This CDS report was written by Markit’s Gavan Nolan
Tumultuous weeks seem to come and go in the modern credit markets. Spread movements that would have seemed outlandish 18 months ago are now commonplace. But this week saw a correction that was extreme even by recent standards.
The Markit iTraxx Crossover index broke through the 1,000bp barrier and kept on going. Its investment grade sibling surpassed an equally important barrier. The Markit iTraxx Europe index widened beyond 200bp and is now trading around 217bp. North American credit indices saw moderate changes in comparison, though they are still trading significantly wider than their European counterparts.
The reason? Thin liquidity has no doubt contributed. But the real driver – surprise, surprise – has been the economy. The markets have been pricing in dire news. However, data releases this week were even worse than expected. Markit PMI surveys, leading indicators used widely by monetary authorities, showed that both the manufacturing and services sectors in the eurozone contracted at a record pace. The same picture was painted by PMIs for the UK. And the gloomy outlook was not confined to Europe. ISM surveys for manufacturing and services – the equivalent of the PMIs in the US – were abysmal.
Then today came the hammer blow. The US non-farm payrolls report – a lagging indicator – always has the potential to move markets. But today’s figure of 533,000 jobs lost in November surprised even the most pessimistic of investors. The report showed that the slowdown has spared no sector, with the exception of healthcare. European central banks cut rates in response to the worsening outlook, and the Federal Reserve is now expected to follow suit.
Monetary authorities have been easing policy dramatically in recent months. Central bankers were already on alert during the banking crises of this year, which saw financial spreads widen sharply (see chart above). Governments intervened and the probability of systemic risk has been reduced. But the contraction in credit and the consequent effects on consumer spending and unemployment are now being felt throughout the economy. The chart above shows that industrial and consumer names have underperformed financials in recent weeks. This trend is likely to continue as the global economy heads into recession. The plummeting oil price should offer some respite to firms. Unfortunately, it is a product of weakening demand and this will outweigh any benefits from reduced costs.