Carlyle Capital defaulting on its debt sent new ripples of fear through credit markets on Thursday, compounded by falling stocks and the slumping dollar.
Fragile sentiment took a hit after the highly-leveraged fund said it was unable to meet snowballing margin calls, sending the investment-grade European credit derivative index to record highs.
Carlyle Capital, the mortgage backed-securities fund of private equity group Carlyle, said it had defaulted on about $16.6bn of its debt, having faced margin calls in excess of $400m in the past week.
“As you get more and more risk aversion, collateral requirements increase, which in turn forces further deleveraging. It’s a vicious cycle,” said Mehernosh Engineer, credit strategist at BNP Paribas.
“The question is, are there dozens of hedge funds like Carlyle in a similar position?”
On Wednesday Drake Management, which manages nearly $5 billion in hedge fund assets, told investors it might liquidate all three of its hedge funds because of “challenging market conditions.”
Worries about highly leveraged funds overshadowed the Fed’s liquidity operations, announced on Tuesday, which left many credit market participants underwhelmed at the time.
“In reality the Fed is plastering over the cracks until the US Government eventually spends taxpayer’s money stabilising the markets,” said Jim Reid at Deutsche Bank in a note. “Perhaps the markets are trying to force the authorities’ hand sooner than they would ideally like.”
The iTraxx Europe, which measures the cost of protecting 125 investment-grade credits against default, returned to record highs, gaining 12.15 basis points to 159.25bp. This means it cost €159,000 per year to insure €10m of iTraxx Europe debt over five years.
The iTraxx Crossover, an index of 50 mostly junk-rated credits, wiped out Wednesday’s 20bp rally by widening 27.43bp to about 625.63bp.
The iTraxx Asia ex-Japan investment grade index, which is dominated by banking credits, jumped 10bp to 213bp. And Japan’s index reached record highs after the slumping dollar breached the Y100 level against the yen for the first time in 12 years.
