U.S.-Europe Divide Reaches Widest Since February: Credit Markets

U.S.-Europe Divide Reaches Widest Since February
The Bank of England added 50 billion pounds ($78 billion) to its asset-purchase program this month as falling inflation gave policy makers scope to spur an economy struggling to emerge from its second recession since 2009. Photographer: Simon Dawson/Bloomberg

U.S. and European corporate bonds are diverging by the most in five months as demand rises for debt of American borrowers seen insulated from the sovereign crisis.

The difference between relative yields on investment-grade notes from the regions expanded to 30 basis points as of yesterday from this year’s low of 9 on July 5, according to Bank of America Merrill Lynch index data. Company bonds of U.S. borrowers from United Technologies Corp. to Wal-Mart Stores Inc. are returning more than comparable European notes for the fourth month, after underperforming from December through March.

The expanding gap underscores the difference in investors’ outlooks as the International Monetary Fund cuts its global growth forecast for 2013 to 3.9 percent, with the U.S. expected to expand at more than three times the rate of the euro area. Bond buyers seeking a haven from global turmoil are funneling cash toward dollar-denominated debt as yields on Treasuries reach record lows.

“Monetary policy and lack of global growth are forcing the same investors into U.S. corporates as U.S. Treasuries,” Nicholas Pappas, Deutsche Bank AG’s co-head of flow credit trading in North America, wrote in an e-mail. “The rotation into fixed income continues regardless of the rich valuations.”

Risk Avoidance

As Italian banks get downgraded and Spain considers liquidating lenders that aren’t viable, investors are avoiding companies they perceive as most at risk.

“During the second quarter, anything European was tarnished with a very broad brush,” said Jonathan Fine, Goldman Sachs Group Inc.’s head of investment-grade syndicate for the Americas in New York. “While this sentiment has shifted in recent weeks, asset allocators were clearly moving out of European credit risk during the quarter, which has driven wider European risk premia versus similarly rated U.S. corporates.”

Elsewhere in credit markets, the cost of protecting corporate debt from default in the U.S. decreased for a second day, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, dropping 2.3 basis points to a mid-price of 108.9 basis points as of 12:58 p.m. in New York, according to prices compiled by Bloomberg.

The measure typically falls as investor confidence improves and rises as it deteriorates. Credit-default 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.

Rate Swaps

The U.S. two-year interest-rate swap spread, a measure of bond market stress, increased 0.5 basis point to 24 basis points as of 12:58 p.m. in New York. The gauge widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds.

Bonds of Goldman Sachs are the most actively traded dollar-denominated corporate securities by dealers today, with 108 trades of $1 million or more as of 1 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The IMF projects the euro area economy will expand 0.7 percent in 2013, with economies in Italy and Spain contracting for a second consecutive year. That compares with an expected growth rate of 2.3 percent in the U.S. next year.

‘Lagging U.S.’

“European corporate spreads are lagging U.S.-dollar corporate spreads, and within the U.S.-dollar market, European issuers are lagging U.S. issuers,” JPMorgan analysts led by Eric Beinstein in New York wrote in a July 16 note. Debt buyers “are investing in safer U.S. credit despite their longer term worries,” according to the report.

Spreads on U.S. investment-grade corporate bonds have narrowed to 203 basis points compared with 233 basis points for comparable European debt, Bank of America Merrill Lynch index data show. The gap is the widest since Feb. 20. Yields on the U.S. debt reached a record low of 3.1 percent on July 16.

“Spreads on European corporates in both categories continue to be extremely wide versus their U.S. counterparts,” Martin Fridson, global credit strategist at BNP Paribas Investment Partners in New York, wrote in a note distributed yesterday. “The ongoing European sovereign debt crisis is still the main factor underlying these valuations.”

Liquidate Lenders

Spain is negotiating the terms of a 100 billion-euro ($123 billion) European bailout for its banks, which are still reeling from the collapse of the debt-fueled real estate boom in 2008. Bank of Spain Governor Luis Maria Linde said yesterday that the nation may liquidate lenders that aren’t viable as part of its European-financed overhaul of the industry.

UniCredit SpA and Intesa Sanpaolo SpA were among 13 Italian banks that had credit ratings cut this week by Moody’s, which cited the nation’s weakening economy and government finances.

Debt from Europe’s most creditworthy borrowers including Enel SpA, Italy’s biggest utility, has returned 1.77 percent since the end of June, after leaders of the 17 euro countries agreed to ease repayment rules for emergency loans to Spanish banks and relax conditions on potential help for Italy.

That compares with 1.86 percent gains on similarly rated notes in the U.S., Bank of America Merrill Lynch index data show. Bonds of Hartford, Connecticut-based United Technologies, the maker of Pratt & Whitney jet engines, have gained 2.93 percent and debt of Wal-Mart of Bentonville, Arkansas, the world’s largest retailer, has returned 3.36 percent.

Investors are turning to U.S. company debt as a refuge from the turmoil as U.S. Treasury yields plummet to 1.5 percent. Yields fell to a record low of 1.45 percent on June 1.

“Despite the fact that we’ve seen a more synchronized global slowdown in the recent months, the U.S. still remains to be the best place to be in terms of the corporate side,” said Dorian Garay, who manages money for a global investment-grade bond fund at ING Investment Management, which oversaw 322 billion euros as of year-end. “My expectation is that the uncertainty will remain in Europe for some time.”

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