Overview: Markets, Interest & Credit

Overview: Market Economics/Interest Rate Strategy/Credit Portfolio Strategy

By Gizem Kara, Nathalie Fillet, Rajeev Shah— BNP Paribas, Banking | 11 February 2008

The tone in the markets was broadly negative last week. News on rating agencies’ tightening the credit rating review process, further downgrades and concerns over the outlook for monolines continued. In particular, market sentiment was significantly affected by much weaker-than-expected US ISM and eurozone PMI services data. Despite the BoE delivering the expected 25bp cut and ECB using a dovish tone in its press conference, pointing out some significant changes to the assessment of the growth outlook, the situation in equity and credit markets did not show any improvement.

In the money markets, interbank rates continued to moderate in the US and the eurozone over the week, while in the UK, Libor rates ticked slightly higher on Friday. 3m interbank/T-Bill spreads were volatile in the US and the eurozone through the week, mainly following the developments in 3m T-Bill yields. By the end of the week, 3m interbank/T-Bill spreads narrowed in the US and the eurozone helped by the sell off in 3m T-Bill. In the UK, the spread widened further during the week as the 3m T-Bill rallied. BOR/OIS spreads widened in all three markets over the week. Particularly, in the eurozone, the widening at the beginning of the week was driven by ECB’s announcement about plans not to join the Fed TAF auctions in February. (Term Auction Facility— The Federal Reserve intends to conduct biweekly TAF auctions for as long as necessary to address elevated pressures in short-term funding markets. Decisions regarding auctions in March will be announced by Friday, February 29.)

Elsewhere, 2y and 10y rallied in all three markets. Flight-to-quality and expectations of lower interest rates intensified, helping to pull government bond yields lower. Particularly in the eurozone and the UK, 2yr rallied significantly over the week. The 10y-2y differential widened further in all three markets, reaching new highs in this cycle. Swap spreads ticked higher in all three markets during the week, while narrowing significantly in the eurozone on Friday.

The continuous flow of negative news led to a sell off in equity markets globally and fuelled a further worsening of credit market indicators over the week. In the US, ABS benchmark spreads ticked higher and the high yield benchmark spread rose close to its highs in late January. ABX and LCDX indices fell further and CMBX spreads widened. The CDX and iTraxx CDS indices widened significantly, all reaching new highs in the US and the eurozone. Given economic data becoming increasingly negative, equity markets selling off, and poor financial results, there remains upward pressure on spreads.

The continuous deterioration in credit markets was also apparent in the decomposition of BOR/OIS spreads. BOR/OIS spreads broadly ticked higher in all three markets. The decomposition of the spread into liquidity and credit premia shows that the main driver of the widening of BOR/OIS spreads was the rise in credit premia over the week. Credit premia increased significantly in all three markets, while liquidity premium ticked slightly higher (in the eurozone and the UK) or at best were broadly flat (in the US).

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Normxxx    
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