Junk Bond Spreads Widening: A Canary in the Coal Mine?

[Joanne98]

As readers no doubt know all too well, the market premium versus safer ones contracts in robust times and widens in downturns. And since credit markets typically signal downturns months before the equity markets, junk bonds are one place to look for advance warnings of changes in economic fortunes (albeit with a risk of false positives).

The Financial Times reports (hat tip reader Joe C) that sovereign debt worries are leading investors to exit junk bonds at a particularly rapid clip:

Investors are selling out of “junk” bonds at the fastest rate since September 2005, in the latest indication that concerns over sovereign debt are spreading to other credit markets.

In the week that ended on Wednesday, nearly $1bn was withdrawn from US funds that hold high-yield corporate bonds (junk bonds), according to Lipper FMI – the largest outflow in almost four and a half years.

As a result, the past month has seen the biggest sell-off of US junk bonds since the equity market bottomed out in March 2009, said Martin Fridson, chief executive of Fridson Investment Advisors, which specialises in high-yield bonds.

Spreads – the difference between the yields on junk bonds compared with US Treasury bonds – have widened by more than 100 basis points since January 11, and now stand at about 700 basis points, as measured by the Bank of America Merrill Lynch Index.

Continued>>>>
http://www.nakedcapitalism.com/2010/02/junk-bond-spreads-widening-a-canary-in-the-coal-mine.html

[dkf]

1. Are the junk bonds they are referencing the sovereign debt in particular or

Is it a different class altogether?

Is it fear across the board that is leading to this outcome or a specific domino effect of the most vulnerable cos?

[Joanne98]

2. I think it's across the board.

[dkf]

3. I'm thinking the biggest fear is the trigger of credit default swaps.

Since the market for CDS are still active there must be someone on the line for them. Still there is no transparency that I know of regarding who is vulnerable in the case of default. Where are the regulators on this? Are all the counterparties collateralized properly? Argh I know these are rhetorical questions but I wonder who if anyone has a clue about the stability of the system. Seems to me we are just as vulnerable as ever.

[Joanne98]

4. I wonder if AIG is still taking those. What a nightmare.

[dkf]

5. I found this interesting comment at DKOS..

The derivatives were traded on a one to one (26+ / 0-)

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basis as bonds so there's no additional exposure and the amount Greece took is really small.

The real problem is that GS then turned around and sold CDS's (insurance) on the debt they sold to Greece, and those contracts were then sold to banks in Greece and Spain. Those banks are totally exposed.

Now consider, since Goldman knows both Greece's finances internally and also the private banks exposure, these speculative attacks which make Greece's debts that much more expensive, how do they impact these banks with toxic paper? A call for austerity on Greeks makes them how much more likely to pay back these banks? And was anyone betting against these banks? And when these banks fall--with their huge investments all over the continent, how are Austria, the UK, Germany and Switzerland effected.

This is how a hedge fund can game the situation to its benefit. It does a simple bond-for-bond deal, then sells insurance on the deal, sells insurance on the insurance, and does a momentum run in the credit markets to create panic and fear.

Goldman is the outfit that was frontrunning program trades for momentum plays in the stock market. They were running a dozen ponzi schemes on Wall Street every day.

There are two kinds of people in this world. The kind who divide the world into two kinds of people, and the kind who don't.

by upstate NY on Mon Feb 15, 2010 at 05:25:39 AM PST

< Parent >

http://www.dailykos.com/story/2010/2/15/837165/-Johnson:-Eurozone-May-Ban-Goldman,-Humiliate-Fed-(updated)