Best of the Week
Most Popular
1.Are UK Savings Interest Rates Finally Starting to Rise? Best Cash ISA 2017 - Nadeem_Walayat
2.Inflation Tsunami - Supermarkets, Retail Sector Crisis 2017, EU Suicide and Burning Stocks - Nadeem_Walayat
3.Big Moves in the World Stock Markets - Big Bases - Rambus_Chartology
4.The Next Financial Implosion Is Not Going To Be About The Banks! - Gordon_T_Long
5.Why EU BrExit Single Market Access Hard line is European Union Committing Suicide - Nadeem_Walayat
6.Trump Ramps Up US Military Debt Spending In Preparations for China War - Nadeem_Walayat
7.Watch What Happens When Silver Price Hits $26...  - MoneyMetals
8.Stock Market Fake Risk, Fake Return? Market Crash? - 2nd Mar 17 - Axel_Merk
9.Global Inflation Surges, Central Banks Losing Control and Triggered the Wage Price Spiral? - Nadeem_Walayat
10.Why Gold Will Boom In 2017 - James Burgess
Last 7 days
USD Gold Myriad of Signs - 28th Mar 17
Ominous Social Trends That Will Shape Our Future - 28th Mar 17
Foundation And Empire: Is Donald Trump The Mule? - 28th Mar 17
Top Ten US Dollar Risks - 27th Mar 17
The Popularity of Gambling and Investing Amongst Students - 27th Mar 17
Is Political Betting on the Rise? - 27th Mar 17
US Stock Market Consolidation Time - 27th Mar 17
Russia Crisis - Maps That Signal Growing Instability and Unrest - 27th Mar 17
Goldman Sachs Backing A Copper Boom In 2017 - 27th Mar 17
Foundation – Fall Of The American Galactic Empire - 27th Mar 17
Stock Market More Correction Ahead - 27th Mar 17
US Dollar Inflection Point - 27th Mar 17
Political Week Presurres US Stock Market - 25th Mar 17
London Terror Attack Red Herring, Real Issue is Age of Reason vs Religion - 25th Mar 17
Will Washington Risk WW3 to Block an Emerging EU-Russia Superstate - 25th Mar 17
Unaccountable Military Industrial Complex Is Destroying America and the Rest Of The World Too - 25th Mar 17
Silver Mining Stock Fundamentals - 24th Mar 17
A Walk Down the Dark Road of Bad Government - 24th Mar 17
Is Stock Market Flash Crash Postponed Until Monday? - 24th Mar 17
Stock Market Bubble and Gold - 24th Mar 17
Maps Of Past Empires That Can Tell Us About The Future - 24th Mar 17
SNP Independent Scotland's Destiny With Economic Catastrophe, the English Subsidy - IndyRef2 - 24th Mar 17
Stock Market VIX Cycles Set To Explode March/April 2017 – Part II - 23rd Mar 17
Is Now a Good Time to Invest in the US Housing Market? - 23rd Mar 17
The Stock Market Is a Present-Day Version of Pavlov’s Dog - 23rd Mar 17
US Budget - There’s Almost Nothing Left To Cut - 23rd Mar 17
Stock Market Upward Reversal Or Just Quick Rebound Before Another Leg Down? - 23rd Mar 17
Trends to Look Out For as a Modern-day Landlord - 23rd Mar 17
Here’s Why Interstate Health Insurance Won’t Fix Obamacare / Trumpcare - 23rd Mar 17
China’s Biggest Limitations Determine the Future of East Asia - 23rd Mar 17
This is About So Much More Than Trump and Brexit - 23rd Mar 17
Trump Stock Market Rally Over? 20% Bear Drop By Mid Summer? - 22nd Mar 17
Trump Added $3 Trillion in Wealth to Stock Market Participants - 22nd Mar 17
What's Next for the US Dollar, Gold and Stocks? - 22nd Mar 17
MSM Bond Market Full Nonsense Mode as ‘Trump Trades’ Unwind on Schedule - 22nd Mar 17
Peak Gold – Biggest Gold Story Not Being Reported - 22nd Mar 17
Return of Sovereign France, Europe’s Changing Landscape - 22nd Mar 17
Trump Stocks Bull Market Rolling Over? You Were Warned! - 22nd Mar 17
Stock Market Charts That Scream “This Is It” - Here’s What to Do - 22nd Mar 17
Raising the Minimum Wage Is a Jobs Killing Move - 22nd Mar 17
Potential Bottoming Patterns in Gold and Silver Precious Metals Stocks Complex... - 22nd Mar 17
UK Stagflation, Soaring Inflation CPI 2.3%, RPI 3.2%, Real 4.4% - 21st Mar 17
The Demise of the Gold and Silver Bull Run is Greatly Exaggerated - 21st Mar 17
USD Decline Continues, Pull SPX Down as well? - 21st Mar 17
Trump Watershed Budget - 21st Mar 17
How do Client Acquisition Offers Affect Businesses? - 21st Mar 17
Physical Metals Demand Plus Manipulation Suits Will Break Paper Market - 20th Mar 17
Stock Market Uncertainty Following Interest Rate Increase - Will Uptrend Continue? - 20th Mar 17
Precious Metals : Who’s in Charge ? - 20th Mar 17
Stock Market Correction Continues - 20th Mar 17
Why The Status Quo Is Under Increasing Attack By 'Populist People Power' - 20th Mar 17

Market Oracle FREE Newsletter

Elliott Wave Trading

Credit Crisis Contraction Gaining Positive Traction

Interest-Rates / Credit Crisis 2009 Jan 14, 2009 - 04:58 PM GMT

By: Prieur_du_Plessis

Interest-Rates Diamond Rated - Best Financial Markets Analysis ArticleIn order to gauge the progress being made to unclog credit markets and restore confidence in the world's financial system, I monitor a range of financial spreads and other measures. By perusing these, as summarized in this “Credit Crisis Watch” review, one can ascertain to what extent the various central bank liquidity facilities and capital injections are having the desired effect.


First up is the LIBOR rate. This is the interest rate that banks charge each other for one-month, three-month, six-month and one-year loans. LIBOR is an acronym for “London InterBank Offered Rate” and is the rate charged by London banks. This rate is then published and used as the benchmark for bank rates around the world.

After having peaked on October 10 at 4.82%, the three-month dollar LIBOR rate declined sharply to 1.09%. LIBOR is therefore trading at 84 basis points above the upper band of the Fed's target range - a great improvement, but still steep compared to an average of 12 basis points in the year before the start of the credit crisis in August 2007.

14-jan-1.jpg

Source: StockCharts.com

Importantly, US three-month Treasury Bills have started making their way higher to 0.12% after momentarily trading in negative territory in December as nervous investors were in desperate search of safety.

US three-month Treasury Bill yield

14-jan-2.jpg

Source: The Wall Street Journal

The TED spread (i.e. three-month dollar LIBOR less three-month Treasury Bills) is a measure of perceived credit risk in the economy. This is because T-bills are considered risk-free while LIBOR reflects the credit risk of lending to commercial banks. An increase in the TED spread is a sign that lenders believe the risk of default on interbank loans (also known as counterparty risk) is increasing. On the other hand, when the risk of bank defaults is considered to be decreasing, the TED spread narrows.

Since the TED spread's peak of 4.65% on October 10, the measure has eased to a five-month low 0.97% - well above the 38-point spread it averaged during the twelve months prior to the start of the crisis, but nevertheless a strong move in the right direction.

14-jan-3.jpg

Source: Fullermoney

The difference between the LIBOR rate and the overnight index swap (OIS) rate is another measure of credit market stress.

When the LIBOR-OIS spread increases, it indicates that banks believe the other banks they are lending to have a higher risk of defaulting on the loans, so they charge a higher interest rate to offset that risk. The opposite applies to a narrowing LIBOR-OIS spread.

Similar to the TED spread, the narrowing in the LIBOR-OIS spread since October is also a move in the right direction.

14-jan-4.jpg

Source: Fullermoney

Despite the interbank lending rates having declined from their peaks, banks have significantly curtailed the amount of money they are actually lending. The US Depository Institutions Aggregate Excess Reserves continue their ascent at levels far in excess of the amount that banks need to keep on deposit to meet their reserve requirements (see chart below). This measure indicates that the balance sheets of banks remain under pressure, especially in view of the fact that the value of some assets is not known. As mentioned before, a peak in the Excess Reserves graph should coincide with a turning point in the recovery of banks.

14-jan-5.jpg

Source: Fullermoney

Not illustrated by a chart, the spreads between ten-year Fannie Mae and other Government Sponsored Enterprise (GSE) bonds and ten-year US Treasury Notes have also tightened significantly over the past few weeks.

The national average rates for a US 30-year fixed mortgage yesterday declined to 5.08% from 5.33% a week ago and 6.46% in October last year. However, the rate is still 399 basis points higher than the three-month dollar LIBOR rate. According to Bloomberg , this spread averaged 97 basis points during the 12 months preceding the crisis, indicating that lower rates are not being passed on to consumers.

14-jan-6.jpg

Source: Fullermoney

As far as commercial paper is concerned, the A2/P2 spread measures the difference between A2/P2 (low quality) and AA (high quality) 30-day non-financial commercial paper. The spread has declined markedly to 2.23% from almost 5% at the end of December.

14-jan-7.jpg

Source: Federal Reserve Release - Commercial Paper

Similarly, junk bond yields have also declined, as shown by the Merrill Lynch US High Yield Index. The Index dropped by 22.9% to 1,682 from its record high of 2,182 on December 15. This means the spread between high-yield debt and comparable US Treasuries was 1,682 basis points by the close of business on Tuesday. With the US 10-year Treasury Note yield at 2.32%, high-yield borrowers have to pay 19.12% per year to borrow money for a ten-year period. At these exorbitant rates it is extremely difficult for companies with a less-than-perfect credit status to conduct business profitably.

14-jan-8.jpg

Source: Merrill Lynch Global Index System

The excellent gains of the iBoxx Investment Grade Corporate Bond Fund (LQD) (+25.8%) and High Yield Corporate Bond Fund (HYG) (+23.1%) since their October/November lows, provide more evidence that the credit markets are moving in the right direction. However, from a short-term technical point of view, the rallies seem overdone and pullbacks will not come as a surprise.

14-jan-9.jpg

Source: StockCharts.com

14-jan-10.jpg

Source: StockCharts.com

Another indicator worth monitoring is the Barron's Confidence Index. This Index is calculated by dividing the average yield on high-grade bonds by the average yield on intermediate-grade bonds. The discrepancy between the yields is indicative of investor confidence. There has been an up-tick in the ratio since its all-time low in December, showing bond investors are growing a little more confident and have started opting for more speculative bonds over high-grade bonds.

14-jan-11.jpg

Source: I-Net Bridge

Deutsche Bank reports that the implied default rates on corporate bonds are at an extreme level, but that it is not inconceivable that especially high-yield bonds could see defaults remaining high for long enough to see a cumulative five-year default figure above the 30% to 35% range of the early 1990s and early part of this decade. “… the chances are far higher of such an occurrence than seeing the investment-grade cumulative five-year rate climbing into double digits,” the bank said.

According to Markit , the cost of buying credit insurance for European, Japanese and other Asian companies has shown a further improvement since the previous “ Credit Crisis Watch ” of three weeks ago, as shown by the tighter spreads (expressed in basis points) for the five-year credit derivative indices listed in the table below.

The notable exception has been the US where the CDX Investment Grade Index and the CDX High Yield Index both edged up. The increase of 29 basis points in the High Yield spread means an increased cost of $29,000 (up from $1,233,000 to $1,262,000) to insure $10 million of debt annually over five years.

• CDX (North America, investment-grade) Index: up from 211 to 218
• CDX (North America, high-yield) Index: up from 1,233 to 1,262

• Markit iTraxx Europe Index: down from 181 to 169
• Markit iTraxx Europe Crossover Index: down from 1,008 to 978

• Markit iTraxx Japan Index: down from 295 to 291
• Markit iTraxx Asia ex Japan IG Index: down from 347 to 307
• Markit iTraxx Asia ex Japan HY Index: down from 1,263 to 1,132

The graphs of the CDX indices are shown below, with the red line indicating the spreads easing over the past month.

CDX (North America, investment-grade) Index

14-jan-12.jpg

Source: Markit

CDX (North America, high-yield BB) Index

14-jan-13.jpg

Source: Markit

As far as the outlook for the credit derivative indices are concerned, Markit said: “Optimists have been declaring that all of the bad news has been priced into spreads, and we are set for a lengthy rally. The implausible default rates implied by current spread levels give this theory a measure of support. But the coming weeks are likely to see a torrent of negative news, and it is improbable that the CDS market can continue its stoic resistance. The upcoming US earnings season will be key, as will the progress of Obama's fiscal stimulus package through Congress. We have already seen several defaults this year, and we are sure to see many more in the coming months.”

Lastly, the tables below show some country CDS statistics, again courtesy of Markit . These prices represent the cost per year to insure $10,000 of debt for five years. For example, Italy is in most trouble among the G7 countries with a cost of $155 per year to insure $10,000 of debt.

It is noteworthy that Germany, Japan and France at the moment all have a lower default risk that the US. It now costs $55 per year to insure $10,000 against US default for the next five years. Although this is down from $65 a month ago, the corresponding numbers were $8 early last year and $36 in November. As in the case of the US, UK CDS spreads are also trading close to record levels as unease over the level of national debt takes its toll on their sovereign credit risk.

Not shown in the table, three of the weaker members of the eurozone (Spain, Ireland and Greece) yesterday saw their CDSs come under renewed pressure following negative rating agency action. Spain's spread widened by 13 basis points to 112 basis points, whereas Ireland and Greece are trading at the widest levels of any eurozone member.

14-jan-14.jpg

The past few weeks saw steady progress on the credit front, with the TED spread, LIBOR-OIS spread and GSE mortgage spreads having narrowed markedly since the record highs, although spreads are still elevated compared to pre-crisis levels. More recently, corporate bonds have also seen a strong improvement, but high-yield spreads remain at distressed levels.

Furthermore, the CDX and iTraxx credit derivative indices have mostly shown a solid improvement since the peaks in November. And even US Treasury Bills have started edging up from panic levels.

Action taken by the Fed and other central bank has resulted in ongoing progress being made to fix the broken credit machine. Although the credit markets are gaining some positive traction, interbank lending has not really picked up and the financial system is still fragile. In short, the thawing of the credit markets has a way to go before liquidity starts to move freely and the world's financial system functions normally again. The Fed's Senior Loan Officer Opinion Survey will provide a useful update on credit conditions when it becomes available on February 2.

Did you enjoy this post? If so, click here to subscribe to updates to Investment Postcards from Cape Town by e-mail.

By Dr Prieur du Plessis

Dr Prieur du Plessis is an investment professional with 25 years' experience in investment research and portfolio management.

More than 1200 of his articles on investment-related topics have been published in various regular newspaper, journal and Internet columns (including his blog, Investment Postcards from Cape Town : www.investmentpostcards.com ). He has also published a book, Financial Basics: Investment.

Prieur is chairman and principal shareholder of South African-based Plexus Asset Management , which he founded in 1995. The group conducts investment management, investment consulting, private equity and real estate activities in South Africa and other African countries.

Plexus is the South African partner of John Mauldin , Dallas-based author of the popular Thoughts from the Frontline newsletter, and also has an exclusive licensing agreement with California-based Research Affiliates for managing and distributing its enhanced Fundamental Index™ methodology in the Pan-African area.

Prieur is 53 years old and live with his wife, television producer and presenter Isabel Verwey, and two children in Cape Town , South Africa . His leisure activities include long-distance running, traveling, reading and motor-cycling.

Copyright © 2009 by Prieur du Plessis - All rights reserved.

Disclaimer: The above is a matter of opinion and is not intended as investment advice. Information and analysis above are derived from sources and utilizing methods believed reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Do your own due diligence.

Prieur du Plessis Archive

© 2005-2016 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

mkin
15 Jan 09, 05:27
Country Default Risk

Very interesting article.

I think this map might be useful too.

http://www.up2maps.net/report/yoiyitsu/World/country_default_risk_by_cds-_december_2008-updated_to_12_january_2009-.html


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife