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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.
investment grade to outperform
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
Research,10 Gresham Street,
Lloyds TSB Corporate
London EC2V 7AE,
0207 626 - 1500
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