Swaps Outlook Bleakest Since ’09 as Growth Slows: Credit Markets

U.S. Federal Reserve Chairman Ben S. Bernanke
Ben S. Bernanke, chairman of the U.S. Federal Reserve. Photographer: Joshua Roberts/Bloomberg

Investors are the most pessimistic about the outlook for corporate credit in three years as the global economy shows signs of faltering, with euro-area leaders struggling to contain the sovereign-debt crisis and U.S. unemployment stuck above 8 percent for 41 months.

A three-month forecast for a benchmark credit-default swaps index in the U.S. swung negative in July, dropping to -19.1 from 15.2 at the start of April, according a survey by the International Association of Credit Portfolio Managers. The outlook for a European index fell to -30 from -9.8. Negative readings indicate expected deterioration in credit conditions.

Investor confidence in a global recovery is waning five years after a crisis in the U.S. triggered a worldwide economic slowdown. The International Monetary Fund cut its 2013 growth forecast to 3.9 percent as China’s economy grows at the slowest pace in three years as Federal Reserve Chairman Ben S. Bernanke warns that Europe’s financial woes are creating “spillover effects” in the rest of the world.

“The issues in Europe remain unresolved, and there’s increasing signs that it’s having an impact in other geographies,” Som-lok Leung, executive director of IACPM, said in a telephone interview from New York. “In the U.S., the just-muddle-along economy seems to be doing worse than just muddling along.”

Spanish Yields Rise

The collapse of the U.S. subprime market in 2007 prompted the worst financial crisis since the Great Depression and the aftershocks are still being felt worldwide with proposed regulatory changes to increase government controls over the financial system. China’s growth has slowed to the weakest pace since 2009 and Europe, struggling to contain its sovereign debt crisis, is flirting with economic contraction.

Concern that Spain will need a bailout sent 10-year yields on its bonds to a euro-era record this week. As the currency bloc’s policy makers weigh the possibility of funding another rescue, U.S. politicians are grappling with a $607 billion so-called fiscal cliff of automatic spending cuts and tax increases set to take effect next year.

Spain is “the boogeyman in the closet,” Timothy Cox, executive director of debt capital markets at Mizuho Securities USA Inc. in New York, said in a telephone interview. “We still have some work to do in Europe and even in the States, as companies are still not hiring people and still trying to cut meat from the bone to meet earnings targets.”

Rate Swaps

Elsewhere in credit markets, the cost of protecting corporate debt from default in the U.S. declined for a second day, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, decreasing 2.9 basis points to a mid-price of 112.6 basis points as of 11:37 a.m. in New York, according to prices compiled by Bloomberg.

The measure typically falls as investor confidence improves and rises as it deteriorates. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

The U.S. two-year interest-rate swap spread, a measure of bond market stress, increased 0.02 basis point to 21.5 basis points as of 11:37 a.m. in New York. The gauge widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds.

China’s Pace

Bonds of AngloGold Ashanti Ltd. are the most actively traded dollar-denominated corporate securities by dealers today, with 110 trades of $1 million or more as of 11:38 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The mine operator’s $750 million of 5.125 percent, 10-year notes rose 1.4 cents from their issue price yesterday to 100.75 cents on the dollar to yield 5.02 percent as of 11:25 a.m. in New York.

The IMF lowered its 2013 global growth forecast from an April estimate of 4.1 percent as Europe’s debt crisis prolongs a recession in Spain and slows expansions in emerging markets from China to India. The National Bureau of Statistics in Beijing said July 13 that gross domestic product in the world’s second-largest economy expanded 7.6 percent in the second quarter from a year earlier, the weakest pace since the global financial crisis.

“There’s no bright spot,” said Cox of Mizuho Securities. “That’s one of the downsides of a global economy. Everybody is affected by things in Germany and in Asia that in the past we could be a little bit more insulated from.”

Spanish Effects

IACPM’s negative outlook for the Markit CDX North America index released yesterday follows seven straight positive readings. The -19.1 grade is the lowest since the measure plummeted to a -38.1 reading at the end of the second quarter in 2009, according to an e-mailed statement. Pessimism about third-quarter performance on Markit iTraxx Europe index is at the highest since a reading of -57.5 at the end of June 2009.

The industry association derives its index from a quarterly survey of money managers at 84 financial institutions from Frankfurt-based Deutsche Bank to Barclays, Britain’s second-biggest bank by assets. The most recent survey, conducted in the first two weeks of July, reflects forecasted changes from prices as of June 29, according to IACPM’s Leung.

“The biggest thing that happened between when we did the first-quarter survey, which was at the end of March, and the end of June was what was happening in Spain,” Leung said.

‘Looking for More’

Euro-area finance chiefs last week approved a bailout of as much as 100 billion euros ($121.5 billion) for Spanish banks. Spain’s access to financial markets is being crimped by yields that reached as high as 7.751 percent yesterday and rescue requests from as many as seven of the nation’s regions.

“People are looking for more” action from the European Central Bank and currency bloc leaders to stem the fiscal turmoil in Spain, Kathy Jones, a fixed-income strategist in New York for Charles Schwab Corp., which has $1.76 trillion in client assets, said in a telephone interview. “They’re looking for the ECB to come in and support the banking sector. They’re looking for some sort of mutualization of debt. They’re looking for a lot of things that just don’t seem to be on the horizon.”

Europe’s debt woes have helped push U.S. Treasury yields to record lows, touching 1.38 percent yesterday. Bernanke told the Senate Banking Committee in Washington on July 17 that reducing unemployment is likely to be “frustratingly slow” and repeated that the central bank is ready to take further action to boost the recovery, while refraining from pledging any new policies.

‘Unsustainable Path’

Bernanke told lawmakers that U.S. fiscal policies are on an “unsustainable path” that must be corrected with a “credible” plan to control deficits, while avoiding damage to the recovery from spending cuts and tax increases that will take effect next year if Congress doesn’t act.

“People are willing to loan to the U.S. government with all the talk about the fiscal cliff and the political imbroglios,” Bonnie Baha, head of global developed credit at Los Angeles based DoubleLine Capital LP, which oversees $39 billion, said in a telephone interview. “What does that tell you? It’s very worrisome to say the least. I don’t think we’d be at these kinds of rates if Europe were in better shape.”

In June, Fed officials cut their forecast for economic expansion this year, estimating growth of 1.9 percent to 2.4 percent, compared with a previous outlook in April of 2.4 percent to 2.9 percent. Central bank policy makers also said they expect the unemployment rate to average 8 percent to 8.2 percent in the fourth quarter of this year.

Cutting Costs

Slower growth and stubbornly high unemployment has kept corporate hiring depressed and discouraged consumer spending, even as second-quarter earnings point to better than forecast results, said Cox of Mizuho Securities.

“Companies are beating expectations, but I think if you drill down to see where earnings are coming from and how companies are achieving them, is it really because of growth or is it really because of them cutting?” Cox said. “Think about what you’re doing, you’re letting workers go that can no longer buy the goods and services that you might be producing. At some point, that comes back to haunt you.”

In the U.S., company sales rose an average 3.3 percent in the second quarter among 190 members of the S&P 500 index that have reported results for the quarter, the weakest since a decline of 9.6 percent in the third quarter of 2009, Bloomberg data show. While 71.4 percent of reporting companies beat analysts’ estimates on profits, 41.4 percent topped on sales.

“The bottom line is we’re still in the deleveraging cycle, which means slower growth and lower demand and it’s going to take some time,” Jones said.

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