Too early to say that the worst is over

The financial markets reached a significant milestone yesterday as a key interbank lending rate fell to a record low.

It is one of the most promising signs to date that suggests the worst of the global financial crisis may be over.

The fall in three-month dollar London interbank rates to below 1 per cent for the first time since the indicator was created in the 1980s comes amid growing signs of confidence elsewhere, most notably among equity investors.

The main equity indices have risen 30 per cent or more since they touched lows in early March, with many now officially considered to be bull markets. The investment-grade corporate bond markets have also seen record levels of issuance in the past few months. In the credit default swap market, spreads have tightened, with the European iTraxx Crossover index of mostly junk-rated credits falling from 960 points at the start of April to 792 yesterday.

Yet, for all the recent optimism, it is too early to celebrate. Important parts of the financial system are still not functioning properly.

First, bank lending to companies has fallen dramatically. Syndicated lending fell to $93bn in April compared with $224bn in March, according to Dealogic, the data provider. It is far lower than average monthly levels in 2008, when monthly volumes did not fall below $100bn once.

Second, the securitisation markets are still on the ropes. Only $28bn was raised through securitisation in April. Before the credit crisis hit in early 2007, these markets were raising more than $200bn a month.

Third, the European high-yield bond market remains in a near coma. It has raised a meagre $1.3bn since July 2007. This was a market that had monthly volumes of about $5bn in early 2007.

Even the fall in three-month money market rates only tells part of the story. Three-month lending for dollar, euro and sterling may have touched lows as interest rates have fallen and fiscal stimulus packages start to take effect but lending further out is virtually non-existent.

Don Smith, economist at interdealer broker Icap, said: “In the money markets, you have to remember there is still nowhere near the strength of activity that there was before the credit crisis. It is still a desert for unsecured lending beyond three months.”

Banks simply will not lend further out because of the continuing uncertainty and worries over counterparty risk that have dogged the market since the collapse of Lehman Brothers.

Hans Lorenzen, credit strategist at Citigroup, says: “There is some optimism as some markets have responded positively to the economic data. But we are talking about optimism based on the fact we are not about to suffer a depression. We have shifted from depression to recession. There is still a long way to go before we are out of this.”

The still-anaemic volumes for bank lending, securitisation and European high-yield bonds have serious repercusions for companies, particularly the small and medium-sized corporates that are the life-blood of any economy.

It is now a lot harder for these companies – indeed, impossible for some – to raise money than it was a year ago.

For this reason, many of these institutions will be out of business by the end of the year as they run out money or break covenants that prompt banks to withdraw funding facilities.

By the end of the year, global default rates are expected to rise to record levels – even higher than those recorded during the Great Depression.

This disconnect between strengthening equity and investment-grade bond markets and those credit arenas that remain dead or barely alive raises the question among some analysts over what markets investors should be focusing on.

Gary Jenkins, head of fixed income research at Evolution, says: “Equity markets will always lead the way as equity investors look for any signs of recovery and will trade off it. They tend to move ahead of the economic data. In other words, these markets are looking for signs of stabilisation. At the moment, that means economic data are not deteriorating as badly as they were. But it is still deteriorating.”