From: US GIO To: Undisclosed recipients:; Subject: Eye on the Market, May 23, 2011: Feast or Famine Date: Mon, 23 May 2011 18:53:14 +0000 Attachments: 05-23-11_-_EOTM_-_Feast_or_Faminen credit_market_update-pcilzip Inline-Images: image001.png; image002.png; image003.png; image004.png; image005.png; image006.png; image007.png Eye on the Market, May 23, 2011 Feast or Famine: an update on public and private credit markets; Why Greece <n Uruguay; Fannie/Freddie post- script Credit markets are schizophrenic things. Instead of holding to an equilibrium that works for both issuers and investors, credit markets often veer back and forth between investor-friendly (after recessions) and issuer-friendly (after yield- chasing by investors). The Fed played a large role this time, as zero interest rates render cash temporarily useless as a store of value, driving even more flows into credit. After the shock in 2008, there was a surge of inflows into high grade and high yield bond funds. High grade spreads are almost back to where they were in the spring of 2007, while high yield spreads are still modestly wider. Last week saw the most high yield issuance on record, as issuers recognize the opportunity. High grade and high yield mutual fund flows 3 month rolling average. USD billions 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 -D.2 -0.4 -0.8 -D.8 2000 2002 2004 2006 2008 2010 Sour e: NOG Data Services. So urce: J.P. Morgan Securities LLC, Ibbotson. Inflows Outflows • High Yield (LHS) High Grade (RHS) `s, High grade and high yield Spreads. 1987-2011 Basis points 5 2,000 Feast 700 4 1,800 600 1,600 3 1,400 500 2 um High Yield(LHS) 400 1,000 1 800 300 o 600 200 400 -1 200 100 -2 0 0 1987 1991 1995 1999 2003 2007 2011 Corporate cash flows and cash balances are at elevated levels, and high yield default rates have plummeted, so we would not characterize credit spreads as being wildly expensive. But there's a risk that th