It may have been a holiday-shortened week, but the winds of volatility picked back up on Friday. After a mostly uneventful week, credit spreads widened on Friday, as the Morningstar Corporate Bond Index expanded 4 basis points to end the week at +185. Credit spreads widened equally among financial and industrial sectors. European credit indices widened slightly more than U.S. corporate credit indexes; however, the European financials widened more than comparable U.S. financial credit spreads. In fact, credit spreads for many European financials are back to the widest levels seen since March 2009.
This is an especially worrying condition. As European banks find it harder and more expensive to borrow, they will contract lending. This contraction would be more detrimental in Europe than it has been in the U.S., as European companies generally use bank financing--as opposed to the capital markets--for a higher proportion of their debt financing. Sovereign contagion risk and its impact on European financials have continued to boost the TED spread, which we have been keeping our eye on as an indication of credit counterparty risk. The TED spread ended last week another 3 basis points wider at 41 basis points.