LTP Trade Finance IndexÖ - November performance update

The LTP Trade Finance IndexÖ - the independent total return index covering the trade finance asset class - reflected further credit problems in November, driven principally by the slow-motion sovereign default taking place in Argentina. Another sharp hike in Argentine credit spreads - coupled with a slight increase in USD LIBOR - generated a capital loss for the month, the first in 2001. Overall, Trade Finance credit spreads are at their highest for the year.

Argentina's steady economic deterioration has forced Economy Minister Cavallo to offer creditors a 'debt swap' (better described as a unilateral renegotiation of terms). Given the alternative - a barely-veiled threat of outright default on existing sovereign obligations - we regard this action as a default, albeit a reasonably controlled one. Trade debt is not subject to the 'swap', but investor appetite for Argentine risk has more or less evaporated against the background of sovereign insolvency and a liquidity crisis in the banking sector. Looking forward, the Argentines may succeed in browbeating the majority of sovereign creditors into acquiescence on this occasion, but debt renegotiation alone will not guarantee an economic recovery. The swap is an alternative to outright default, but absent a devaluation of the Peso it is not a long term solution to the Argentine debt trap.

Looking more closely at the November Index performance, a slight increase in short term USD interest rates (up by 9 basis points during the calendar month, the market having fully discounted the last Fed cut) combined with a 19 basis point increase in the average credit margin to generate a capital loss for the month. With US interest rates at a cyclical low (and the futures market pricing in an increase) investors will be increasingly reliant upon improvements in the average credit margin in order to generate capital gains in 2002.

The following table breaks down performance between capital appreciation and interest accrual - (note that, because of compounding effects, the constituents may not sum to the total).