There was little sign of a relief rally in credit markets on Thursday, as European credit indices caught in a vicious circle remained near their record peaks.
Jim Reid at Deutsche Bank summed up the mood with this note:
“For sale! The credit market. Pretty good value for money. Only one previously (fast driving) owner but no damage to the bodywork. Reluctant seller but can’t afford the ever higher refuelling costs. Cash buyers only, no credit. All serious offers considered.”
A dearth of participants willing to sell protection in any volume - despite the fact this trade is more lucrative than ever before - reflects the deep-seated belief that spreads will widen much further.
“You’re in a market where there is no-one who wants to take any risk. You’re surrounded by people who want to reduce risk,” said Geraud Charpin, analyst at UBS. “As soon as you try and buy protection in any size, you gap the market because no-one wants to take the other side of the deal.”
With credit markets lurching higher as structured products are unwound or rehedged, fundamentals have fallen by the wayside. Economic data and company results are having less effect on spreads as they move to their own, self-feeding dynamics.
“Fundamentals do not seem to be at all relevant in what appears to be a one-way, technical market dominated by deleveraging and unwinding of credit structured products,” said analysts at BNP Paribas in a note.
The iTraxx Europe index of investment grade credits, which pulled back 8.2 basis points from a late surge on Wednesday, was at 124.2bp. The index is pricing a default-rate over 5 times higher than the highest recorded in the past 50 years, according to BNP Paribas calculations.
The iTraxx Crossover of junk-rated credits receded somewhat from Wednesday’s peak, 25bp tighter at 580.4bp. Analysts say the Crossover, unlike the Europe, is still underpricing risk. The technical unwinds have put much more pressure on the investment-grade index, because unwinding senior tranches involves buying protection on investment-grade names.
