UBS is telling investors to get short credit and to stay short, while Merrill Lynch squarely lays the blame for the whole mess with the Fed’s provision of ‘easy money’.
UBS - US Credit Strategy
Credit markets held in reasonable well yesterday despite a meaningful sell-off in equities. Don’t be fooled by the credit market’s relative outperformance. It suggests a lack of liquidity and limited trading in a market currently in lock-down mode rather than a sense of optimism. Immediate liquidity problems in the interbank and commercial paper market have eased somewhat, but disappointing announcements from Wal-Mart and Home Depot sparked fears that consumer demand would slow in 2H07. The prospect of slower growth combined with tighter credit conditions would not be favourable for credit fundamentals going forward. Many investors are hanging their hat on the hopes that a rate cut by the Fed would “bail out” the market. In our opinion, the Fed will ultimately need to cut rates, but not before things get meaningfully worse. We continue to recommend that investors play credit from the short side. While the prospect of a snapback in spreads is possible, we see too many near-term obstacles to allow an enduring rally in credit spreads. As such, we would use any strength to reset shorts and stay defensively positioned. What started as a Subprime mortgage problem has migrated to an LBO funding problem to a De-leveraging problem to a Liquidity problem. It now appears that the real economy is being hit and we can only assume that rising corporate defaults are the next shoe to drop. Stay short credit.
Barclays Capital - US Daily Credit Anticipator
The subprime mess continues to expand, and yesterday Thornberg Mortgage, which specializes in high-quality jumbo mortgages, reported “sudden and unprecedented” losses in its triple-A securities, and said that liquidity has been a struggle given that banks aren’t providing credit to lenders and that the asset backed and CP markets have effectively shut. Also yesterday, another investment group, this one providing cash management services for commodity brokers and hedge funds, has halted redemptions. Given the volatility in the market, we are likely to continue to see investors trying to withdraw money from troubled funds. With equities in negative territory across the board, the iTraxx indices are weaker this morning, although off their wides of the day. Not surprisingly, the CDX indices are opening somewhat wider as well.
Merrill Lynch - The Credit Monitor
“Easy money” is the root cause of current credit volatility. While mortgage finance, Hedge Funds, LBO’s, Yen-based financing, SIVs/Conduits and CDOs have all been cited as sources of structural leverage they are derivative of the 1% funds rate policy from the early part of this decade. As the Fed began the process of removing excess monetary liquidity, market participants simply manufactured it with financial leverage.
This process was seven years in the making. We doubt it will be unwound in two months time. We caution investors: beware of false recoveries.
The irony is not lost on us: last week’s apparent short-lived recovery in credit spreads was prompted by rising expectations of a 2007 Fed rate cut. Yet, it is the 1% “easy money” Fed Funds rate policy that is the origin of many of the current structural problems in the credit market. A rate cut seems like a curious solution to a problem that was incubated by liquidity. Moreover, the currency outcome could prove troubling. Should credit rally on such an action, it may serve as an opportunity to add new shorts/underweights.