Credit stress continues

As the Financial Times Alphaville blog reports here, the credit markets continue to be under great pressure.
Specifically, the European high yield CDS benchmark iTraxx crossover, which tracks credit default swap spreads on European junk bond issuers, broke through the 1000 basis points barrier for the first time.



The I-Traxx crossover index of European corporate junk bond CDS Click on chart for larger image

Concerns over corporate solvency continue to mushroom, especially as it is not quite clear how easy it will be for junk bond issuers to roll over debt in the current climate. It seems in fact quite likely that a number of bankruptcies will be triggered by such failures to roll over debt.

Credit spreads on corporate debt have generally made yet another explosive move higher, as treasury yields have imploded in the recent blow-off move in government notes and bonds. Note in this context that we have once again a case of 'unintended consequences' at work here, as the implosion in treasury yields can be attributed directly to the Fed's decision to montize $800 bn. in MBS and ABS, forcing duration hedging of large MBS portfolios.

The current junk bond spread over treasuries indicates a 21% default rate of junk borrowers over the coming year, which is quite extraordinary.

The Barron's confidence index is also making new lows - this index is a ratio chart comparing a high grade with an intermediate grade corporate bond index. When it falls, it means that lower graded bonds are falling in price relative to higher grade bonds. The collapse in this index is nothing short of astounding. Once again, the only (relatively nearby) historical period with which the current situation can be compared is the 1929-1932 collapse.


the Barron's confidence index, courtesy of sharelynx click on chart for larger image

Thus one has to still tread very carefully in the stock market as well, even though it is technically more than ripe for a good bounce. As Monday's 8,9% one day crash in the SPX has shown, extremely large sell-offs coming seemingly out of the blue have to be expected at any time. It is the continued deterioration in credit markets that is triggering these bouts of short term plunges in the stock market.

Here is a very useful bookmark, showing a table of all corporate CDS index spreads published and administered by Markit. One should keep a close eye on future developments in these index spreads.