June 21, 2007 is when the financial crisis – which had officially started on February 7 with an announcement by HSBC – hit home for Wall Street, with the news that Bear Stearns had staved off the collapse (not for long) of 2 subprime-focused hedge funds. This is what the NYT wrote that day:
The high-stakes game of brinksmanship began early yesterday on Wall Street, and continued throughout the day. Bankers traded telephone calls, frenetically negotiating the fate of two hedge funds.
All wanted to avoid a fire sale in the troubled mortgage-securities market, but at the same time, not get stuck with an exploding liability that could result in steep losses. The day ended with deals that appeared to have forestalled a meltdown. But questions remained about how successful they were and whether they had merely delayed the inevitable.
It wasn’t until the next day, however, that credit finally started to move, or as Bank of America’s Barnaby Martin writes, “Happy 10yr anniversary – do you remember the great unwind?“
Because it was 10 years ago today, on June-22nd 2007, that credit spreads finally began to widen in what would soon turn out to be the most painful 2 year bear market that corporate bonds had experienced in recent history. And – just like now – Martin notes that before the unwind kicked-in, “high-grade spreads had become tremendously compressed, given the proliferation of CDOs.” Now we have ETFs… oh and central banks of course.
So fast forward to today, and while high-grade spreads are still far from their ’07 tights (106bp vs 46bp), Martin notes in the chart on the left that “high-grade spreads are close to being as compressed as they were 10yrs ago.”
According to the BofA credit strategist, this is a key consequence of the ECB’s Corporate Sector Purchase Program (which as discussed yesterday was used to directly fund over $ 10 billion of Europen corporate issuance in the primary market) in that “eligible” names are now treated as having the “same risk” (because the ECB has shown little in the way of credit differentiation).
The chart on the right highlights this theme in a different way: “it shows the standard deviation of high-grade spreads versus the market spread level. As can be seen, high-grade spreads are much more compressed than they should be given the current spread level” according to BofA.
So is it time for spreads to do what they did exactly 10 years ago and restart the “great unwind.” For now the answer is probably not for the simple reason that there is an record tide of money chasing every last possible drop of yield in a world where central bank buying has forced everyone to the very edges of the risk curve. Here’s Martin:
“Goldilocks” credit technicals remain. Spreads are hugely outperforming equities in June and shrugging-off the drop in commodities. While arguments of complacency in credit are fair, we think they miss the point. What’s key at present is how significant investment-grade inflows have become lately. Inflows have reached record levels which we think highlights the ongoing pressure on retail investors to find quality yield, but perhaps also reflects their skepticism on central banks’ ability to turn hawkish.
For now the answer to what will be this generation’s “Bear Stearns hedge fund moment” that resets the cycle remains unknown.