Credit resilient against shutdown

The US government might have shut down its government for the first time in nearly 18 years but it was business as usual in the credit markets.

Rather than the spread widening many would expect after such a seismic event, the credit markets staged a modest rally. The Markit CDX.NA.IG index tightened 1.5bps to 80.5bps, while the Markit iTraxx Europe rallied 5.5bps to 99bps. Both indices are now tighter than where they started the week.

The sanguine reaction indicates that the markets expect the shutdown to be short-lived. Neither the Republicans in the House or the Democrats in the Senate have showed any signs of compromise in the resolution debate, but it is possible that opprobrium from the public will force the politicians to reach an agreement.

Negative growth effects from the shutdown - 800,000 government employees have been sent home on unpaid leave - also appear to have been shrugged off. The probability of QE tapering in October seems lower given the political turmoil, and credit markets are always highly sensitive to monetary policy direction.

However, there is still a risk that the impasse could persist and rollover into the debt ceiling debate, which is more important from a credit perspective. One would hope that Congress comes to its senses before this stage is reached, but it cannot be ruled out.

A side-effect of the shutdown is the non-farm payrolls report due on Friday may not be released. The quality of government data, when it finally comes to light, could also be impinged.

The Markit PMIs were published today as scheduled, and they painted a mixed picture of the global economy. China's survey came in below expectations, and the eurozone index was unchanged from the flash estimate. France's 49.8 reading was an improvement from the initial estimate but still just in contraction territory. There are signs of life in the periphery but they are faint and will have to be much stronger before we see any meaningful pickup.

Italy's CDS tightened 7bps to 260bps, meaning they are now tighter than before the resignations from Berlusconi's party. The government's future is in the balance but the markets have faith in the ECB.

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