This CDS report was written by Markit’s Gavan Nolan
Political risk is typically associated with sovereigns in the developing world. However, events in the UK this week reminded investors that the more mature nations can suffer from governmental upheaval. Results dripping through for yesterday’s local elections indicate an abysmal showing by the incumbent Labour Party. Prime Minister Gordon Brown’s position is under threat and morale in government appears to be at rock-bottom. It was no surprise that sterling lost ground against the major currencies. But the spillover into the credit markets was limited, where the pessimism prevalent among Labour Party members was in short supply.
Markit CDS indices continued to rally this week, outperforming the equivalent benchmark equity indices. Both the Markit iTraxx Europe index and the Markit CDX IG index have tightened to levels last seen prior to the Lehman Brothers default (some of this can be explained by the effects of the last roll). The European index is threatening to go below 100bp, though it will probably meet resistance at this level. Investors, unlike UK politicians, are focusing on the economy. Leading indicators provided further evidence that the world’s largest economies could return to growth this year. Markit PMI surveys published this week were consistent with the view that the recessions in the UK and other major European countries are drawing to a close.
Official economic data has also had an impact. The US non-farm payrolls report for May, released today, showed 345,000 jobs were lost over the month. Though a large number, it was significantly better than the 525,000 consensus estimate and an improvement from the 504,000 (revised) lost in April. Manufacturing continued to bear the brunt of job losses, a trend that is likely to continue. The “white-collar recession” -forecast by vocal sections of the commentariat – never materialised and appears more ludicrous by the day. The restructuring of the US car industry in the coming months will only accentuate the trend.
In fact, the jobs report was mixed than the headline figure implied. The unemployment rate rose to 9.4%, its highest rate for 26 years. The figure was higher than expected and served as a reminder that the economy is still contracting. There are signs that consumer sentiment is improving but rising unemployment and tight credit conditions are hardly the conditions for a spending spree. Short investors, feeling the pain of the recent rally, will be hoping that a plethora of bad news – perhaps emerging from eastern Europe – will reverse the tide.