Reuters Edge

Stars align for easing of U.S. credit crunch

NEW YORK (Reuters) - Multiple market signals are leading analysts to bet that the worst credit crisis since the 1930s is easing, as debt markets slowly heal after two years of extreme upheaval.

Traders work on the floor of the New York Stock Exchange March 14, 2008. REUTERS/Brendan McDermid

The return of private investors to markets they had shunned as recently as the first quarter this year, a surge of corporate debt issuance, and the easing of inter-bank lending rates all indicate that financial rescue measures by government are working, analysts said.

Yet while debt markets are on the road to recovery, turning around a battered economy will be a longer haul that’s still fraught with danger, they said.

“The revival of corporate bond issuance and the narrowing of spreads from the peaks are good news,” says Ward McCarthy, managing director with Stone & McCarthy Research Associates, in Princeton, New Jersey.

The bad news however includes “continued poor performance of many financial firms and the persistent reluctance of banks to lend,” especially to homeowners, adding stress to an already strained housing market, said McCarthy.

U.S. house prices are still sliding and foreclosures rising in many places. Federal Reserve Chairman Ben Bernanke has warned the job market may struggle for another two years.

A worsening economy may yet may push corporate bond prices lower. The global credit market rally is likely overdone and due for a pull-back, the June survey of fund managers by the International Association of Credit Portfolio Managers, released on Wednesday, found.

But for now, many gauges of lending market stress are easing.

McCarthy cited the decline in banks using the Federal Reserve’s emergency liquidity facilities as one sign the credit crunch is abating.

The gap between interbank lending rates and those of virtually risk free three-month U.S. Treasury bills, known as the “TED Spread”, has narrowed to near 0.3 percent from about 3.5 percent at the height of fears for the global banking system in October.


“There was pricing of tremendous systemic risk in the marketplace at the beginning of the year,” said Cam Albright, managing director of fixed income for Wilmington Trust’s Investment Management group in Wilmington, Delaware.

“A lot of that has been taken out of the market and that risk has also come down dramatically.”

In a record-breaking six-month surge, riskier, U.S. “junk” bonds returned about 30 percent in the first half of the year.

And though troubled U.S. lender CIT CIT.N may ultimately succumb to bankruptcy, analysts cite bondholders' willingness to provide emergency financing, after the government refused more aid, as a sign private investors are becoming bolder.

“It’s a relief to me that this is mostly a private bailout,” said Jamie Cox, managing partner at financial planning and asset management company Harris Financial Group in Colonial Heights, Virginia. “That is a major turning point in the credit cycle,” he said.

Overall, the rally of high yield and investment grade bonds reflects less dismal-than-expected corporate earnings and a sentiment shift, said Cox. Investors have overcome the fears of a second Great Depression that weighed as recently as the first quarter.

U.S. high yield bond spreads over Treasuries have halved to about 10 percentage points from extremes of nearly 22 percentage points in December. Credit rating agencies have trimmed expectations for the U.S. high yield bond default rate, forecasting a peak at about 13 percent this year, rather than the record 16 percent last seen in 1933.

“There has been this widespread belief we will have this unbelievable number of corporate bankruptcies,” said Cox. “Maybe we will be able to navigate through this without as much carnage as people think,” he said.

Stress in the speculative grade or “junk” bond market has eased for the first time since the credit crisis erupted two years ago, a quarterly indicator by Moody’s Investors Service showed last week.

Unprecedented cash injections into the financial system by central banks and governments have restored a semblance of normalcy to markets. However, that’s only a first step in ending the credit crisis, analysts caution.

“The traditional barometers do register significant improvement from where they were six-to-12 months ago. The most obvious one is Libor rates: you have seen a substantial decline,” said William Sullivan, chief economist at JVB Financial Group in Boca Raton, Florida.

The three-month London Interbank Offered Rate (LIBOR), the leading global benchmark off which short term loans are referenced, has fallen to record lows around 50 basis points, from highs above 480 basis points in early October, shortly after Lehman Brothers collapsed, roiling markets.

However, Sullivan adds: “these improvements in traditional gauges are not being matched by any acceleration of credit to households and businesses (which) remains tight.”

(Dena Aubin contributed to this report)

Reporting by John Parry