This CDS report was written by Markit’s Gavan Nolan
The great and the good met in Davos this week, and it was much documented that the overall mood was one of pessimism. Economic data from the US provided ample support for such a stance. On Thursday, initial jobless claims rose to 589,000 last week, more than expected, while continuing claims for unemployment benefits hit 4.78 million, the highest level since records began in 1967. Then today US GDP figures showed the economy contracting by 3.8% in the fourth-quarter of 2008. The figure was lower than the 5-5.5% expected by the street, but the damage was apparent in the constituent parts of GDP. Inventories increased by 1.3%, indicating that the inevitable slowdown in production will feed through into Q1 2009. President Obama saw the figures as an opportunity to pressure Congress into passing his fiscal stimulus bill. The bill was passed by the House of Representatives on Wednesday but the bipartisan support he had been seeking was conspicuous by its absence. Not a single Republican voted for the bill and it faces a tough time getting through the Senate.
Despite the gloom and the weak fundamentals, credit performed relatively well during the week. Spreads were tighter, with investment grade outperforming high yield. The latter saw another default in the US, this time in the packaging sector. Smurfit-Stone, a constituent of the Markit CDX HY since its inception, filed for Chapter 11 bankruptcy protection. The default came as no great surprise as Smurfit had disclosed the appointment of bankruptcy advisors earlier this month. Investors in investment grade credit took heart from reports that the Obama administration is considering the creation of a “bad bank”. This would remove distressed assets from bank balance sheets and hopefully restore confidence in the banking system. However, the details are sketchy and the formulation of such as structure would pose many problems, particularly round the valuation of the assets.
The basis between indices and their theoretical levels remained steady, though the gap remains significant (see charts below). Investors are still focused on idiosyncratic risk and are protecting themselves on single names. Unwinds of synthetic CDOs will also put upward pressure on the basis. There is some evidence that the negative basis between CDS and cash has decreased this week amid high debt issuance. Several firms brought bonds to market at attractive yields, and the debt was snapped up by investors. The success of these placings demonstrated that there is a market for new debt, but it has to come from high-quality issuers.
