Ugly feedback loop: Debt fears, stock fears, recession fears
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The vicious circle keeps getting more so.
One catalyst for today’s global stock market rout is soaring fear that many companies and even some governments will default on their debts before this market and economic disaster has run its course.
Those deepening worries are evident in credit default swaps -- essentially, insurance contracts against debt defaults.
As Bloomberg News reports:
The cost of protecting corporate bonds from default surged to a record as a global asset sell-off pushed U.S. stocks lower and sent commodities markets falling. Swaps protecting against a default by companies including Bayer AG, Germany’s largest drugmaker, French automaker PSA Peugeot Citroen and U.S. newspaper publisher New York Times Co., soared to records. ‘The fear is truly palpable among investors we are speaking to this morning,’ Kenneth Hackel, head of fixed-income strategy at RBS Greenwich Capital Markets, said in a note to clients. ‘The non-stop volatility overwhelms any good news on the margin as investors assume the next sharp move is imminent and will be negative.’ The slump has been driven by hedge funds dumping assets amid record losses and investor withdrawals, and concern that governments from Argentina to Pakistan may default in a global recession.
This is the ugly feedback loop: As credit default swap prices rise, expectations of financial calamity surge, which drives stocks lower. And the continuing crash in stock prices threatens to turn a recession into something much worse by destroying consumers’ wealth and their purchasing power. A severe recession, in turn, would assure more debt defaults.
The prices of swaps on General Motors Corp. debt imply a 93% chance of default in the next five years, Bloomberg said, based on JPMorgan Chase & Co. model.
The model assumes credit investors could recover 15 cents on the dollar in a GM failure.
‘They are very bloody figures, a lot weaker than expected,’ Sven Kreitmair, a Munich-based credit analyst at UniCredit SpA, told Bloomberg. ‘It looks very bad.’
GM shares were down 89 cents, or 14.6%, to $5.21 at about 11:30 a.m. PDT. The Dow industrials were down 348 points, or 4%, to 8,342.