This was the week the credit crisis began. The level of the Australian iTraxx index I quoted (blowing out from 25 to 44) is laughable. Its now around 285 (out about 1000%!) and has been at high as 400.
Insto Bond Diary
***Credit market meltdown (27 July 2007) ***
A chaotic week in global credit markets has shown no signs of abating. Credit indices globally are blowing out and the Australian Itraxx CDS index of 25 corporate names continues to widen. The last quoted price was 44.5/45.5 basis points, out from 38.5 this morning. At the start of June the index traded at 25 basis points.
“It's a case of pure panic as investors try to reduce risk as quickly as possible. There has been a rash of protection buying, and the indices as a liquid source of exposure have gapped wider,” said Mark Bayley, director - credit and structuring, ABN AMRO.
'Credit fundamentals remain sound, so negative sentiment is driving the spread widening. There is a circle of fear of the unknown,” said Craig Saalmann, credit strategist, JPMorgan.
Primary markets throughout the world remain shut with investors hesitant to buy and issuers hesitant to raise funds.
The nervousness stems from the narrow confines of US sub-prime lending sector. Its weakness had already triggered a fall in credit markets and an S&P report has revealed that sub-prime losses have exceeded expectations.
“There's a concern that sub-prime may have far reaching implications for the US economy and households, and investors are running for the exits,” said Saalmann.
Earnings have remained strong with US banks Merrill Lynch and Citi posting strong results. Investors, however, are not interested and equity prices and credit spreads are being hit hard.
Markets are also concerned with the exposure of some of the investment banks with over US$300 billion of leveraged buyout financing still remaining on their books. Bear Stearns CDS spreads widened by 20 basis points, while Goldman Sachs, Lehman Brothers, Merrill Lynch and Morgan Stanley were all out by about 10 basis points.
Another fear lies in the black hole of CDOs, and with limited pricing, the extent of the fallout is not clear. Bear Stearns' hedge fund losses have been well documented but ABN AMRO’s Bayley feels that most of the CDO risk ultimately rests with investors. Where investment banks will feel most of the pinch, he says, is from a decline in new issue and M&A fees.
Liquidity remains an issue with bid only prices being quoted for most assets. According to a nabCapital report some larger dealers offshore are not providing prices to lower value clients until market liquidity picks up.
In domestic cash markets spreads of HSBC Finance, the first major lender to reveal sub-prime losses, widened significantly.
Investment grade credits are being dragged along in the sweeping tide. The four major banks have all seen their senior spreads widening and sub debt CDS spreads are out by about 10 points.
“The whole credit spectrum is being repriced as a result,” said Bayley.
Signs of shift in sentiment and risk valuation are being seen in other asset markets.
Equity markets have tumbled on the back of credit concerns with The Dow and S&P 500 down 2.3 per cent and the FTSE 3.1 per cent lower. The ASX opened 150 points weaker at start of today's trading.
A textbook flight to quality also drove a rally in US Treasury bonds, and hedge funds that have been riding the carry trade (borrowing in low yielding currencies to invest in high yielding currencies), are finally seeing an unwinding as the Yen spiked against other currencies.
“The Japanese are still buying today but within the US and European investor community, lots of wounds are being licked,” said a currency trader.
“We expect to see more volatility in the coming weeks. The market will be thin due to the northern hemisphere summer holidays and opaque, with cash prices difficult to obtain. All investors can see is the indices and elsewhere there won't be much liquidity,” said Bayley.
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