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Friday January 11, 2008 - 17:41:25 GMT
Lloyds TSB Financial Markets - www.lloydstsb.com/corporatemarkets

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Credit Market Analysis - Themes for 2008

Credit Market Analysis 11 January 2008

Themes for 2008

The macro backdrop
Tensions in the money markets have eased, helped by coordinated global central bank liquidity injections at the end of 2007, see chart a and table 1. However, uncertainty remains regarding the outlook for the financial sector, especially in the near term, with further announcements of subprime-related losses and writedowns expected and which could adversely affect market sentiment.

The tightening of bank lending standards will result in weaker growth in the broader economy this year. We forecast UK growth to slow to 2.3% this year from 3.1% last year and for corporate insolvency rates to rise. However, insolvency rates will rise only gradually and from a low base, given relatively low levels of interest rates, prospects of further policy easing and continued economic growth, see chart b.

A US recession is a risk, but we believe that the weaker dollar and lower interest rates will support the economy. Instead, the weaker US housing sector will result in a welcome rebalancing of global growth away from the US consumer. In the euro zone, positive economic fundamentals and high inflation will lead to a resumption of ECB policy tightening, once the credit crisis eases, see forecasts in chart c and table 2.

Financials and investment grade to outperform
Corporate credit spreads have widened significantly relative to benchmark in the past half year. Financial spreads, in particular, have increased massively, reflecting the fallout from the US subprime crisis. According to ML indices, sterling financial spreads (relative to risk-free government bonds) have risen to 200bps, compared with 80bps a year earlier, and are higher than during the 1998 Russian default crisis, see chart d.

It would appear that the credit markets have priced in a very gloomy outlook for the financial sector. With increasing signs of money market tensions easing, banks expanding their balance sheets and the possibility of further capital injections by sovereign wealth funds, there is scope for financials to outperform non-financial corporates, especially in the medium term. As for non-financial corporates, spreads relative to benchmark have widened significantly more than econometric models would suggest, as chart e shows. This reflects some decoupling with equity markets last year (the FTSE all-share index actually rose), as chart f shows, as well as market illiquidity and possibly the anticipation of a rise in defaults.

We expect non-financial corporate spreads to remain wide in the early part of 2008, but an easing of the credit crisis and lower interest rates should support the economy and help spreads to narrow again. Nevertheless, with insolvency rates expected to edge higher this year, spreads will remain above long-term averages and investment-grade corporates should outperform high yield (where spreads may widen again in H2 as table 2 shows). Non-cyclicals such as telecoms and utilities should also outperform cyclical sectors.
Hann-Ju Ho, Senior Economist

Economic Research,
Lloyds TSB Corporate
Markets,
10 Gresham Street,
London EC2V 7AE
,
Switchboard:
0207 626 - 1500
www.lloydstsb.com/corporatemarkets

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  • POTENTIAL PRICE RISK: HIGH Tue-- 08:30 GMT GB- CPI top tier confirmation of Inflation.

  • POTENTIAL PRICE RISK: Medium Tue-- 09:00 GMT DE- ZEW Survey second most important German monthly Survey.

  • POTENTIAL PRICE RISK: Medium Tue-- 09:00 GMT EZ- final HICP revision to flash report. Revisions are usually minor.

  • POTENTIAL PRICE RISK: Medium Tue-- 13:15 GMT US- Industrial Production. Top output indicator.



  • POTENTIAL PRICE RISK: Medium Wed-- 12:30 GMT US- Housing Starts and Permits revision to flash report. Useful housing leading indicator.

  • POTENTIAL PRICE RISK: Medium Wed-- 14:30 GMT US- EIA Crude. Top WTI inventory measure.



  • POTENTIAL PRICE RISK: Medium Thu-- 01:30 GMT AU- Employment. Top economic indicator.


  • POTENTIAL PRICE RISK: Medium Thu-- 02:00 GMT CN- GDP. Top economic indicator.


  • POTENTIAL PRICE RISK: HIGH Thu-- 08:30 GMT GB- Retail Sales. Top consumption indicator.


  • POTENTIAL PRICE RISK: Medium Thu-- 12:30 GMT US- Weekly Jobless. Employment Indicator.



John M. Bland, MBA
co-founding Partner, Global-View.com

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