Though we do not wish to draw any apocalyptic join-the-dots conclusions, we can now add a significant increase in credit stress within the global banking sector to the lengthening list of investor concerns . For example, since the start of the year the 5y credit default swap premium on Deutsche Bank has doubled to 200bps, Exhibit 1. It would not however be fair to highlight only a single institution; outside the eurozone, bank sector credit in the US and UK has also suffered significant spread widening, Exhibit 2.
In December we noted that US high yield bond and leveraged loan markets were performing poorly and this has continued into 2016, Exhibit 3. In February, the US senior loan officers’ survey showed a continuation of the trend to tighter bank credit conditions for the US corporate sector, Exhibit 4. We would also highlight that in prior cycles (1990, 1998, 2007) there has been a tendency for credit tightening to accelerate once initiated.
Since 2007, credit markets have provided useful early warning of pending trouble in both the economic outlook and equity market declines. The record is not perfect, as exemplified by the false positive in 2012 when policymakers were able to stem the panic arising from the European sovereign debt crisis. But even if firm conclusions at this stage are too early to draw, resolution of this credit stress in the financial sector in our view becomes another item on investors’ to-do list ahead of any calming of global equity markets. As discussed previously, other items on this to-do list might include stabilisation of EPS forecasts, a change of course by the US Fed and possibly a globally coordinated policy to ease upward pressure on the US dollar. But in any case, investors should be aware of and tracking these developments in credit markets.