Monday, April 23, 2007

. FT Alphaville: "Moody's blames globalisation for tight credit spreads".

The Financial Times' Alphaville Blog, always a must-read, reviews the paper "Why Is Credit Risk Priced So Low? A Perspective on Global Liquidity", by Moody's economist Pierre Cailleteau (*). According to the review, “the paper dismisses the global liquidity explanation as somewhat circular, saying 'the fact that the demand for financial assets increases at a higher pace than the supply is more a symptom than a cause.'” Instead, says Moody's, investors ought to ask why the expected risk-adjusted returns on financial investments are perceived to be higher than the funding cost, even as the major world central banks have tightened interest rates.

“The answer”, adds Alphaville, “rests with the assymetrical nature of globalisation. In Moody's words, 'The core of the explanation lies in the interaction between the deepening of financial integration on the one hand, and differences in the financial completeness of world economies on the other.'” (Our Global Dollar Liquidity Measure, by the way, tries to capture just that). The reviewer then asks: What could go wrong? According to Cailleteau, there are three key risks out there: (a) An adverse surprise on inflation; (b) A sharp decline in oil prices; (c) A dramatic change in Asian foreign exchange policies.

(*) Paper presented at a conference on Corporate and Structured Default Research for Basel II and Credit Risk Strategies, London, April 19.