On the wake of the news out of Dubai we saw credit spreads widen today as fears over commercial real estate once again crept into the minds of investors.  Tim Backshall at Credit Derivatives Research was kind enough to send us some thoughts along with an excellent chart (see bottom chart).

Spreads (rather unsurprisingly) ended wider from Wednesday’s close as HY broke above 700bps for the first time since Nov 7th and underperformed IG. Volumes were pretty decent for a holiday half-day and while we ended off the wides, having tracked stocks most of the day, the close was generally weak.

Single-name breadth was very negative, at around 10-to-1, but indices underperformed intrinsics in all the major indices. IG saw its widest close since Nov 3rd as sovereign risk was up in pretty much all cases. Our discussion yesterday of SovX and this morning’s look at CRI and GRI, while early, tend to portend some inherent systemic threats undermining the recovery’s shaky foundations at best. CMBS prices fell modestly amid very low volumes today and the weakness in financials (Citi back above 200bps and GS back above 100bps) continue to support our view on Sen-Sub over SovX.

Some perspective shows Aussie 9.3% wider in spread since Wednesday’s close, Asia 5.8% wider in spread, US IG & HY around 4.1%. The dollar strength (and commenst from Japan) as this ‘event’ occurred should provide those momo carry traders with some pause for thought as we suspect that there will be some move back to JPY as the carry currency given its similar low levels of rates and perhaps less chance of systemic devaluation (and today’s comeback in gold prices perhaps signals a bifurcation among those seeking safety of not just buying ‘safe’ dollars, but buying ‘safer’ gold in any panic scenario).

The recent narrowing & (and then) widening in spreads has an alarming correlation with the mortgage resets occurring in the residential market.  Of course, the resets work with a lag in the market because consumers (and banks subsequently) don’t feel the immediate pain of the rate changes, but the implications here are clear.  We are likely in the eye of the storm with regards to commercial and residential real estate and the back half of the storm is likely to be as ferocious as the front half.  As we’ve discussed thoroughly in the past, the majority of commercial and residential resets will hit in 2010 and 2011.  Are we due for another real estate relapse?  At the very least, it looks like tough sledding through 2012….

Source: CDR