The collapse in subprime mortgages doesn’t pose “any threat to the overall economy,” U.S. Treasury Secretary Henry Paulson said last week. He would, wouldn’t he? He’s hardly going to advocate we all stock up on tinned food and bottled water in our basements.
The tremors from the subprime debacle are vibrating throughout the interconnected web of modern global financial markets. Derivatives, corporate debt, loans and bank stocks are all getting trashed. Here are five reasons to expect the turmoil to worsen.
Don’t Bet on Helicopter Ben . . .
A week ago, traders in the futures and options markets were pricing the chances of December interest-rate cuts from the U.S. Federal Reserve at about 21 percent. Prices now suggest a 47 percent chance that Fed Chairman Ben Bernanke will sanction lower borrowing costs to rescue the mortgage market, based on July 26 closing levels.
The rapid turnaround in interest-rate expectations shows the financial community is far from convinced that the wider economy is immune from the woes afflicting particular pockets of the bond and credit markets.
Is Helicopter Ben, as he was dubbed early in his monetary- policy career, really going to fly over the global financial markets and shower investors with dollar bills in the form of cheaper money? Even a hint that the Fed might be planning a rescue would be a signal that the outlook is bleaker than officials have admitted so far.
That hasn’t prevented the iTraxx Crossover index, a barometer of creditworthiness for 50 European companies, from surging to as high as 440 basis points last week, up from about 260 basis points two weeks ago and a low for the year of 170 in February. The higher the index, the less confident investors are about the outlook for corporate bonds.
Once fear grips a leveraged market, the so-called credit fundamentals aren’t worth the paper you print your spreadsheets on. The yield on the benchmark 10-year U.S. Treasury note has declined to about 4.8 percent from as high as 5.3 percent seven weeks ago, as investors seek the warm, comforting embrace of the U.S. debt market.
“While the fundamentals, such as global growth and corporate balance sheets, are at their best for arguably decades, the technicals are as bad as we’ve ever known them and arguably the worst in the era of leveraged finance,” Jim Reid, a London- based credit strategist at Deutsche Bank AG, said in a research note last week. “Never has so much money been thrown at and been levered up in credit and never has there been such a liquid derivatives market to hedge risk.”