The CDR Counterparty Index has risen to levels not seen since the Bear Stearns blowup. (Source:

The selling had to be expected after a 18% rise in the financials (using the Financials Sector Select SPDRs ETF), but analysts warn that various measures of credit stress suggest that fixed-income investors and those involved in overnight lending markets are still seeing things cautiously. It leaves open the possibility that the euphoric late-week rally on the back of earnings from J.P. Morgan Chase & Co. and Wells Fargo may not continue without an attendant improvement in the more pessimistic bond markets.

“It is highly unlikely that reports out of other institutions will be met with the same market jubilation witnessed during the past two sessions,” writes Mike O’Rourke, chief market strategist at BTIG.

Key measures of risk in the banking sector have shown a bit of improvement in the last two days, such as Credit Derivatives Research’s counterparty index, which measures the cost of insurance against default on debt for a basket of 15 financial institutions. That index closed Thursday with an implied cost of $165,200 to insure $10 million in bonds against default for five years, down from $173,800 Tuesday, but still higher than $108,300 a month ago. Tuesday marked the highest level for the index since just after the Bear Stearns debacle.

Meanwhile, the Markit CDX investment-grade index, which also measures the cost of insurance against default for a broader basket of investment-grade bonds, was at $141,000 as of Thursday evening, compared with $117,000 a month ago.

The difference between overnight LIBOR and the expected federal-funds rate remains high, suggesting risk-aversion in the funding markets. (Source: Lehman Brothers)

Analysts at Barclays Research note in morning commentary that “the government’s bailout of Fannie Mae and Freddie Mac is unlikely to be a sufficient catalyst for a sustained rally in credit spreads,” saying that fundamentals, or at least the earnings outlook, has to improve before this index breaks out of the $135,000 to $145,000 range it has been in since mid-June, and for the financial index to continue to rally.

Lastly, the difference between overnight LIBOR and the overnight index swap, a credit-market measure of the expected federal funds rate, still remains very high, at 74.71 percentage point. The OIS was at 2.04% as of this morning, while U.S. LIBOR was fixed at 2.79%.

This ongoing condition is unusual and suggests that “conditions in the money market are severely dislocated,” says Zach Pandl, economist at Lehman Brothers. And although he says it “doesn’t feel like conditions are in that sort of frantic mode, or people are very nervous as they were last year,” he notes that this spread has widened over the past month.