Investor concern that a slump in the U.S. housing market is threatening the global economic recovery triggered a surge in the cost of insuring against losses on European bank bonds to the highest level in a month.
The Markit iTraxx Financial Index of credit-default swaps on 25 banks and insurers rose 7.25 basis points to 142, the highest level since July 20, according to JPMorgan Chase & Co. The Markit CDX North America Investment Grade Index of contracts linked to 125 companies in the U.S. and Canada jumped 3.27 basis points to 112.7, according to Markit Group Ltd.
Foreclosures and weak jobs growth are hurting the American housing market with sales of existing homes dropping 27.2 percent in July. Europe is also at risk of sliding back into a recession as governments cut spending to reduce budget deficits, Nobel Prize-winning economist Joseph Stiglitz said today.
“High excess supply, high unemployment and rising delinquencies all make for an explosive mix, powerful enough to tip the U.S. economy back into recession,” said Christian Weber, a Munich-based credit strategist at UniCredit SpA. The conditions could create a “negative feedback loop,” he said.
Previously owned homes make up about 90 percent of the U.S. housing market and sales last month dropped to a 3.83 million annual rate, according to the National Association of Realtors. The pace compares with the median forecast of a 4.65 million rate, according to a Bloomberg News survey.
Governments in the euro area pledged to cut deficits to below the European Union limit of 3 percent of gross domestic product after the Greek crisis earlier this year eroded confidence in the 16-member currency union. While the economy expanded at the fastest pace in four years in the second quarter, the recovery is showing signs of weakening.
Growth in the region’s services and manufacturing industries slowed more than economists forecast in August and German investor confidence slumped to the lowest in 16 months. Moody’s Investors Service said yesterday that “risks to economic growth are clearly to the downside.”
“Cutting back willy-nilly on high-return investments just to make the picture of the deficit look better is really foolish,” Stiglitz told Dublin-based RTE Radio. “Because so many in Europe are focusing on the 3 percent artificial number, which has no reality and is just looking at one side of a balance sheet, Europe is at risk of going into a double-dip.”
The cost of insuring corporate bonds rose to the highest levels in a week, JPMorgan prices show. Contracts on the Markit iTraxx Crossover Index of 50 companies with mostly high-yield credit ratings increased 19 basis points to 518 and the Markit iTraxx Europe Index of 125 companies with investment-grade ratings climbed 5.75 basis points to 117.5.
A basis point on a credit-default swap contract protecting 10 million euros ($12.7 million) of debt from default for five years is equivalent to 1,000 euros a year.
Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. An increase signals deterioration in perceptions of credit quality.