Wednesday, September 16, 2009

The "irrational exuberance" of the credit markets

The corporate credit market rally is beginning to look silly. It is "irrational exuberance" at it's best.

The chart below shows speculative grade credit indices for HY bonds, leveraged loans, and emerging market bonds. We are now above the pre-Lehman levels and going higher today with the equity markets. If you invested in a diversified portfolio of HY bonds last summer, you would be up right now!

Companies that nobody would touch a few months are back are issuing paper. Blockbuster ($675 MM 12% notes) and Ford Motor Credit ($1 Billion 5-year notes, yielding as low as 9%) are some of the examples. Investment grade bonds are flying high as well. It's as though 2008 never happened.

All the new government served liquidity is making it's way into the market, chasing assets again. And there is no shortage of liquidity out there. The chart below shows the MZM measure of money supply. This measure includes all the cash instruments that are redeemable at par at any time: demand deposits, money funds, etc.

The risk of course is that at some point soon the Fed will start taking liquidity out, which will force interest rates up. And that can't be good for corporate credit markets in need of refinancing, as maturities loom.

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