Are The Credit Markets Getting Unstable?

I (and a few Wall Street spread traders) were blown away with the announcement by the Fed that they were shelving the Maiden Lane asset sales. This deal has been on the table for a long time. The reason given was “market conditions”. It turns out that the Fed was right. The credit market stinks. The question is, “What does that mean”?

This chart tells the story of why the Fed pulled the plug. This tracks securities that are comparable to those that the Fed had up for sale.

Note that this basket of assets has been on a downward tear all year long. The only price bounce came yesterday. That was “smart” guys getting short the index knowing that the Fed was going to be a seller of like paper. After the Fed announcement there was a rush to the exits by the shorts. That blip means very little. The big picture shows a sharply deteriorating trend.




Is this a phenomenon that just hit the Maiden Lane swill? No. This chart looks at AA collateral. The time frame is extended for perspective. It is clear that the last four months has been mostly to the downside for this asset class.


S&P commented on this as well. They look at “Repricings” as a measure of the health of the market. This tracks the amount of deals that can be refinanced to achieve a savings. S&P had this to say about the results:

Investors, empowered by the eroding technical situation, just said no to a lot more requests. The data speak for themselves:



So where is the pressure on spreads coming from? Is it because of excess supply? No, not the case. Consider Munis:



Second quarter global debt activity totaled US$1.3 trillion, a 21% decrease from the first quarter of this year.


The 2nd quarter saw the first consecutive quarterly decline since the second quarter of 2010, with just over US$100 billion in high yield new issues. High yield activity in June 2011 totaled US$15.5 billion, a decrease of 69% from May 2011.

The Wall Street Journal had this to say recently:

Bonds backed by subprime home loans and commercial real-estate debt plunged 20% to 25% in a span of a few weeks, erasing a whole year’s worth of price gains.


“Risk tolerance has changed on Wall Street”

Just a final word on global spreads. There are at least a ½ dozen major countries that are shut out of the debt market today. Greece, of course, is on top of that growing list.

OK. When you put this together you have to conclude that there is a problem in credit land. My thoughts:

*This precisely what QE2 was supposed to address. Bernanke and all of his cohorts have said a dozen times that “spread compression” was a principal objective of the LSAP program. The theory was that if spreads declined it would encourage borrowing.

Let’s be real clear. The fact that the Fed junked the Maiden Lane sale on June, 30 is the smoking gun evidence that the policy of QE was a miserable failure.

*IMHO debt creation is a necessary condition for economic growth. AAA sovereigns and very high-grade corporate names still have an open market for debt capital. But the window is closing for everyone else. Where does that take us?

*The short-term US calendar looks terrible. Sometime in about a month Treasury is coming to market with very big wad of paper. They will have to fund the deficit and all of the catch-up borrowing they have missed over six weeks. The second half of the year MUST bring us a very substantial new issuance of Munis. The fall will be where the rubber meets the road. (That also may be the time where Meredith Whitney gets back her mojo.)

*There ain’t going to be no QE/POMO/flip-em to the Fed stuff. At least not for the next six months. That’s more of that ‘rubber meeting the road’ stuff to look forward to.

*I’m happy to see that some of the “white spats” boys got their fingers burned by shorting the ABX in front of the Fed. Some of them must have had a miserable afternoon and evening. That’s nothing. Think of this type of front running that goes on in EVERY Treasury auction. The “rake” that the street takes is much smaller than on the Maiden Lane deal. But there are so many more zeros involved. The street takes a bite out of $3 trillion a year. Yes, sometimes they get hit for their efforts. But the business of funding the government is a cash cow for those who play in this space.

*On the other hand, this business of widening spreads and declining assets is the very worst thing that could happen to a banker. What’s that say about the financials?

*I’m looking at a tale of two tapes. Stocks are saying the future is bright. Credit spreads are saying the exact opposite. One thing for sure. One side is wrong. The only question is, “Which one?

*In the past week the 10-year interest rate increased by 12%. That is a monster change. This equates to 2,000 Dow points or 240 on the S&P.


Yes, it was not so long ago that the Bond had a 3.20 handle. And yes, the Euro story drove the big change in yields. So no big deal.

I disagree. This is a very significant ramp in volatility. I might even call it unstable. I wonder what the second half will give us given the price action in bonds.

To those who live in this nutty country, a happy 4th. To those who don’t, have a nice weekend. Rest up. I sense that fast markets are ahead.


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