The worst of the credit crisis is not behind us, warns Willem Sels, head of credit strategy at Dresdner Kleinwort.

He says that while liquidity tensions are easing, the market is entering a second phase of the crisis. Real credit losses are accelerating and many areas of the market have yet to see the worst of the crunch. He says corporate defaults have only just started rising and he expects high yield defaults to accelerate sharply to 7-11% by mid-2009, particularly in the US.

The market, however, is only currently pricing in a 6% rate of default, he estimates. Mr Sels says rising corporate and consumer defaults will lead to real losses in portfolios, leading credit spreads wider, especially for non-financials.

He notes the weakness in the housing market seems to be gathering momentum and could still provide a shock to the economy.

"Even if we get a W-shaped economic recovery, the current mid-cycle credit rally seems overdone," says Mr Sels. "We believe the recent rally has been exacerbated by investors who are "afraid to miss out" or who are too impatient to recognise the lags with which the economy and the profit cycle typically react to shocks."

Bank risk appetite will remain low and lending will therefore remain depressed, leading to a long period of sub-trend GDP growth and weakening corporate profit margins, Mr Sels believes.