Credit Bubble seen BEWARE...

Credit Bubble Seen in Davos as Cohn Warns of Repricing By Christine Harper & Michael J. Moore - Jan 25, 2013 4:31 AM GMT+0530 

Goldman Sachs Group Inc. (GS) President Gary Cohn warned of a potential drop in fixed-income prices as bankers and policy makers in Davos celebrated surging demand for financial assets. Debt markets that have seen junk-bond yields drop to record lows may face a “substantial repricing” if interest rates spike or investors begin pulling money out of fixed income, Cohn, 52, said in an interview yesterday with Bloomberg Television’s Erik Schatzker at the World Economic Forum in Davos, Switzerland. The Spanish government attracted record demand for its 7 billion-euro ($9.4 billion) sale of 10-year bonds this week and Portugal sold five-year debt for the first time in two years. TheStandard & Poor’s 500 Index (SPX) topped 1,500 yesterday for the first time since 2007. “Markets are really giving the sign that progress has been made,” Martin Senn, chief executive officer of Zurich Insurance Group AG, said in an interview after a meeting of bankers and policy makers including Italian Prime Minister Mario Monti and Bank of Canada Governor Mark Carney. Senn said that he and his colleagues have to avoid becoming “complacent.” “I’m not concerned at this point of that because there’s a good awareness of the respective risks,” he said.

Resurgent Markets

For bankers in Davos, the resurgent markets come as a relief after four years of fretting over regulation and fiscal woes in Europe and the U.S. Investors have funneled cash into junk bonds at a record pace as the Federal Reserve holds benchmark interest rates between zero and 0.25 percent and buys back bonds to suppress borrowing costs. Morgan Stanley (MS) CEO James Gorman, whose New York-based firm helped sell Portuguese bonds this week, said in a Jan. 23 Bloomberg TV interview that central banks’ policies of keeping interest rates low aren’t creating asset bubbles. “I’d be hard-pressed to describe this as toppy,” Gorman 54, said. Low interest rates have stoked demand for riskier assets. Yields on dollar-denominated junk bonds dropped to an unprecedented 6.46 percent on Jan. 22, and prices rose to 105.6 cents from as low as 54.8 cents in December 2008, according to Bank of America Merrill Lynch index data.

The declining yields have created a potential for a “bond bubble” that could result in significant losses for debt investors, Fitch Ratings said in a Dec. 19 statement. Oaktree Capital Group LLC’s Howard Marks said in a Jan. 7 memo to clients that the “scramble for return has brought elements of pre-crisis behavior very much back to life.”

Portuguese Debt

Portugal, which is rated junk, sold 2.5 billion euros of five-year bonds through banks, the first offering of that maturity in almost two years. Spain, rated one level above junk by Moody’s Investors Service and S&P, saw demand for its Jan. 22 bond sale that was unmatched in the country’s history, Economy Minister Luis de Guindos said in Brussels that day. Buyers of fixed-income products must be told that “just because it is a bond doesn’t mean that it trades at par,” Cohn said yesterday. “At some point, interest rates will go higher again, and all of the money that has piled into fixed income over the past three years, some of it will come out,” Cohn said. “We will clearly be there to facilitate, we will clearly be there to provide balance sheet and liquidity to our clients, but ultimately, we can’t be the buyer of last resort.”

Cutting Assets

The 13 largest investment banks have announced plans to cut $1.03 trillion in risk-weighted assets, consulting firm McKinsey & Co. said in a Jan. 23 report. Inventory holdings of corporate bonds by top dealers have dropped about 40 percent from two years ago and are less than a quarter of their 2007 peak, according to data compiled by Bloomberg. “A lot of the banks have a new plan of de-risking their balance sheets, getting their risk-weighted assets down to try to improve their equity ratios,” Cohn said. “And I’m not sure that that capital can come back into the market quick enough” if there’s a sell-off, he said.

To contact the reporters on this story: Christine Harper in New York at charper@bloomberg.net; Michael J. Moore in New York at mmoore55@bloomberg.net To contact the editor responsible for this story: David Scheer at dscheer@bloomberg.net

http://www.bloomberg.com/news/2013-01-24/credit-bubble-seen-in-davos-as-cohn-warns-of-repricing.html