Outdoor fruit and vegetable market vendors protest in the center of Athens on May 25, 2010 against tax reforms.LOUISA GOULIAMAKI/AFP / Getty Images
They're esoteric credit market risk measures with the weird, alphabet soup names. But if you're wondering where stocks might be heading next, or why markets are beset by such wild turbulence, they're invaluable.
We're talking about such indicators as Libor-OIS spread, the Markit iTraxx Crossover index and CDS levels.
These days, once-obscure indicators that track perceptions of risk in the credit market are what savvy traders and market participants are studying to explain the extreme volatility in markets. Since the onset of the crisis over a possible Greek debt default more than a month ago, these measures of risk have been going haywire, a warning that the global financial system is under stress. None of them are anywhere near the panic levels reached in the aftermath of the Lehman collapse in September, 2008, but they're moving sharply and, more worrisomely, haven't been calmed by Europe's massive $1-trillion (U.S.) rescue package for countries facing default jitters.
One of the most closely watched risk indicators is the Libor-OIS spread, the difference between the three month London interbank offered rate and the overnight index swap rate. Although the name hardly spins easily off the tongue, Libor-OIS essentially tracks the skittishness banks have about defaults in the financial industry. When the spread is rising, it's a sign that banks, which should know a thing or two about their competitors, are growing more leery about lending to them.
"It's something that's more on the radar screen today than in the past," Eric Lascelles, chief Canada macro strategist at TD Securities, says of the Libor related measures of credit market stress.
On Tuesday, Libor-OIS widened to 31.4 basis points from 28.4 basis points the day before, according to Bloomberg, which tracks the measure. (A basis point is 1/100th of a percentage point.) In March, just before the Greek crisis started to worry investors, the spread had been a mere 6 basis points. While the spread hasn't reached the extreme level of 364 basis points attained post-Lehman, having more than quintupled in two months has caught the notice of market participants.
The widening of the spread is a "measure of uncertainty in the banking sector," observes Ron Torrens, managing editor at BCA Research, a Montreal-based independent market research firm. "There is growing concern that there is stress in Europe in the banking sector, much as we had in the U.S. after the Lehman crisis."
Although almost every credit market pro has favourite indicators of risk, Mr. Torrens also is following the yield on ultrasafe 10-year U.S. Treasury notes. Yields, which move inversely to prices, have fallen precipitously since early May from just under 4 per cent to around 3.18 per cent Tuesday, as investors scramble to buy the securities. The yield is "sinking like a stone," Mr. Torrens says, attributing the trend to renewed double dip recession fears, capital flight from Euro investments, and deflation jitters.
Another sign of nervousness in the market is the rising worry about corporate default risk, particularly in bonds with junk or low credit ratings.
One measure of this risk is the Markit iTraxx Crossover index, which covers the cost of credit default swaps on 50 lowly rated European companies. It was trading Tuesday at 642 basis points, up more than 50 per cent from the levels around 400 basis points before the Greek jitters.
Not all the credit market risk measures are flashing warning signs. Mr. Lascelles at TD Securities is noting that yields on Greek government two-year bonds have fallen from 18 per cent during the worst of the crisis to 7 per cent now. Yields on 10-year bonds have also dropped , a sign that fears the country could go broke are diminishing.
Mr. Lascelles says market players are missing the significance of this improvement.
"I do personally think that the market has overdone it," Mr. Lascelles says. "As a result, my feeling is that these other market variables are out to lunch in the sense that they're continuing to deteriorate at a time when frankly they should be improving."