Short View: No reason for optimism

By John Authers

Published: January 5 2009 18:47 | Last updated: January 5 2009 18:47

Is the post-Lehman crisis in financial markets almost over? It is tempting to say yes.

The bankruptcy of Lehman Brothers in mid-September led to an immediate spike in equity volatility and in the cost of high-grade corporate credit. The CBOE Vix index of fear of volatility in the S&P 500 index shot from 25 just before Lehman’s collapse to a high of 79. It has now crept back below 40 – a symptom at least of returning calm.

In credit, the Moody’s index of yields on BAA-rated investment grade corporate bonds went from 7 per cent before Lehman to more than 9.5 per cent. It has now dropped below 8 per cent.

Both were symptoms of the rush by investors to pay down debts and get out of relatively risky positions. Both suggest that the virtual zero interest rates from the Federal Reserve are bringing relative normality closer. Further, the Japanese yen, which strengthens when investors are anxious, has fallen significantly in the last weeks.

But the cause for optimism is limited. Financial markets may almost have stabilised after the Lehman shock. But we do not yet know the full economic effects of that market crisis.

The year’s first new data, the US ISM survey of purchasing managers, gives no reason for optimism. It showed the lowest level of new orders ever, in a survey that started in 1948, while deflation in prices was the worst since 1949.

 

And while the Fed has cut the price of credit for companies and consumers, distrust in the markets is as high as ever. Investment-grade bond yields have fallen 1.5 percentage points from their highs; but their extra yield compared with long-dated government bonds, a measure of the extra risk seen by investors, has fallen only slightly, from 5.68 per cent to about 5.4 per cent. Before Lehman, it was below 3 per cent. Even if the Lehman crisis is almost over, the market is braced for a new crisis, of rising defaults.

Copyright The Financial Times Limited 2009

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