Credit yields in Europe are moving to record lows, trading at levels not seen since the inception of the euro, while spreads in the credit markets are seeing some widening. Traders at investment bank Société Générale are reporting that non-financial yields of 3% are at their lowest level since the single currency for the European Union launched in 2002. This is compared to around 4.5% to 5% seen before the current crisis. “Yet, spreads are now around 127bp versus 60-80bp in 2007,” said Suki Mann, a credit strategist at the Paris-based bank. “Such low yields pose a growing dilemma since the lower they go, the less it takes to wipe out the performance as breakevens decline. Our reading is that for the remainder of 2010 government yields will stay low and stand a good chance of declining further with cash spreads tightening gently.” According to an August MBS outlook report, Deutsche Bank analysts say the impact of economic crises elsewhere, mainly in Europe, provided some drag on the mortgage finance market. In the note, Steven Abrahams said foreign investors were not highly attracted to the U.S. MBS market, and he expects spreads in MBS to likely continue widening over the next few months. “The raft of reasons: uncertainty about secondary market supply coming out of the Fed portfolio, better Fed demand for Treasuries, headline risk about a government-engineered refinancing of mortgages, a mortgage market on the cusp of sharply rising refinancing volume in lower coupons if primary mortgage rates drop another 25 basis points, and—to top it all off—soft demand from banks and foreign portfolios,” Abrahams said. SocGen’s Mann believes that any new issuance into the European credit markets will not be enough to fulfill demand and some of the idle cash will have to go to secondaries – and this will likely push spreads tighter. “Furthermore, we do not expect a major asset allocation shift out of credit given its safe haven characteristics and its stable returns,” Mann said. “In 2011 the story will be trickier but for now, only a massive shock to the system can derail the positive performance of credit.” Write to Jacob Gaffney.
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