Credit market fears dislocation contagion
Some dealers have already suffered from the widening of spreads on the ABX index. Will the problems spread?
The dislocation in ABX – the synthetic index of the 20 most liquid US subprime securitizations – has had a remarkably limited effect on the wider credit sector. Regulators will be pleased that despite a 15 point drop in the past months there are no obvious signs of distress elsewhere.
But there might well be some second-order effects from the belated realization that the US subprime market is in trouble. On these pages Euromoney has highlighted not just how serious the problems are but also the threat that the sector’s weakness poses to both the US economy and the financial system [Have Wall Street banks gone subprime at the wrong time? Euromoney December 2006]. The economic impact will be intrinsically linked to the fortunes of structured finance and these second-order effects might take time to have an impact.
The question in market participants’ minds is: will the dislocation overspill to the credit market? Everyone is searching hard for a link, both from a technical perspective but also from a client perspective. Are reinsurers or mortgage providers CDO-friendly names? Will the credit hedge funds be looking at relative value opportunities between credit and ABX?
There are signs that some credit hedge funds are looking at buying ABX – and who can blame them, the implied spread of 850 basis points for the BBB– sub-index offers incredible value on an historical basis.