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By Ambrose Evans-Pritchard, Telegraph.co.UK | 19 February 2010
Jitters over Chinese credit tightening and default risks in Greece and Dubai are causing bond vigilantes to batten down the hatches across the world, bringing the most dramatic credit rally for a century to a shuddering halt. The Markit iTraxx Crossover index measuring yields on lower-grade debt has jumped by almost 130 basis points since mid-January to 514, while the main index of investment grade bonds has jumped by a third to 93. "This is the biggest move since the financial crisis in early 2009," said Gavan Nolan, Markit's credit analyst.
"The index is a leading indicator so it is a warning signal. This is being driven by volatility in sovereign debt, with Greece being the biggest issue at the moment but tightening in China could be a bigger negative catalyst in the long-term," he said. The rating agency Moody's said market ructions have led to a "material" rise in borrowing costs over the last month, prompting the cancellation of debt issues by the Dutch energy group New World Resources, Italy's Snai betting group, and the UK's Travelport. Sixteen companies wordwide have pulled debt issues worth a $7.3bn (£4.66bn) since mid-January, including Canada's Bombardier.
Dr Suki Mann, a credit specialist at Societe Generale, said stronger companies should weather any squall but concerns are mounting. "The world has woken up to the real possibility of a double dip. These are nervous times," he said. BusinessEurope, the EU-wide lobby, warned this week of a "very worrying situation" as it becomes harder to raise money at a viable cost, if at all. The group called on the European Central Bank to send a "clear signal" about its collateral policy. Fears of tougher ECB rules are a key factor causing market flight from Greek debt.
The sudden halt in bond issues is disturbing since companies have been relying on capital markets to raise money as an alternative to Europe's fragile banks. The ECB said on Tuesday that 42% of small businesses in the eurozone had reported worsening credit conditions in the second half of last year, despite the emergency stimulus of the authorities. Conditions appear to be deteriorating. Bank loans to companies contracted at an annual rate of 1.9% in November and 2.3% in December.
Consumer credit also fell. The Bundesbank fears that disastrous earnings last year will cause scores of German companies to breach loan covenants, triggering a wave of downgrades that further damage German banks and potentially setting off a second wave of the credit crisis. New Basel III rules intended to force banks to raise risk-adjust capital levels may be making matters worse. The rules are causing weaker banks to cut lending, throwing the 'credit multiplier' into reverse.
Andrew Sheets, a credit expert at Morgan Stanley, said corporate bond spreads have not spiked as far as Greek or southern European sovereign yields, so they may rise higher as the price of risk comes back into alignment. "What's changed over the last two weeks is that valuations have become too rich compared to broader sovereigns," he said. Credit rallied far ahead of stocks last year, creating the chance of an "equity carry trade". Dividend yields on Telefonica are 8.2% while yields on the company's five-year debt are 3.8%, comparable to Spanish state debt. Likewise for France Telecom at 8.5% against 3.3%.
This is an extreme aberration by historical standards. Either equity prices must rise a long way, or credit spreads must widen.
Normxxx
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