But over preceding days major damage had already been done in the credit markets, serving as a precursor to, or even as a trigger for the latest share market panic.
Let’s review the recent moves in key Markit iTraxx indices.
Though both indices have jumped this week (the iTraxx Europe by 40%, the Crossover by 28% from Friday’s closing levels), they are still well short of the highs recorded early last year. However, it looks as though the bond issuance binge that continued all the way through last month may now have come to an abrupt end, and the more recent credit and corporate bond buyers will now be sitting on sharp losses.
Generally, though, there’s still a perception that recent tensions in certain areas of the credit markets – peripheral Eurozone government markets, for example – aren’t really a concern for investment grade corporate credits, and for those just below investment grade (which the Crossover index represents). This needs to stay the same for credit crunch part two to be averted.
The moves in the iTraxx senior and subordinated financials indices have been far more pronounced than those in the Europe index or the Crossover. The levels of both iTraxx financial indices have more than doubled since January, and the senior financials’ index of CDS spreads is alarmingly close to the peak recorded in March last year. Incidentally, try taking the relevant banks’ share prices back to the levels of March 2009 and you’d see equity indices a whole lot lower, even after yesterday’s sell-off.
What’s behind the rise? Putting it bluntly, it was governments who rode to the rescue of the banks in late 2008 and early 2009, and now the quality of those governments’ own guarantees is under increasingly severe scrutiny. If the bailers out need bailing out themselves, who’s left to pay?
The deterioration of sovereign creditworthiness can be seen most dramatically in the iTraxx SovX Western Europe index, which shows an unweighted average of 15 CDS spreads of Western European governments.
The equal weighting methodology means that the representation of less creditworthy sovereign issuers – Greece, Portugal and Ireland, for example – is overstated from the point of view of their overall economic footprint. Nevertheless, the four-fold rise in the index since its September launch is remarkable.
The linkages between these indices, and between them and other asset markets – for example, equities – are complex, with plenty of unpredictable feedback loops.
But since the start of the credit crisis there has tended to be a clear chain of cause and effect in asset markets, with signals tending to be transmitted from credit to equities. Credit markets have consistently sounded warnings that equity investors ignore at their peril. So as a renewed bout of credit market turbulence – from sovereigns to financials to industrials – seems to be setting in, it looks about time for investors to don their hard hats once again.