Corporate Spreads Show Strain, Swaps Soar, Returns Dwindle: Credit Markets
The failure of European leaders to contain the region’s debt crisis with a bailout of Ireland has driven relative borrowing costs in the global corporate bond market to a 12-week high.
Investors demand an extra 1.77 percentage points in yield to own company bonds instead of government debt, the most since Sept. 8, Bank of America Merrill Lynch index data show. The premium European banks pay in the currency swaps market to borrow in dollars has almost doubled in the past three weeks, reaching the highest level since May yesterday, as the cost to protect against losses on their bonds jumped to a 20-month high before paring the gain today.
Global debt markets are showing signs of strain on concern a sell-off in euro-region bond markets will force leaders to bail out more nations, impose losses on creditors and cause growth to slow. Company bonds lost 1.04 percent in November, the worst performance since falling 4.44 percent in October 2008, Bank of America Merrill Lynch’s Global Broad Market Corporate index shows.
“There’s definitely more fear in the market than we had a couple of weeks ago,” said Eric Stein, a money manager who helps oversee $54.2 billion in fixed-income assets at Eaton Vance Management in Boston. “We need a real sustainable solution. These kind of ad hoc Band-Aid measures aren’t really going to do anything to help Europe over the long term and investors are more and more realizing that.”
While the credit markets have weakened, it’s not as pervasive as in May, when the combination of a potential default by Greece, the end of a Federal Reserve debt-buying program, the biggest offshore oil spill in U.S. history and a government investigation of Goldman Sachs Group Inc. triggered the largest jump in spreads since the financial crisis of 2008.
“It’s completely different from what we saw in May,” said Jason Quinn, co-head of U.S. high-grade trading at Barclays Capital in New York. “That could change pretty quickly. Our market is going to lose more and more confidence each day that they feel the situation is worsening.”
Elsewhere in credit markets, the cost to protect U.S. corporate bonds from default fell from a six-week high. The Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, decreased 4.7 basis points to a mid-price of 94.66 as of 12:06 p.m. in New York, according to index administrator Markit Group Ltd.
The index, which falls as investor confidence improves and rises as it deteriorates, ended yesterday at 99.4 basis points, the highest since Oct. 19. Credit swaps 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.
Citigroup Inc. plans to sell $1.875 billion of five-year notes as soon as today, according to a person familiar with the offering. The transaction is a remarketing of 6.7 percent junior subordinated debt due in March 2042, said the person, who declined to be identified because terms aren’t set.
Freddie Mac, the government-supported mortgage company, sold $4 billion of two-year debt. The reference notes yield 0.69 percent, or 17 basis points more than similar-maturity Treasuries, the McLean, Virginia-based company said today in an e-mailed statement.
Last month’s loss in corporate bonds was the first since they fell 0.4 percent in May, and trims this year’s gain to 8.01 percent, according to the Bank of America Merrill Lynch Global Broad Market Corporate index. Average yields rose to 3.734 percent, the highest since Aug. 2, the index shows.
Europe’s debt crisis is beginning to distract U.S. investors from signs that an economic recovery is gaining traction and from a plan by the Fed to buy $600 billion of Treasuries through June to support financial markets. U.S. investment-grade bonds lost 0.86 percent last month, trimming this year’s gain to 10.6 percent. Bonds rated below investment- grade lost 1.12 percent paring 2010’s rally to 13.2 percent.
Even after European leaders agreed on an 85-billion-euro ($110.5 billion) rescue package for Ireland, investors are focusing on the possibility that larger nations may also need aid. S&P said yesterday it may cut Portugal’s ratings on concern the government has made little progress on boosting growth to offset the fiscal drag from scheduled 2011 budget cuts.
Concern that Spain will fail to close Europe’s third- highest deficit has driven up financing costs for the nation’s lenders. Relative yields on euro-denominated Spanish bank bonds rose 141 basis points to 385 basis points in November -- the biggest monthly jump on record, according to data compiled by Bank of America Corp.
“Stabilizing Spain would go a long way toward creating broader stability and re-instilling confidence in the market,” Quinn of Barclays Capital said.
Credit markets rallied for the first time in a week today after European Central Bank President Jean-Claude Trichet said investors were “tending to underestimate the determination of governments” to solve the crisis.
The Markit iTraxx Crossover Index of credit-default swaps insuring European junk bonds declined 22.7 basis points to 503, after surging to a two-month high yesterday, according to Markit Group Ltd. The Markit iTraxx Financial Index linked to banks’ subordinated bonds dropped 16 basis points to 295.5, after yesterday climbing to the highest since April 2009, JPMorgan Chase & Co. prices show.
Default swaps insuring Belgian bonds dropped 6 basis points to 199, contracts on Ireland fell 40 basis points to 566 and Italian risk declined 29 basis points to 239, according to CMA. Spain decreased 39 basis points to 325 and Portugal dropped 57 basis points to 485. Swaps on all the nations were at record highs yesterday.
Credit-default swaps typically rise as investor confidence deteriorates and fall as it improves. Swaps 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.
Signs of strain are showing up in the interest-rate swaps market. The difference between the rate to exchange floating-for fixed-interest payments for two years and the comparable- maturity Treasury yield, known as the swap spread, widened 3.78 basis points to 27.1 basis points after reaching 30.88 yesterday, the most since July.
Swap spreads are used as a gauge of investor perceptions of credit risk. They serve as benchmarks for investors in many types of debt, including mortgage-backed and auto-loan securities.
“The general theme is that investors are getting more and more concerned about the creditworthiness of European banks, and whenever we’ve seen this throughout the whole financial crisis, we’ve seen pressure in the dollar funding markets,” Eaton Vance’s Stein said in an interview yesterday.
The European crisis also is causing a surge in the premium European banks pay to borrow in dollars in the swaps market. The price of two-year cross-currency basis swaps between euros and dollars reached minus 50.6 basis points yesterday, the largest effective premium for dollar borrowing in swaps since May, according to data compiled by Bloomberg. The gap, which narrowed to minus 46.75 basis points today, has widened from minus 30.3 basis points on Nov. 22.
“People perceive credit risk much higher in European counterparties,” Douglas Borthwick, head of foreign-exchange trading at Stamford, Connecticut-based Faros Trading LLC, said in an interview. The increase in swap rates is “extremely aggressive, and what that means is that essentially over the last three or four days, credit departments have gone around saying we need to adjust your credit with local names,” he said.
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