Credit Market Message: Banking Risk is Rising

One of the lessons learned from the 2008 credit crisis was not to ignore warning signs that emanate from the credit markets. Lately we are watching credit market relationships move in a way that indicates that stress is increasing in the global banking system. One measure that is raising concerns is the rise in interbank lending rates, as measured by the spread between Euribor and Overnight Indexed Swaps (OIS). This measure is higher than it was in 2010, and rising fast.

We have also been following credit default swap pricing on several European and domestic banks. Credit Default Swaps (CDS) are contracts that investors buy to protect against company defaults, and the price of this insurance has been rising quickly, particularly in European banking names like Societe Generale, which was rumored last week to be having short-term funding problems. Some believe that CDS prices are overshooting actual problems, and that the Societe Generale rumor was nonsense.

We can’t be sure that rumors aren’t helping to fuel the fire, but we have learned over a long period of time to respect the message from the credit markets. We’ve already been in de-risking mode at Pinnacle due to our call that a recession is probable, and that we are likely trapped in a bear market rather than a deep correction. The current message from the credit markets just adds another element of risk at an already risky time.