Movement in many yardsticks within the global credit markets suggest the worst of the credit crisis may be over.
However, not all indicators fully support the notion that the worst may be behind us. Significant increases in government yields have occurred in a number of the major market western markets, including the US, UK and Europe. The fallout from the credit crisis with investors flocking to gilts pushed yields to extremely low levels.
Although banking markets are still jittery, the contagion risk of bank failures has abated. Interest rate cuts in both the US and the UK have probably finished for the time being. Inflation now is on the radar of most of the main central banks. The shift in the yield curve to a traditional long-term basis will be needed to curtail inflation, which now represents a more immediate risk to global economies.
Financial subordinated bond spreads have also fallen back sharply over the last two months, supporting the view that the market sees bank default risk as decreasing. The cost to protect corporate and government bonds from default in the Asia-Pacific region has fallen, and this follows declines in credit-risk benchmark indexes in the US and Europe.
The Markit iTraxx Asia ex-Japan High-Yield Index has dropped to 437 basis points, its lowest level for some time. The Asian benchmark of 50 investment-grade borrowers has declined to 86 basis points.
Citigroup recently reopened Australia's mortgage-backed bond market by offering investors a record high yield margin on A$500m ($470m) of securities. Citigroup priced the debt to yield 145 basis points more than the one-month bank bill swap rate, the company said yesterday in a statement. The bonds have the top AAA credit rating, which is supported by a Citigroup cash reserve of A$25m. The sale breaks a five-month drought in the Australian mortgage-bond industry and shows record-high yields are enticing investors to return to debt markets.
Contracts on the benchmark Markit North America Investment Grade Index of 125 companies in the US and Canada has decreased to 90. In Europe, the benchmark Markit iTraxx Crossover Index has fallen to 424. A decline indicates improvement in the perception of credit quality. A basis point on a credit-default swap contract protecting $10m of debt from default for five years is equivalent to $1,000 a year. However, although the credit market may have improved, the focus of risk has moved to economic growth prospects.
Despite positive indicators, some market players rightly state that financial markets are still not behaving normally. Although costs have come down slightly, financial institutions are still reluctant to lend to each other, with bank borrowing costs still expensive.
Myron Scholes, co-writer of the Merton Scholes Option Pricing Theory, believes we still do not know if the worst of the storm has passed with any new shocks occurring severely hitting the markets.