Bloomberg News

Europe Crisis Pushes Default Swaps to Biggest Rise in 8 Months

May 18, 2012

A gauge of U.S. corporate credit risk is set for the biggest weekly rise since September as Europe’s worsening debt crisis rattles confidence.

The Markit CDX North America Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses on corporate debt or to speculate on creditworthiness, increased 15.2 basis points this week, the most since Sept. 23, to a mid-price of 123.7 basis points at 2:36 p.m. in New York. The gauge has climbed by 0.6 basis point today.

Investors have pushed the gauge higher this month on concern that European leaders may fail to prevent fiscal turmoil from spreading globally, damaging the balance sheet of American corporations. Spreads on high-yield bonds in a Bank of America Merrill Lynch index jumped by 22 basis points to 644 basis points yesterday, the highest level since Feb. 6.

“The increase in sovereign-related volatility during the first few weeks of May is eerily reminiscent of last spring,” Barclays Plc strategists led by Jeffrey Meli and Bradley Rogoff said in a research note today. “We do not believe that markets have priced in enough risk relative to some of the larger macro concerns.”

Spreads on junk bonds had touched a high of 910 basis points in October, Bank of America Merrill Lynch index data show. The catalyst for the rise this week in the extra yield investors demand to hold junk-rated bonds instead of Treasuries was a shift in investor sentiment and the possibility of future outflows, the Barclays analysts wrote in the report.

‘Risk-Off Signals’

The move isn’t likely to spark as severe a selloff as the threats in the market aren’t as great as last year, according toRoger Horn, managing director and head of credit research for the Americas at Societe Generale SA.

“Classic high-yield managers know that and are not going to run away from their holdings,” he said in a telephone interview. “But the high-yield bond market cannot be resistant to other risk-off signals.”

Citigroup Inc. downgraded its view on high-yield debt from neutral to negative last week, citing “full valuations, consistent risk-off signals in other markets and weakening U.S. economic growth.”

Jobless claims in the U.S. held at 370,000, higher than what economists forecast, while the index of U.S. leading indicators unexpectedly fell in April, showing the pace of economic expansion may cool.

Liquidity

The default-swaps index, which typically rises as investor confidence deteriorates, increased by 16 basis points in the week ending Sept. 23. The gauge has gained for 12 straight days this month.

“Liquidity in cash is low compared to the CDX indices,” Barclays credit strategist Shobhit Gupta said in a telephone interview. “The move wider in derivative spreads appears to be driven in part by an increase in hedging activity.”

The swaps contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

To contact the reporter on this story: Sridhar Natarajan in New York at snatarajan15@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net


Tim Cook's Reboot
LIMITED-TIME OFFER SUBSCRIBE NOW
 
blog comments powered by Disqus