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CDS report: “potentially the worst economic outlook we’ve had since the Depression”
October 21 2008

Once again credit markets are signalling not all is well, despite rallying equity markets in Europe on Monday.

The disconnect is being driven by a continuing wave of deleveraging, with investors seeing companies needing to raise cash and sell assets adding to existing concerns about corporate credit quality over the next year. And moreover that there will not be enough demand to support corporate bond issuance.

“Credit is underperforming equities because creditors fear supply of new bond issues may exceed demand,” said Willem Sels, head of credit strategy at Dresdner Kleinwort.

These factors pushed the Markit iTraxx Crossover index of junk rated borrowers’ credit default swaps to new record wides. At 1130 GMT it posted a new wide of 783 basis points according to one trader. Markit had a closing level of 760.4bp Friday amd 779bp at 1133 GMT. “It feels veryweak,” said one credit trader. “High beta names are much wider.”

The LevX index of credit default swaps on risky loans was two points lowerat 83 - implying the market believed that 70 per cent of the constituents of the index would default on their secured loans, said the trader.

Other European credit derivatives indexes are also wider, as were initial indications of pricing on the US investment grade CDS index.

“There does seem to be a consensus emerging that there has been a genuine thawing in the money markets and it does seem that systemic risk has been underwritten by the Governments around the globe (…)So it appears we can mostly move on to how badly the economy is likely to perform in 2009. Over the weekend our economists have sharply lowered their forecast for the Global economy. They now expect a major recession for the world economyover the next year, with growth in industrial countries falling to its lowest since the Great Depression and global growth falling to 1.2%, the lowest since the early 1980s,” said Jim Reid at Deutsche Bank in a note this morning.

Some of the companies seeing the greatest deterioration in credit spreads include Veolia Environnement. The cost of protecting its debt from default rose to 170bp versus a closing level of 134bp according to Markit. The moves came as the French waste management company plunged 21.3 per cent to €18.41 after it cut is outlook for both investment and operating cash flow for 2008 as economic growth slows. The credit checking group Experian saw the cost of protecting its debt from default rise from 101bp from 87 bp Friday, according to Markit. The move follows reports analysts cut their earnings per share estimates on the company.

This week sees US third quarter earnings seasons kick off, “but the real deterioration in the economy is only just beginning so the market is
unlikely to pay disproportionate attention to such backward looking information,” says Reid. ” The focus now will be on how earnings hold up in
light of potentially the worst economic outlook we’ve had since the Depression.”

Source: www.ft.com


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