Friday, July 31, 2009

French Credit Musings

Suki Mann, the credit strategist at Societe Generale, wrote in a daily wrap-up yesterday:
The iBoxx cash index has tightened by 52bp this month to B+232bp, helping credit return over 2% in July alone, with subordinated bank debt leading the charge in terms of performance. The stock market jitters earlier this week have passed, the Main index’s flirtation with 100bp was just that and the month will end with the same gusto that has helped credit become the asset class of choice in 2009. There’s been no summer sell-off in stocks - those who sold in May will regret the move; the earnings season is surprising to the upside though year-on-year comparisons remain atrocious, and the macro-economic numbers are much more mixed now than they have been for a while. Whether or not it’s jumping the ahead of the non-trivial potential for an economic double-dip, the equity/credit rally still has room to go. There’s now a lack of supply too, with this week looking to be the first week of zero issuance this year in the euro-denominated IG corporate world which had previously averaged some €7bn per week this year. So the cash credit world remains illiquid, squeezed, frustrated and going tighter through August – albeit at a slower pace now, as market participants exit for their summer vacation. We think the interest will pick up steam through the last week of August and we anticipate a fairly active primary market from September to year-end. The supply dynamic won’t be as strong as in the first 7 months, with almost €200bn issued, but if interest and inflows remain good, credit will continue to offer the requisite performance.
Click on chart to enlarge, courtesy of Nordea Markets.
Credit Strategists at BNP Paribas are flying lower, and focus on exuberance in their "Credit Driver" today:
Risk assets continue to rally strongly, aided and abetted by central bank liquidity, but a bit of exuberance is starting to creep into investor mentality, which raises a few cautionary flags.

The US consumer after enjoying the sugar rush in the spring, provided by government support to household incomes is starting to lose confidence in the recovery story due to rising unemployment, wage deflation, expected rise in taxes from healthcare reform and cap and trade legislation, lack of credit availability, rising energy costs and deteriorating state balances and services.

This week, the Conference Board confidence index
dropped back down from 49.3 to 46.6. The deterioration in the labour index (jobs plentiful - jobs hard to find) was
particularly worrisome, exceeding the level printed in March and the worst level in 17 years, indicating that the unemployment rate is likely to rise sharply again. This
should be no surprise as local governments at all levels are cutting back on employment, wages and hours of employment.

Credit has also begun to price in a very bullish outlook for
the next twelve to eighteen months, with BBB spreads over bunds now reflecting growth of 1% (Chart 3). This is overly bullish in our view and investors should brace for disappointments and volatility over the medium term.

The bottom line is that we are now starting to see a big disconnect between fundamentals and valuations and the over reliance on technicals may come back to haunt investors.

The central bankers have managed to create another minibubble and it would be wise to burst it here, or at a minimum, let some air out.
BNP Paribas has been pointing to the expectations and reality gaps earlier. Watch out!

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