign debt, with Greece being the biggest issue at the moment but tightening in China could be a bigger negative catalyst in the long-term".

According to Moody's, market ructions have led to a "material" rise in borrowing costs over the last month, prompting the cancellation of debt issues by several companies. Sixteen companies wordwide have pulled debt issues worth a $7.3B since mid-January, including Canada's Bombardier, the Dutch energy group New World Resources, Italy's Snai betting group, and UK's Travelport.

"The world has woken up to the real possibility of a double dip. These are nervous times," said Dr. Suki Mann, a from Societe Generale.

"The sudden halt in bond issues is disturbing since companies have been relying on capital markets to raise money as an alternative to Europe's fragile banks. The ECB said on Tuesday that 42pc of small businesses in the eurozone had reported worsening credit conditions in the second half of last year, despite the emergency stimulus of the authorities.

Conditions appear to be deteriorating. Bank loans to companies contracted at an annual rate of 1.9% in November and 2.3% in December. Consumer credit also fell. The Bundesbank fears that disastrous earnings last year will cause scores of German companies to breach loan covenants, triggering a wave of downgrades that further damage German banks and potentially setting off a second wave of the credit crisis.

New Basel III rules intended to force banks to raise risk-adjust capital levels may be making matters worse. The rules are causing weaker banks to cut lending, throwing the 'credit multiplier' into reverse.

Andrew Sheets, a credit expert at Morgan Stanley, said corporate bond spreads have not spiked as far as Greek or southern European sovereign yields, so they may rise higher as the price of risk comes back into alignment. "What's changed over the last two weeks is that valuations have become too rich compared to broader sovereigns," he said."

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