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Credit Insights

Market Pins Hopes on New European Policy Initiatives

Despite official denials, we've suspected for a while that policymakers have been working on a Plan B to allow Greece to fail while supporting the short-term funding markets.

Credit spreads continued to widen last week as investor concerns ranging from systemic risk emanating from Europe to a possible double-dip recession in the United States took their toll on the market. However, the greatest losses occurred after the Federal Reserve released its statement and the yields on Treasury bonds dropped precipitously. Interestingly, all-in corporate yields were close to unchanged as credit spread widening closely matched the tightening in longer-dated Treasury bonds. It appears that investors either have all-in yield targets that they refuse to budge from or that the credit market does not believe that underlying interest rates will stay near their lows for very long.

The Morningstar Corporate Bond Index widened 18 basis points to +243; however, that spread could easily be higher or lower by a few basis points. This was the second-largest weekly change since May 2010, when the sovereign debt crisis first reared its ugly head (38 basis points of widening at the beginning of August was the largest). Traders struggled to discern accurate trading levels as spreads gapped out, often on little to no volume. Trading was especially sloppy on Thursday. Lowball bids were hit, but then as several of the trades were reported, the bid on the follow was higher as investors looked to purchase paper on the cheap. On Friday, the markets were apparently buoyed by rumors that European policymakers would speed up plans to address the sovereign overhang and related solvency concerns for European banks. If the markets trade up on these rumors and nothing is substantiated in the near term, we fear there could be a quick reversal of those gains.