Bank Default Swaps Heading for Biggest Monthly Rally on ECB Cash

Credit-default swaps insuring bank bonds are heading for their biggest-ever monthly rally after the European Central Bank’s injection of 489 billion euros ($646 billion) of cash.

The Markit iTraxx Financial Index of swaps linked to senior debt of 25 European banks and insurers fell six basis points today to 220, according to JPMorgan Chase & Co. at 3 p.m. in London. The gauge, which started in 2004 and declines as investor confidence improves, dropped 57 basis points so far this month.

The ECB is planning a second longer-term refinancing operation at the end of February and the Financial Times reported today that lenders could request as much as 1 trillion euros of new three-year 1 percent loans. Banks have used the money to buy government bonds yielding more than 2.5 percentage points extra.

“This kind of monetary stimulus is certainly a positive for riskier assets,” said Orlando Green, an analyst at Credit Agricole SA in London. “One of the key drivers is that there’s going to be a huge amount of demand” for ECB loans, he said.

Corporate bonds are providing the best back-to-back monthly gains in more than two years as the surge in central bank lending keeps credit flowing and buoys investor confidence the region’s debt crisis can be contained.

Bond Returns

Debt worldwide returned 4.03 percent from the end of November through Jan. 27, compared with a 4.86 percent gain in all of 2011, according to the Bank of America Merrill Lynch Global Broad Market & High Yield Index. Yields have dropped to a more than five-month low.

Investment-grade company bonds in Europe returned 4.8 percent in the two months through Jan. 27, while junk-rated debt gained 9.5 percent in the same period, according to Bank of America Merrill Lynch index data. Speculative-grade bonds in Europe returned 6.4 percent in January while high-grade debt gained 2.3 percent, data show.

The cost of insuring corporate debt fell today with the Markit iTraxx Crossover Index of credit-default swaps on 50 companies with mostly high-yield credit ratings dropping 13.5 basis points to 621, according to JPMorgan. The gauge is heading for its best month since October. The Markit iTraxx Europe Index of 125 companies with investment-grade ratings was down 3.5 basis points at 143.75.

The Markit iTraxx SovX Western Europe Index of credit- default swaps on 15 governments fell one basis point to 334 basis points.

A basis point on a credit-default swap protecting 10 million euros of debt from default for five years is equivalent to 1,000 euros a year. Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

To contact the reporter on this story: Namitha Jagadeesh in London at njagadeesh@bloomberg.net

To contact the editor responsible for this story: Paul Armstrong at parmstrong10@bloomberg.net

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